The Path Function
We believe success for our clients is optimizing the path that begins on the issue date and runs through all the ups and downs to the retirement date.
This perspective took roots beginning in 1982. As we traded convertibles through their entire life cycles, we saw issuers struggled with the challenges of a complex hybrid security that acted like equity one day and debt on another.
Convertible debt cost of capital is a path function, known only at the end date.
Our pattern recognition skills were developed over decades of convertible market activity in arbitrage, underwriting, sales & trading, derivatives, and liability management.
We have been through every market cycle, every bubble and crash, since 1982.
We have traded, underwritten, restructured, or just observed thousands of convertibles over complete life cycles.
Experience has given us an edge in providing advice to our clients.
B. Dyson Capital Advisors seeks to optimize the path for our clients.
In the 1980’s convertible debt always seemed to work out well for issuers and investors.
The market standard convertible was 25 years to maturity and immediately redeemable.
Convertible exchange offers were rare.
As an arbitrage, we exploited the gap between what we thought issuers should do and what they believed they could do.
Our First Equity “Flush”
In 1990, we completed what may have been the first convertible 3a9 debt-for-equity “flush”, for Continental Medical.
We realized there was another arbitrage, acting between issuers and the market.
In 1999, we executed what may have been the first 3a9 flush as agent, rather than as principal, for P-Com, Inc.
Acting as agent allowed us to execute larger transactions for our clients
Changing The Indenture
In 1995, we completed our first public convertible exchange, under 3a9, for OrNda Health Corp.
OrNda wanted to convert all of its convertible to equity but was prohibited by their indenture provisions.
We changed the indenture provisions resulting in 100% conversion.
Advancing The Craft
Public Registered Exchange Offers
In 2000, we raised new capital in a distressed public SEC registered convertible exchange offer, for Read-Rite Corp.
At the closing dinner we learned they had been advised to file for bankruptcy and had thought our proposal was “preposterous and could never work.”
They engaged us “only to go down fighting.”
They introduced us to their spouses as “the team that saved our Company.”
That dinner changed how we viewed the capital structure challenges facing our clients.
We redoubled our efforts. Our public convertible exchange deal volume grew to exceed the next four most active banks, combined.
Maturities and Redemption
By the mid-2000s, 25-year maturity terms were history, replaced by shorter 5-year and 7-year terms.
Immediate soft-call redemptions were nearly extinct, replaced by restrictive non-calls, often for life.
As a direct result, convertible exchange offers became a frequent necessity.
Public exchange transactions were challenging.
Final pricing had to be announced 20 days prior to closing.
It was duck hunting, where you had to aim and fire 20 days prior to the arrival of the ducks.
We needed a better solution.
Private 4a2 Convertible Exchanges
In a 2006 exchange for Kulicke and Soffa Industries, we identified the securities law that allowed us to execute large-scale convertible exchange offers, privately, under 4a2.
Over the next 15 years 4a2 private convertible exchanges became our largest business, primarily at Lazard, where we sole-managed over $10 billion of 4a2 exchanges.
Although the 4a2 convertible private exchange process has become a staple, for us it remains one of many evolving tools we use to implement creative ideas for our clients.
High Yield Debt
Conversion “Grafting” Exchanges
In 2015, after the collapse in oil prices, E&P clients struggled to turn high yield debt overhangs into equity, in large-scale, without share price pressure.
Our solution was to “graft” mandatory conversion features directly into high yield bond indentures.
The high yield debt converts to equity as soon as the share price rises to the mandatory conversion price.
There is no incentive for the market to push share prices down.
We exchanged over $2 billion of high yield bonds in 4a2 private convertible “grafting” transactions.
For one client, we exchanged high yield bonds converting into over 70% of their primary common share count, with their share price rising.
A drawback was all the new shares went to bondholders and diluted shareholders.
We needed a better solution.
Avoiding Shareholder Dilution
The Warrant Dividend
One of our clients, Nabors Industries, asked a simple question:
“Could we reduce leverage, without dilution, by issuing warrants as a dividend to our shareholders, rather than by giving our equity over to our bondholders?”
Our answer was “Yes”.
We advised Nabors on a $550 million dividend of warrants, distributed pro-rata to all shareholders. The warrants are exercisable with cash or with the issuer’s outstanding bonds.
Upon exercise, bonds are retired for equity without dilution to shareholders or share price pressure.
This strategy provides clients with a simple mechanism to retire debt, in what is effectively an inside round with their own shareholders, without coercion or share price pressure.
Derivative Bond Hedges
When They Work
In 2003, we executed our first bond hedge derivative as a capped call for Cypress Semiconductor.
We remained perplexed even as we structured and advised on additional bond hedges.
What exactly made these complex derivatives work so well for issuers, but left so much on the table for investors and counterparties that they clamored to take the other side?
Unwinding bond hedges “gone wrong” taught us.
For certain low growth issuers, they worked.
For others, (especially volatile high growth issuers), they didn’t.
The derivative strategy appeared to work using simple point function cost of capital graphs.
Cost of capital exposure, calculated using the derivative dealer’s own path function hedging and pricing models, is often eye-popping.
The High Premium Convertible Bond
Back to the Future
Questioning bond hedge derivative logic led to an insight.
What would happen if the conversion price on the bond was set at the same high premium as achieved with a derivative?
The answer was the High Premium Convertible Bond.
Everything else being equal, we found investors would buy the High Premium Convertible Bond with higher net proceeds to the issuer, and lower dilution exposure, than achieved with a derivative strategy.
As a bonus for issuers, it was simpler, scalable to a longer maturity, and immediately redeemable.
The High Premium Convertible Bond structure was the missing link back to the 1980s, back to when convertibles always seemed to work out well for everyone.
Testing The Market
A Big Success
We issued a $1 billion 15-year immediately redeemable High Premium Convertible Bond for Micron Technologies. Investors were so eager for yield it priced at a lower credit spread than Micron’s 5-year debt.
The knock is the higher investor yield is presented as a higher cost of capital to issuers in the simple point function cost of capital graphs.
In a path function model, over a complete life cycle, the simplicity and flexibility of the High Premium Convertible minimize realized cost of capital and dilution by what could be an order of magnitude.
The Path to Success
Banks and advisors stress the importance of execution efficiency at the point in time the securities are issued.
Our goal is minimizing the cost of capital over the entire path to retirement.