Convertible notes often allow companies to issue debt at lower interest rates than would be normally possible. However, these notes also have the potential to dilute the value of existing shares, explains Taesik Yoon, editor of Forbes Investor.
That’s why it’s not unusual for such offerings to have a negative impact on the stock price. Just look at Avid Technology (AVID).
Shares of the digital media content solutions provider have tumbled nearly 30% since announcing a convertible note offering in early June.
But this seems far too harsh when you consider that the stock would have to nearly double before any potential dilution would take place.
Moreover, much of the proceeds were used to fund a key acquisition that should help AVID deliver on its favorable growth outlook for the rest of the year.
The company's Avid Everywhere technology platform enables the creation, distribution, and monetization of audio and video content.
This platform is used by a wide range of customers including film studios, TV networks, and recording studios.
Furthermore, the company recently enhanced this value of its platform through the acquisition of Orad Hi-Tec Systems Ltd., an Israel-based provider of state-of-the-art 3D real-time graphics and video servers.
Indeed, Orad’s highly complementary solutions should help solidify AVID’s global position as the most comprehensive provider of content creation to distribution workflows for broadcast and media customers.
Because of the potentially dilutive impact of convertible debt on total shares outstanding, it’s not unusual for a company’s stock to fall after such an announcement. In the case of AVID, that dilution could be as high as 16% if fully converted.
A sharp sell-off would be understandable if this conversion premium was low. But with an initial conversion price of $21.94, that’s simply not the case here.
In fact, due to a derivative transaction, the company entered into concurrent with the offering, the stock would actually have to rise to $26 or basically double from its current price before any effective dilution would occur.
There is nothing to suggest any material deterioration in AVID’s promising outlook for the remainder of the year since its last operational update.
As such, we strongly believe that the steep sell-off in the stock since early June is well overdone and has resulted in a great buying opportunity, one that could begin to pay off quickly if AVID’s Q2 results (due to be released on August 10) are as robust as we expect.
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