Convertible bonds: debt that can become equity
The company borrows cheaply by selling you the right to become a shareholder. The price of that discount is your future dilution.
Understand why a company issues one, and what it costs you as an existing holder.
How Convertible bonds: debt that can become equity works, in one picture
The same argument as the text, as a chain. Each step is what makes the next one possible.
Why the debt is the engine
Put in 30, borrow 70, secure the loan against the company you are buying. A 30% rise in the business doubles your money. The same arithmetic works in reverse, which is why buyouts fail loudly.
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It is a bond with an escape hatch
You lend the company money and receive interest. You also hold the right to convert the loan into shares at a set price. If the shares soar, you convert and participate. If they do not, you are still a lender and you get repaid.
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Which is why the coupon is low
The option has value, so the buyer accepts a lower interest rate in exchange for it. For the company, this is cheap money. That is the entire appeal, and it is real.
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But existing shareholders pay for it, later
If the company succeeds, the bonds convert, new shares appear, and every existing holder's slice shrinks. The cheap borrowing was not free. It was paid for with your equity, contingent on things going well.
Check the fully diluted share count, not the current one. A company with large convertibles outstanding is bigger than it looks.
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And watch who is buying them
Many convertible buyers are not making a bet on the company at all. They buy the bond and short the stock, harvesting the option's volatility. That short pressure is a real, mechanical drag on the share price and has nothing to do with the business.
You can compute the fully diluted share count if every convertible converted.
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The company borrows cheaply by selling you the right to become a shareholder. The price of that discount is your future dilution.
Every one shows its exact method, and the circumstances in which it is wrong. Free, and no account to look.