Tech Bear Market's Latest Casualty Is Pandemic-Era Convertible Debt

Tech Bear Market’s Latest Casualty Is Pandemic-Era Convertible Debt

(Bloomberg) — The equity-linked debt of some of the pandemic’s darlings has plunged to record lows and is now considered distressed.

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The convertible bonds of Peloton Interactive Inc., Ocado Group Plc, Just Eat Takeaway.com NV are trading between 45 cents to 75 cents on the dollar or euro — levels that are considered distressed territory by debt investors.

It’s a dramatic turnaround from the frothy heights of 2021, when investors were clamoring for fast-growing technology stocks. Companies across the consumer cyclical and tech sectors sold a record $157 shares billion of convertible bonds — debt that can be converted into — in 2020 and 2021.

“This debt was issued when market sentiment was very positive and yields were very low, so there was a real rush to get exposure,” said Pierre-Henri de Monts De Savasse, a portfolio manager at BlueBay Asset Management LLP. “But equities corrected and some of these names were in the tech or tech-like sector with high multiples, so they corrected enormously.”

The bonds from those companies paid little or nothing in the way of interest, so the big attraction for investors was the ability to exchange the securities for stock, assuming the shares rallied enough to surpass the conversion price.

But then the bear market happened, and the stocks are trading at a fraction of their previous highs. When the debt matures, the companies will face two options: find the money to pay back the debt or trigger the conversion, which may cause a massive dilution of existing shareholders.

Peloton Bond

For example, Peloton’s $1 billion zero-coupon bonds convert at about $239 a share. With the stock trading at about $10, investors have no incentive to convert when the bonds mature in February 2026 unless it stages a remarkable recovery.

Investors don’t seem confident this is possible: The bonds trade at 66.5 cents on the dollar, translating to a record high yield of about 11.5%, meaning that refinancing it will prove expensive.

It’s a similar story for Ocado and Just Eat Takeaway, as well as finance companies SoFi Technologies Inc., Zip Co. and Affirm Holdings Inc. They all have zero- or low-coupon convertible bonds trading at 45 cents to 75 cents and yields of 10% and above.

This puts the market in distressed territory, said Andrew Feltus, US-based co-managing director of high yield at Amundi SA. “It’s been since the early 2000s that we’ve seen such a wide spread” between conversion prices and share prices, he said.

Spokespeople for Ocado declined to comment on the convertible bonds while Peloton, SoFi and Affirm didn’t immediately respond to a request for comment.

A spokesperson for Zip said the company “has narrowed its focus in response to a change in external market conditions” and remains engaged with its bond holders to ensure they are aware of “relevant developments.” Just Eat pointed to its March 2 earnings statement, in which it said the company’s debt maturities are “well aligned” with planned improvements in profitability, and that it has a strong cash position.

Investors snapped up tech and consumer cyclical company convertible bonds at a record pace in the pandemic. Issuance reached a record high in 2021 at $79.5 billion, surpassing 2020’s $77.5 billion, according to data compiled by Bloomberg.

The advantage for companies is that investors are usually willing to settle for a lower interest rate, or coupon, in exchange for the option to swap the debt for shares at a future date at a fixed price.

Market Concern

Most of this debt matures between 2024 and 2027, giving the companies time to prepare for this issue, and for market sentiment to shift. But while economists predict that central banks will stop raising interest rates if the global economy slows, market suggests rates won’t be anywhere near the low levels they were in 2020 and 2021.

The stronger companies will be able to mount a recovery or come up with a refinancing program, said Howard Needle, a portfolio manager at Wellesley Asset Management Inc.

“A company like SoFi or Affirm probably has many ways in which they can generate cash, or the stock may appreciate to the point where it looks healthier,” he said. “But there are a host of companies which have their debt trading in the 30s and 40s where there is a genuine market concern.”

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