Convertible-Bond Issues Could Delay Profits at Internet Firms
March 17, 1999
(c)THE WALL STREET JOURNAL
Heard on the Street
Convertible-Bond Issues Could
Delay Profits at Internet Firms
By GREGORY ZUCKERMAN
Staff Reporter of THE WALL STREET JOURNAL
It may take even longer than you think before your Internet stock starts
turning a meaningful profit.
The unlikely culprit: convertible bonds.
A spate of Internet companies recently issued such bonds, often under the
radar screen of investors. As much as $2.63 billion of "convertibles" --
securities with fixed-income payments, lately around 5%, that investors can
convert into shares of the issuer -- has been sold since November. Look for
more.
For the companies, the issuance provides a boost of needed cash that can be
used to bolster their businesses. So what is the problem?
These convertibles will lead to a flood of new Internet shares, specialists
say, slashing long-awaited earnings of many Internet companies and
threatening to reduce the scarcity of shares that has helped to drive up stock
prices.
"It's clearly an overhang for these stocks because the convertibles weigh on
earnings," says Robert Willens, an accounting expert at Lehman Brothers.
Among the recent converts: At Home, CNET,
Exodus Communications and Beyond.com.
Amazon.com raised $1.2 billion in January in
the biggest convertible sale ever. The
companies wouldn't comment, or didn't return
calls. Today, DoubleClick is planning to raise
$200 million in convertible debt, while Citrix
Systems hopes to raise $300 million.
Of course, investors haven't yet needed to see earnings to make money on
Internet plays. But they have bid up these stocks on the hope that big-time
earnings will materialize down the road. Because these bonds will eventually
convert into shares, they are counted against fully diluted earnings from the
get-go.
The result: The spate of convertible issuance is diluting earnings of those
few Internet companies that can claim earnings, and will reduce the
long-awaited earnings of most other Internet companies. The
convertible-bond issuance of Beyond.com, for example, expands the
company's shares by a huge three million shares, or 11%.
One of the reasons Internet stocks are climbing is because few of these
shares are available to investors, forcing them to bid up prices to get their
hands on them. Convertibles could help to change the equation. When the
convertible bonds are exchanged for stock they will cause an immediate
surge in the float, or number of shares available for trading. The float of
Exodus Communications will jump 53% when the company's bonds convert
into stock.
It typically takes two to three years before investors convert their bonds to
shares, or a company initiates a conversion by redeeming its convertible
bonds. But the timetable is shrinking in the Internet sector. Amazon.com's
deal contained an unusual clause allowing the company to convert the bonds
as soon as the stock trades at $234 for an extended period. Such a
conversion will increase Amazon.com's float about 13%. Amazon.com
closed at $133.8125 in Nasdaq Stock Market trading Tuesday.
More Internet companies are expected to seek similar ways to speed up the
conversion of their bonds into stocks, to avoid paying the fixed-income
payments of the bonds.
Once the bonds are converted, Internet stocks could suffer. That is because
convertible-bond investors generally are hedge funds and conservative stock
and bond buyers, not traditional Internet investors. Some have internal rules
barring them from holding stocks.
As such, they are seen as likely to dump the stocks when a conversion takes
place.
The shares of many convertible-bond issuers tend to lag behind the market,
academics say. According to a research paper completed last month
co-written by Craig Lewis, associate professor at the Owen Graduate
School of Management at Vanderbilt University, shares of companies
issuing convertible bonds rose 56% in the year preceding their bond sale, but
just 9% the year after a sale. Most convertible-bond issuers consistently
underperform the market and their peers for five years following a sale, Mr.
Lewis says.
For their part, Internet companies have good reasons to turn to convertible
bonds. They need capital to grow, but can't turn to the bond markets or
banks without earnings, and a big follow-on stock offering could hurt shares.
"The least amount of dilution that can happen is with a convertible bond
offering, so it's a very attractive option, and the stock market has reacted
positively," says Kevin Ryan, president of DoubleClick.
Some wonder if it will last. "A convertible-bond offering is a signal to the
market that a company needs capital, but can't go to the debt or equity
markets," Mr. Lewis says, "and that its stock will likely underperform both
its own recent history, as well as the market going forward." |
