* Japan CB issuance through August nearly double year-ago
* Most CBs issued with 20-40 pct premium to current stock
* Companies include conditions to offset dilution risks
By Lisa Twaronite
TOKYO, Aug 29 Convertible bond issuance by
Japanese companies in 2014 nearly doubled from the previous
period, and is on track for a banner year as firms tap a cheap
source of funding and a pause in Japan's recent stock market
rally reduces conversion risks.
Japanese firms issued about $5.0 billion worth of
convertible bonds in the year through August, compared with $2.6
billion issued in the same period a year ago, according to
Thomson Reuters data which showed issuance hit an eight-year
peak in the first half of 2014.
A convertible bond has an embedded option to convert to a
company's shares at a fixed conversion price. The hybrid
fixed-income/equity instrument allows companies to raise funds
without some of the disadvantages of either a straight bond or a
standard share offering. A zero-coupon CB will not increase a
company's debt burden, and high conversion premiums reduce the
chances that a company's shares will take a hit.
Most CBs are issued at a 20 to 40 percent premium to the
level where the stock price is currently trading, according to
In 2013, the Nikkei stock average surged more than
56 percent, riding hopes for Prime Minister Shinzo Abe's
ambitious programme to beat deflation and spark sustainable
growth. But so far, the Nikkei has given back about 5 percent
this year, after an April hike in the national sales tax dragged
Japanese CBs carry a zero coupon, meaning a company faces no
debt servicing costs as it would if it issued a straight bond.
CBs also allow issuers to sidestep the immediate share dilution
of a straight stock offering.
"Practically, you're issuing at a premium from the current
market price. If you do a public offering, it's diluted right
away, but with a CB, investors don't convert into shares right
away, so the impact to the stock price is light compared to
POs," said Shaw Kitahara, director at Daiwa Securities in Tokyo.
"Of course, no matter how high the conversion premium is,
there is no guarantee that the CB will not be converted. There's
always a chance," Kitahara added.
Therefore, some Japanese companies include clauses in their
CBs spelling out further conditions to blunt any potential
impact on their stock price.
Some CBs, including those issued in May by Toray Industries
and Yamada Denki, contain net-share settlement
clauses. If the company's stock price at the bond's maturity is
above the conversion price, it can repay the principal amount in
cash instead of shares, and only give investors shares for the
value above the conversion price.
Such issues usually have an upside "contingent convertible"
or "coco" clause, making conversion "contingent" on set
conditions, such as the share price exceeding a fixed level for
a specified time.
Moreover, some companies, including Toray and Yamada Denki,
which each issued 100 billion yen worth of CBs, used some of the
funds they raised to buy back their own shares, which supported
their share price in the near term.
"The idea of dilution down the road - who cares? If the
stock price goes up by that much, then the company's doing
something well," said Chris McGuire, chief executive and chief
investment officer of Chicago-based Phalanx Capital Management,
a fund primarily focused on Japanese convertible bond arbitrage
and holds about $1 billion of the instruments.
"If the shares don't go up, the company just pays back the
money, after not paying any interest on it. They've just
received a free loan," he said.
McGuire estimates there are about $40 or 50 billion of
Japanese convertibles outstanding, roughly 10 percent of the
global supply of the instruments.
He typically sells away the fixed-income portion of the
convertible through an asset swap, and keeps the equity option.
"Even though it's zero-coupon, based on the credit
worthiness of the company, we can sell away the fixed income to
a counterparty, who then will sell us back an option," said
McGuire. "A Japanese pension fund, or trust fund, or regional
bank that wants yield is happy to buy it."
(1 US dollar = 103.7800 Japanese yen)
(Reporting by Lisa Twaronite; Editing by Simon Cameron-Moore)