Monday, July 27, 2020

Death Spiral Convertibles

In last week's ""Flood of new and cheap shares sink Nikola stock" (NKLA)" I mentioned:
PIPE's into a blind pool. This is like a re-run of the Mafia on Wall Street in the '90's.
In pre-market action the stock is down $9.07 (-18.57%) at $39.77.
Now all we need are some death-spiral convertibles and  "Macarena" blasting everywhere you turn.
Here's a Social Science Research Network paper on the nasty little converts, no Macarena (yet):

Death Spiral Convertibles
104 Pages Posted: 24 Jun 2001
Pierre Hillion
INSEAD - Finance
Theo Vermaelen
INSEAD - Finance
Date Written: May 2001
Death spiral convertibles are privately held convertible securities (preferred stock or debentures) with a conversion price that is set at a discount from the average (or sometimes the minimum) of past stock prices in a look-back period. Although, in theory, these securities have the potential to reduce agency costs of debt and problems related to adverse selection, they have been called "death spirals" because of their potential to create dilution and stock price declines. On the basis of all 487 issues announced before August 1998, we find that this bad reputation is indeed justified: an investor who buys the common stock of the issuer loses, on average, 34% of his wealth one year after the issue date. Although our sample period coincides with one of the strongest bull markets in U.S. history, in 85% of the cases one-year post-announcement returns are negative. However, we also find that issuers also experience a significant decline in operating profitability relative to benchmark firms.