Another good article regarding Debentures:
Convertible Debentures & Stock Prices
When a company issues a variable conversion
debenture (and usually at a discount to average
trailing price, eg. 80%) they are asking for real
trouble. Whether these debentures are reg s or
not, the holders of these debentures, smell blood
and they sell the shares of the company short
against the block, in this case the block is their
own debenture. This is one of the few cases that
short selling of non margin stock is feasible (by
anyone but a MM), since they sell against their
stock. Now, the stock declines under the wave of
short selling, the debenture they hold can cover
additional shares, thus they sell more short
bringing the price further down in the process. At
some point it makes sense for them to cover or
convert and deliver the shares from the conversion.
All this could be foreseen. The holders of the
debentures do not wait the 40 or 45 days until
conversion to go into action, they start shorting
with the debenture at hand. Lets say the stock is
at 1, they short for each thousand face value of
their debenture 1000 shares (they do not convert,
yet), the stock drops to .5. Now their debenture
can buy 2000 shares but they are short only 1000
shares, so, they go in and short another 1000
shares. Guess what that causes the stock to go to
.25, which now lets them short another 2000
shares, so the shorting volume increases as they
short more.
Finally, they get the wind of some potential good
developments and they start either converting their
shares to stock (and deliver the stock which was
converted at values lower, at least 20% than their
last shorting) or going in and outright buying (with
the money made from the shorting since they got
paid back by the investor every penny of the
money they put to buy the debenture and then
some) the stock to cover their shorts. For them it
is a win-win situation and since the size of the
debenture is very large relative to the normal
demand for the stock, the stock collapses
according to plan.
Credit for post to Zeev Hed
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