How a Senior Note Hits the Market
So what does convertible arbitrage mean to you and me as a retail investor? It means we can get blindsided by volatility if we don’t know the driving force. Let’s use LDK Solar as an example. No opinion is being inferred on the company or management. This is simply a stock I know and can use as an example. There are hundreds of deals a year like this.
The offering came a month after LDK hit an intraday low of $19.64 off the Fed’s bailout day on March 12th. The next day LDK released news about their entire 2008 inventory being sold. The stock popped 24% that day. A couple weeks later the wheels were in motion on LDK’s convertible bond arbitrage. During the offering period the greater stock market was relatively flat. The Dow had no +/- 100 point days. This makes for an interesting look at how convertibles effect the underlying stock.
Chronology
On
Here is the relevant price history:
|
Date |
Vol. |
Close |
High |
Low |
|
|
1,853,100 |
27.50 |
|
|
|
|
4,734,000 |
30.09 |
|
|
|
|
7,123,200 |
31.62 |
|
|
|
|
10,737,300 |
36.40 |
37.86 |
33.26 |
|
|
11,291,400 |
32.50 |
39.25 |
32.03 |
|
|
8,106,600 |
33.15 |
|
|
|
|
4,946,300 |
31.43 |
|
|
LDK Solar Signs a Ten-Year Wafer Supply Agreement
LDK Solar Signs Two Additional Wafer Supply Agreements and One Polysilicon Sourcing Agreement. Notice the stock had x3 average volume, a 15% price increase, and hit the NYSE Top 10. Retail investors had no info on the convertible notes yet.
April 3rd,4th, and 7th saw gap opens to the upside. Pre-market buy orders forced LDK’s NYSE specialist to raise the open above the previous day’s close. It’s possible this was done to create a better offering price. I’m not an arbitrage attorney, so I don’t really know.
LDK Solar Files Annual Report on Form 20-F.
The stock was shorted hard from the open and sold down all day on the highest volume during the offering period. This confirms hedge funds shorting the underlying after buying the convertibles.
It looks like all the inside work was done by the 7th, the day prior to news of the senior notes being released to the public. After this day the stock didn’t move much until another gap open on the 15th, the closing of the period. LDK then finished April very flat with declining volume.
The notes will pay cash interest semiannually at a rate of 4.75% per annum and in certain circumstances, will be convertible into LDK Solar’s American depositary shares, cash or a combination of cash and American depositary shares. The initial conversion rate, subject to adjustment, is 25.4534 LDK Solar American depositary shares per US$1,000 principal amount of notes, which is equal to the initial conversion price of approximately US$39.29 per American depositary share, which represents an approximate 25% premium to the closing price of $31.43 on
What Does This Mean?
If I did my math right the bond issue converts into 10 millions shares. How’s that for a quiet addition to an initial float of 17M. The latest numbers from NASDAQ list 27,767,000 shares outstanding. Is the convertible now counted in the float?
I would love to hear from anyone who can figure out this formula:
I had a friend do the math, and fumbling with it we got Delta 0.77. Does that mean for every $1000 of notes $770 of stock was shorted?
In theory as LDK climbs above $39 it should meet resistance from short selling. As it approaches down to $39 it should see support from buying. What is curious is this level is very close to the 200 day moving average. Looking at the recent 60min bar chart one can see heavy volume candles bouncing off this level. When it comes time for the bonds to be offloaded they must sell above $39 to be accretive.
Notes of Interest
Convertible arbitrage is an important strategy in down markets. It’s seen as a lower risk method for a company to raise capital and allows investment hedging strategies. Historical data points to an increase of convertible arbitrage in bear markets.
“However, as majority of the trading activities in the convertible bond market takes place over-the-counter (OTC), there is no direct way of observing the risk and return characteristics of providing short-term liquidity to the CB market.”
“Unless they are registered, these notes may be offered or sold only in transactions that are exempt from registration under the Securities Act and the securities laws of any other jurisdiction.”
Long-term the strategy is seen as good for the market with a boost to liquidity. For the hedge funds it’s been a mixed bag of diminishing returns, but is still a very popular way of raising capital.
US convertible issues between December 1997 and December 1998 increased almost threefold from 152 to 430.
CBs accounts are 1/50th of the equities market by valuation.
[If you can clarify any of my uncertain points I’d love to hear from you!]
Resources:
http://www.ldksolar.com/Company%20news.html
http://www.nasdaq.com/quote.dll?mode=stock&symbol=LDK&page=multi&selected=LDK
http://chipstocktrader.com/ldk.samurai.7.htm
Risk and Return in Convertible Arbitrage Strategies: Evidence from the Convertible Bond Market and Hedge Funds
The Convertible Arbitrage Strategy Analyzed
By Igor Loncarski, Jenke ter Horst, Chris Veld
October 2006
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