Maybe not.Sleeper
From: lnkennedy
Wednesday, Mar 17 1999 9:00AM EST
-Preview-
Point-Counterpoint.
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." |
