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A convertible bond issuance in 2021 was supposed to be rocket fuel for the exercise bike maker Peloton. Another such issuance last month looks more like a life raft. In the three years between these deals, Peloton’s prospects have faded while interest rates have jumped.
The appetite for these instruments that combine a fixed income security with an equity option has picked up again, thanks to the specialist hedge funds that go long and short in the various components to capture pricing inefficiencies and lock in riskless profits.
Chinese companies including Alibaba and JD.com have found huge demand for convertible bonds among US investors this year, raising billions of dollars. Microstrategy, the software company turned cryptocurrency speculator, has sold more than $1bn in convertibles to buy more bitcoin. But Peloton itself may present the most intriguing opportunity.
The terms of the two Peloton convertibles tell the tale of the company and the change in market conditions. In 2021, Peloton shares were trading near an all-time high.
The company raised $1bn in cash by selling just a potential 1.4 per cent of the company shares at a 60 per cent premium to its already inflated stock price. Peloton had so much negotiating clout that the bond component paid no interest to holders, nor was it issued with any original issue discount. The company’s prospects plummeted in 2022 and the share price never came close to ever putting the equity option in the money.
The latest convertible could not be more different. To raise $350mn, Peloton had to pay an annual cash interest rate of 5.5 per cent. The equity option becomes exercisable if the stock trades at just $4.58. The 2021 convertible went in the money at $239 per share. The shares underlying the latest convertible then represent a staggering 17 per cent of Peloton’s total share count.
In other words, Peloton was desperate for cash and if there is even a modest operational turnaround, the new convertible holders will be in line for a windfall. And if not, they will at the very least clip a decent coupon.
A regular leveraged loan or junk bond offering would prove too costly for Peloton. A convertible allows a company to at least sell dilutive equity at a decent premium to current market prices.
Three years ago feels like ancient history. But Peloton hopes that some clever financing can forestall its final chapter.
