Stories
Stories
Podcast
23.11.2020
2020 almost became the year in which the crane flew for the last time. The crane has always been the symbol of Lufthansa, Germany's largest airline, and thus a global ambassador for Germany's progressiveness. But when borders suddenly closed due to the coronavirus pandemic and no one dared to fly, the flagship of the German economy was in danger of falling. On March 19, the company announced that 95 percent of all flights would be canceled. The imbalance was threatening. Lufthansa lost 1.7 billion euros in the second quarter alone.
In the end, the German government had to step in. The unloved former owner, whose departure Lufthansa executives had celebrated in the 1990s, is now back and owns 20 percent of the shares in one fell swoop. The German government has secured an option for a further five percent with an instrument that has rarely been used by companies of this size: the convertible bond. The special thing about this type of bond is that it can be converted into shares at the end of its term. Convertible bonds have recently been more of a niche product on the international capital market - but they are currently enjoying great popularity.
There are plenty of prominent examples this year: the travel start-up Getyourguide raised 114 million euros, while the Austrian sensor manufacturer AMS received as much as 750 million euros. And Lufthansa also seems to have taken a liking to the instrument, as it issued another convertible bond for 600 million euros in the fall.
At around 500 billion euros, the volume of outstanding convertible bonds in August was already a good 100 billion euros higher than the previous year, as fund managers reported. The uncertain situation on the markets is also driving established companies to use this instrument. This is because convertible bonds can be used to avoid both market volatility and high interest payments. In the long term, however, they can entail risks and uncertainty.
To understand what the danger of convertible bonds is for companies, you first need to look at how they work. In its simplest form, the investor subscribes to a convertible bond and receives regular interest in return, just like a coupon bond. The difference is that at a fixed point in time - usually at the end of the bond's term - the investor can have the company pay them in shares instead of receiving the nominal value of the bond back. Both sides usually determine the exchange ratio at the beginning. This structure is usually accompanied by lower nominal interest rates than with regular bonds; the investor pays a kind of premium for his share option.
"Other options for raising capital are not very attractive at the moment" - Alexander Pütz, University of Cologne
In this simple structure, convertible bonds are therefore a hybrid between a capital increase via shares and traditional borrowing from the company's perspective. For the investor, they are a bet on rising share prices, because in this case he could later multiply the money invested by converting it. This has so far made the instrument particularly interesting for young companies.
"Fast-growing technology companies in particular have used convertible bonds in the past," explains Alexander Pütz. He works at the Department of General Business Administration and Finance at the University of Cologne. This makes it easier for start-ups to raise money, as investors initially only lend money, but share in the potential success in the long term. The interest rates are relatively low and, at least in the short term, the shares of the existing owners are not diluted, as would happen with an immediate capital increase.
The American car manufacturer Tesla, for example, issued a whole series of convertible bonds to finance its rapid expansion. Delivery Hero, which recently joined the German stock index, raised EUR 1.75 billion via convertible bonds at the beginning of the year to finance a takeover in South Korea. The Berlin-based travel platform Omio also announced in August that it would finance takeover plans in this way.
At GetYourGuide, they responded to the slump in tourism this year with a convertible bond: "Corona has hit the global tourism industry hard, but we are convinced that our mission is more important than ever and stands for a new era in tourism," says Johannes Reeck, CEO of the company: "This financing is a vote of confidence that GetYourGuide can lead the recovery of global tourism."
But why are established companies such as Lufthansa, AMS and Tui also currently turning to convertible bonds? "Other options for raising capital are not very attractive at the moment," says Pütz from the University of Cologne. The stock markets are very volatile, while at the same time the interest costs for bonds have risen. Accordingly, the convertible bond is a lifeline for many.
It plays a particularly important role in state support measures, says Pütz: "The state is often criticized for stepping in as a rescuer itself, but others benefit from it. The convertible bond is different." If Lufthansa and Tui, for example, recover from the current crisis year in the medium term, the state could convert the bond in future and make a nice profit by selling the shares at higher prices. Non-governmental investors such as hedge funds are also increasingly buying convertible bonds in order to avoid being exposed to the uncertainty on the stock markets. According to the analysis company eVestment, they were able to achieve gains of 6.9% with these bonds up to August. All other investment strategies only yielded 2.2 percent.
However, the convertible bond is not a silver bullet for companies. "In principle, it is a conditional increase in equity," explains Pütz. In other words, after the bond period has expired, the company may have to issue a large number of shares. The previous owners would suddenly hold significantly fewer shares and the bond subscribers would gain control. In view of the fact that convertible bonds can of course also be traded on the stock exchange, this is a certain risk.
Lufthansa, for example, has had to accept this risk. Companies can also structure a convertible bond in such a way that this risk is excluded. For example, they can grant themselves the right to decide on the conversion. Or they can issue a so-called Coco bond(contingent convertiblebond), in which the conversion is only carried out if a certain event occurs. This could be, for example, the time at which the company's wealth falls below the amount of debt. However, this is naturally not appreciated on the market, says Pütz. "In such a case, investors demand a significantly higher interest rate."
Stories
23.11.2020
Lars-Thorben Niggehoff
Up to now, convertible bonds have primarily been a means for start-ups to obtain capital at low cost. In the crisis year 2020, however, established companies are also using this option. Issuers and investors benefit in the short term, but companies could face trouble in the long term.
2020 almost became the year in which the crane flew for the last time. The crane has always been the symbol of Lufthansa, Germany's largest airline, and thus a global ambassador for Germany's progressiveness. But when borders suddenly closed due to the coronavirus pandemic and no one dared to fly, the flagship of the German economy was in danger of falling. On March 19, the company announced that 95 percent of all flights would be canceled. The imbalance was threatening. Lufthansa lost 1.7 billion euros in the second quarter alone.
In the end, the German government had to step in. The unloved former owner, whose departure Lufthansa executives had celebrated in the 1990s, is now back and owns 20 percent of the shares in one fell swoop. The German government has secured an option for a further five percent with an instrument that has rarely been used by companies of this size: the convertible bond. The special thing about this type of bond is that it can be converted into shares at the end of its term. Convertible bonds have recently been more of a niche product on the international capital market - but they are currently enjoying great popularity.
There are plenty of prominent examples this year: the travel start-up Getyourguide raised 114 million euros, while the Austrian sensor manufacturer AMS received as much as 750 million euros. And Lufthansa also seems to have taken a liking to the instrument, as it issued another convertible bond for 600 million euros in the fall.
At around 500 billion euros, the volume of outstanding convertible bonds in August was already a good 100 billion euros higher than the previous year, as fund managers reported. The uncertain situation on the markets is also driving established companies to use this instrument. This is because convertible bonds can be used to avoid both market volatility and high interest payments. In the long term, however, they can entail risks and uncertainty.
To understand what the danger of convertible bonds is for companies, you first need to look at how they work. In its simplest form, the investor subscribes to a convertible bond and receives regular interest in return, just like a coupon bond. The difference is that at a fixed point in time - usually at the end of the bond's term - the investor can have the company pay them in shares instead of receiving the nominal value of the bond back. Both sides usually determine the exchange ratio at the beginning. This structure is usually accompanied by lower nominal interest rates than with regular bonds; the investor pays a kind of premium for his share option.
"Other options for raising capital are not very attractive at the moment" - Alexander Pütz, University of Cologne
In this simple structure, convertible bonds are therefore a hybrid between a capital increase via shares and traditional borrowing from the company's perspective. For the investor, they are a bet on rising share prices, because in this case he could later multiply the money invested by converting it. This has so far made the instrument particularly interesting for young companies.
"Fast-growing technology companies in particular have used convertible bonds in the past," explains Alexander Pütz. He works at the Department of General Business Administration and Finance at the University of Cologne. This makes it easier for start-ups to raise money, as investors initially only lend money, but share in the potential success in the long term. The interest rates are relatively low and, at least in the short term, the shares of the existing owners are not diluted, as would happen with an immediate capital increase.
The American car manufacturer Tesla, for example, issued a whole series of convertible bonds to finance its rapid expansion. Delivery Hero, which recently joined the German stock index, raised EUR 1.75 billion via convertible bonds at the beginning of the year to finance a takeover in South Korea. The Berlin-based travel platform Omio also announced in August that it would finance takeover plans in this way.
At GetYourGuide, they responded to the slump in tourism this year with a convertible bond: "Corona has hit the global tourism industry hard, but we are convinced that our mission is more important than ever and stands for a new era in tourism," says Johannes Reeck, CEO of the company: "This financing is a vote of confidence that GetYourGuide can lead the recovery of global tourism."
But why are established companies such as Lufthansa, AMS and Tui also currently turning to convertible bonds? "Other options for raising capital are not very attractive at the moment," says Pütz from the University of Cologne. The stock markets are very volatile, while at the same time the interest costs for bonds have risen. Accordingly, the convertible bond is a lifeline for many.
It plays a particularly important role in state support measures, says Pütz: "The state is often criticized for stepping in as a rescuer itself, but others benefit from it. The convertible bond is different." If Lufthansa and Tui, for example, recover from the current crisis year in the medium term, the state could convert the bond in future and make a nice profit by selling the shares at higher prices. Non-governmental investors such as hedge funds are also increasingly buying convertible bonds in order to avoid being exposed to the uncertainty on the stock markets. According to the analysis company eVestment, they were able to achieve gains of 6.9% with these bonds up to August. All other investment strategies only yielded 2.2 percent.
However, the convertible bond is not a silver bullet for companies. "In principle, it is a conditional increase in equity," explains Pütz. In other words, after the bond period has expired, the company may have to issue a large number of shares. The previous owners would suddenly hold significantly fewer shares and the bond subscribers would gain control. In view of the fact that convertible bonds can of course also be traded on the stock exchange, this is a certain risk.
Lufthansa, for example, has had to accept this risk. Companies can also structure a convertible bond in such a way that this risk is excluded. For example, they can grant themselves the right to decide on the conversion. Or they can issue a so-called Coco bond(contingent convertiblebond), in which the conversion is only carried out if a certain event occurs. This could be, for example, the time at which the company's wealth falls below the amount of debt. However, this is naturally not appreciated on the market, says Pütz. "In such a case, investors demand a significantly higher interest rate."
About the author
Lars-Thorben Niggehoff
Lars-Thorben Niggehoff writes about real estate, start-ups and investing.
