Warrants and Convertibles

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Warrants and Convertibles
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Some securities firms can offer

• Equity, Debt, Warrant
• Biodelivery Sciences Intl (BDSI) went public on
  June 24, 2002. Rather than a straight equity
  IPO, their issue included
• 1 share of common stock
• The right to purchase an additional share of
  common stock _at_ 6.30. The right expired June 24,
  2007.
• The package (unit) cost 5.25.

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Last trade 2.75 Bid 2.73 Ask 2.78
Last trade .54 Bid .37 Ask .49
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Warrants

• Quite a bit like call options, except new shares
  are created when the warrant is exercised.
• Black-Scholes price for warrant will be too high
• Unit IPO Example
• BDSI sold 2 million units and had 5.15 million
  shares outstanding before the offer.
• They have 7.15 shares outstanding now. If
  warrants are exercised, theyll have 9.15 million
  shares outstanding.
• Call options can be valued w/o considering
  dilution factor, warrants cannot.

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Convertible Bonds

• In 1999, Amazon raised 1.25 billion by selling
  convertible bonds with the following features
• Coupon rate 4.75
• 1000 face value in debt converts at any time to
  6.41 shares
• Effectively, this is like a 1000/6.41 156.01
  dollar conversion price
• Stock price at the time was around 120
• You also have to consider missed interest
  payments and (possibly) dividends

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Value of Amazons convertible
Conversion
Value of Amazons convertibles
Default
Value of Amazons assets
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Convertibles cont.

• Convertibles are a lot like bondcall option
• Except, again, new shares are created
• Bond is forfeited when conversion occurs
• Convertibles are a lot like bondwarrants
• Except they are indivisible and cannot trade (or
  be issued) separately
• Bond is forfeited when conversion occurs

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Reasons for warrants and convertibles

• Bogus Cheap debt or equity
• Not if investors pay a fair price!
• Possible explanations
• Warrants stage financing, a la venture capital
• Convertibles stage equity capital (back door
  equity?)
• Converibles may mitigate the games between
  shareholders and bondholders.