One weakness of convertible bonds is the uncertainty of outcome for an issuer as the bonds near maturity. A share price close to the conversion price means a company must prepare for conversion or repayment. A surprise repayment could be painful.
Having conducted multiple stabs at liability management over the years, Mexican cement giant Cemex employed a new security to manage potential debt obligations. Long-time partner Citigroup was principal architect of the innovation.
Cemex acted six months ahead of the maturity of its 4.875% convertible bonds in March 2015.
Through a series of induced conversions negotiated with holders earlier in the year, the principal amount of the CBs outstanding had been whittled down from the original US$750m issued to just US$204m by early September.
Still, there was uncertainty for the issuer.
At the time of the offering in September, Cemex’s shares were trading around US$12.50, above the US$11.18 conversion price, but this had not been the case earlier in the year. If the stock held firm, investors would convert into equity; if they dropped, the company would need to come up with cash to meet the maturity.
The simple answer would be to refinance by selling equity or straight debt. However, neither option was available, as the company lacked authorisation to issue more stock and senior loan indentures stipulated that the CBs could only be refinanced with another convertible bond issue – an unattractive option as it could turn out to be entirely unnecessary.
The solution was to sell a convertible bond offering structured as a six-month forward contract. If more than US$100m principal of the 4.875% notes were presented at maturity, then buyers of the units would receive new six-year CBs. If issued, the new bonds would pay five-year swaps (at issue) plus 195bp and convert at the greater of US$11.20, 130% of five-day VWAP or 110% of the closing price at the time of issue. Cemex will cover the cost if less than US$100m is presented, though clearly the outcome is binary with either all the bonds converting or none.
“Innovation tends to come from a problem being posed to you,” said Cristian Gonzalez, a director in the structured equity group at Citigroup, adding that the terms on the new security were negotiated via a wall-crossing exercise. “While this worked for Cemex, a large-cap issuer, under a specific set of circumstances it could be applicable to other forward contingencies, such as an M&A event or maturity of a term loan,” he said.
The financing allows Cemex to prepare for the worst at a monthly payment that equates to just 3% per year, while hoping for the best. When the company’s share price briefly dropped below US$11 in October, that insurance looked an even better investment.
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