Symantec's Striking $2B Convertible Financing

Nobody gets it.  Symantec issued $2 billion of convertible notes on Monday.  That in itself is notable news but there are a couple much more interesting elements to this transaction.

Rethinking Leverage

This financing is really in essence a recapitalization of Symantec.  $1.5 Billion of the proceeds are being used to finance the purchase of Symantec common stock.  In other words, Symantec sold bonds to pay the cash to shareholders.  Why are they doing this?  Well, finance theory states that the cost of debt is less expensive than the cost of equity (up to a certain point).  The direct manifestation of this is that following this deal, Symantec will have fewer shares of common stock outstanding, which will increase their EPS, even when factoring in the carrying cost (interest cost) of the debt.  Higher EPS = higher stock price, excluding other factors that impact stock price.  So simply put, this is Symantec management working to enhance shareholder returns by placing prudent amounts of debt on the balance sheet.  This is the continuation of a fairly nascent trend toward optimizing capital structure within large software vendors (and frankly has implications across the entire technology sector).  Computer Associates was a pioneer in the use of debt and Oracle, Veritas, RedHat, Mercury Interactive and Symantec among others have begun to rethink their historical aversion to debt.  MANY more technology companies are considering this move now.

Why a Convertible Bond?

The second extremely interesting element of this transaction is that they issued a convertible bond instead of high-yield debt.  In other words Symantec actually issued a security that gives a right to buy Symantec stock at a higher price in the future.  Well, that certainly isn't consistent with the recapitalization argument stated above.  But wait, Symantec also entered into a derivative transaction, know as a call spread, which was structured in a way to compensate for the dilution that would occur if holders of the convertible bonds wanted to exercise their right to buy the common stock.  Its sort of a complicated way to get to the same place but what Symantec and their underwriters did was create synthetic high-yield debt.  Why would they do that when the high-yield market would have voraciously snapped up Symantec high-yield bonds?  Well, the convertible bond market, combined with a complicated derivatives trade were a better deal.  Us outsiders will never know the real data, but I can assure you that Symantec was thrilled with the outcome. 

Underwriters LOVE these deals because the fees are very high.  Bankers and issuing company executives also feel good because effort put into structuring a rather complicated deal (satisfying in its own right) results in superior terms for their shareholders.  Believe me, every technology company over $2 billion in market capitalization is getting bombarded by bankers selling this same technique.  Investment bankers get giddy sometimes.

So lets get back to our opening statement, nobody gets it.  The real story here is what I outlined above.  In my check of press reporting and blogging, their is no mention of the real significance of the deal or the rationale which motivated it.  Striking.  Here is the take from Stock Market Beat.  All the bonafide press just regurgitated the press release.

Comments

[Sundowne Financial]

Or said another way management feels that the company equity is worth more than the markets valuation.

[Trent]

Eric,

Thank you for explaining some of the rationale. Part of your article appears to justify part of our premise:

"Underwriters LOVE these deals because the fees are very high. Bankers and issuing company executives also feel good because effort put into structuring a rather complicated deal (satisfying in its own right) results in superior terms for their shareholders. Believe me, every technology company over $2 billion in market capitalization is getting bombarded by bankers selling this same technique. Investment bankers get giddy sometimes."

While the bankers may be satisfied with both the fees and the intellectual thrill of a complicated offering, it seems fair for investors to be suspicious of the value being provided. Is there any way you could walk us through a similar issue, and how the economics work for the company, the buyers of the converts, and the existing shareholders?

Thanks,

Trent

[John Hershey]

Eric,

Nice post. You briefly touch on the call spread. Perhaps you can expand on that a little: how is it structured? Who are the buyers of such an instrument?

John

[John Beck]

Different investment opportunities includes high yield bonds as they have low influence of market direct impacts .