Symantec Convertible -- Part Two

In our first post, we mentioned that Symantec entered into a form of derivative transaction, widely known as a call spread, which was structured to compensate for the dilution that would occur if convertible bonds holders exercise their right to convert into common stock.

Transaction Structure 

So, what the heck is a call spread?  In this case it was the the purchase of a call option at one exercise price and sale of another call option at a higher exercise price.  Symantec did the following:

1.  Purchased a Call:  Symantec purchased a call option (from one or more of the underwriters) that gives Symantec the right to buy its own shares at a price 22.5% above the current stock price. That is $19.12, the same conversion price as the convertible notes.  The number of shares underlying the call option was likely the same that would be issued if the convertible converts, 104,590,200 shares.  This component is what Symantec refers to as "convertible note hedge transactions" in the press release.

2.  Sold a Call:  Symantec also sold a call option ( again, to one or more of the underwriters) that gives the purchasing underwriter(s) the right to purchase Symantec shares at a price 75% ($27.32) above the current stock price.  Again the number of shares would have likely been something close to 104,590,200 shares.  This component is what is referred to as "separate warrant transactions" in the press release.

Transaction Impact on Potential Equity Dilution

So what does all that accomplish?  It allows Symantec to eliminate all equity dilution resulting from the conversion of the convertible up to a stock price 75% above the current price (again $27.32).  Even if Symantec's stock price is above $27.32, it still protects against equity dilution somewhat as the proceeds paid to Symantec from the exercise of the sold call option (#2 above) could be used to repurchase common stock in the market.

Let's illustrate equity dilution with several scenarios:

Scenario One, Stock Price $18.00:  Convertible bond holders elect to get repaid as bond value ($2 billion) in more valuable than value as converted into common stock ($18.00/share x 104,590,200 shares = $1.9 billion).  Result: No equity dilution.

Scenario Two, Stock Price $25.00:  Convertible bond holders are incented to convert to common stock ($25.00/share x 104,590,200 shares = $2.6 billion as converted value vs. $2 billion bond value) and receive 104,590,200 shares.  Symantec exercises purchased call (#1 above), purchasing 104,590,200 shares.  Result: Purchased call exercise offset convertible bond conversion 1:1.

Scenario Three, Stock Price $35.00:  Convertible bond holders are incented to convert to common stock ($35.00/share x 104,590,200 shares = $3.7 billion as converted value vs. $2 billion bond value) and receive 104,590,200 shares.  Symantec exercises purchased call (#1 above), purchasing 104,590,200 shares.  As in Scenario #2 above, the purchased call exercise offsets the convertible bond conversion 1:1.  But, in this case, the purchaser(s) of the sold call (#2 above) are now incented to exercise their right to purchase 104,590,200 new treasury shares at $27.32.  Symantec receives $2.9 billion in cash from the sold call exercise which is then used to repurchase 81,640,122 ($2.9 billion sold call exercise proceeds / $35.00 stock price) shares in the open market.  Result: Net 22,950,078 shares issued instead of 104,590,200 without the call spread in place.

So in conclusion, the call spread works to either eliminate or mitigate the equity dilution resulting from the conversion of the convertible notes.

Economic Cost

Symantec had to pay $ for the "convertible note hedge transactions" and got paid $ for the "separate warrant transactions".  So what are the numbers?  According the the 8K, Symantec paid $592 million for the purchased call (#1 above) and received $326 million from the sale of the call (#2 above). 

So, the net cost to Symantec was $266 million to create the call spread.  $266 million amortized over the average life of the bonds (6 years) is $44 million per year.  That equates to a 2.2% annual cost.  Tack this imputed cost to the coupon on the convertible (.75% and 1.0% depending on the maturity) and you have an imputed annual cost of roughly 3%.  So, simplisticly, Symantec is borrowing $2 billion and paying a 3% annual pre-tax cost.  Not bad terms.

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