Convertibles & Other Dilution
Convertible debt and preferred can become shares too. The If-Converted and Net Share Settlement methods size the dilution.
- ✓Apply the If-Converted method
- ✓Apply the Net Share Settlement (NSS) method
- ✓Know when to count convertibles as debt vs. equity
Convertible securities give holders the option to swap debt (or preferred) for common stock. If they're in-the-money, they dilute - and there are two ways to size that dilution.
- ›Assume the convert becomes shares in full
- ›Incremental shares = face value ÷ conversion price
- ›Remove the convert from debt and its interest from the P&L
- ›Simpler; more dilutive
- ›Company pays face value in cash
- ›Only the value ABOVE face converts to shares
- ›Caps the dilution at the in-the-money excess
- ›Less dilutive; common in practice
- •Current share price: $15.00
- • outstanding: $150mm
- •Conversion price: $10.00
- 1.If-Converted - incremental shares
- 2.NSS - total convert value
- 3.NSS - excess over face
- 4.NSS - incremental shares
If-Converted adds 15mm shares; NSS adds only 5mm. NSS is far less dilutive because the company settles the face value in cash and issues stock only for the excess.
When you treat a convertible as converting to shares, you must also remove it from total debt (and its interest/dividends from the P&L). Otherwise you'd double-count it as both debt and equity. Out-of-the-money converts stay as debt.
Convertible debt of $200mm with a $20 conversion price, under the If-Converted method, adds how many shares?