Conversion tactics

4 May 2006 By Antony Currie Follow @AntonyMCurrie

That may sound wacky, but a handful of US firms seem to be doing just that by issuing a convertible bond with funky derivatives attached. The net result is a much lower funding cost. More growthoriented companies are sure to follow suit.

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Last week Gilead Sciences issued a twotranche $1.3bn convertible bond. Gilead is using $545m of the proceeds to buy back stock. One tranche matures in 2011, pays a coupon of 0.5% a year, and can be converted when Gilead's stock rises 17% from the price at the time of the offer. The second tranche matures in 2013, pays 0.625% a year, and has a 19% conversion premium.

The company used $350m of the proceeds to buy call options from an investment bank. This hedges the risk of shareholder dilution. Simultaneously, Gilead sold warrants to an investment bank, although has yet to announce how much the proceeds are. The warrants effectively raise the conversion premium of the fiveyear tranche to 56% and the sevenyear tranche to 65%.

Furthermore, should the conversion strike price be hit, Gilead will pay the principal amount to convertible investors in cash, not stock. Gilead also decides whether to pay cash, stock, or a combination of the two for anything above the principal amount.

The deal structure is similar to Medtronic's $4.4bn offer earlier in the month, and to Amgen's $5bn convertible bond sold in February.

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