Sell shares - buy bonds?

Traditional bonds - such as this issued by the US govt - are making way for hybrid bonds

Nervous share markets have left companies wondering how they are going to raise money.

It is a dilemma many companies have faced since shares fell out of bed in March last year.

Orange has decided to back its flotation with a convertible bond issue to help the share sale weather stock market volatility.

Telcos need money quickly and they can't go tap the equity market

Roddy Conway, convertible bond analyst, J.P Morgan

Many of the world's companies already raise as much money, if not more, in the multi-billion dollar global bond market, than they do in share markets.

But many bankers and analysts are now warning that some companies have borrowed too much money.

Desperate to raise more cash, telecom companies - in particular - are keen to exploit fresh ways they can raise money outside the stock market.

But although there may be short term gains in borrowing money this way, telecom companies may be only delaying the day they have to come to terms with their debt-laden balance sheets.

Some analysts pointed to the fall of Vodafone's share prices earlier this week as an indicator of the potential downside of convertible bonds.

Hybrid bonds

Convertible bonds are a cross between a bond and a share.

Generally, shareholders own a slice of the company, bought in the hope that the price of the share will increase and that the company will perform well, offering them dividends.

Bondholders own a slice of the company's debt.

Convertible bonds

Bonds are an I.O.U

Debt is repaid after a fixed term

Rate of interest paid over fixed term

Convertible bond owners have option to convert it into shares

A company that borrows money in the bond markets effectively issues an I.O.U.

This piece of paper - now more likely to be an entry on a computer screen - acts as proof that the bond holder or investor has lent that company a certain amount of money.

In return, the bond holder will receive regular interest payments over a period of years. At the end of this agreed time, the bond holder gets his capital back.

If it is a convertible bond, the bondholder may decide not to collect his money, but convert it into shares in the company, which they can then sell or keep.

Companies, who want to sell either their own shares or one of their crossholdings, find it can be cheaper and easier to launch this kind of bond than to just sell shares in the stock market.

Euro boom

In recent years, this market has boomed and is now worth about $140bn across Europe, almost double what it was before the euro was launched.

More companies wanted to raise money while - at the same time - investors were looking for some place else to put their money as the returns on government bonds started to fall.

Many chose convertible bonds and now several bond funds have been set up across Europe solely with the purpose of investing in these bonds.

In theory, investors should have the best of both shares and bonds.

If the shares perform badly, investors can choose to collect the money from the borrower at the end of the bond term. If the shares perform well, investors can exchange the bond for the shares.

For companies, the clear attraction is that they can borrow money at lower interest rates, e.g. Hutchison paid 2% interest on the bond they launched which was exchangeable into Vodafone shares, compared with the 7% or 8% rate that a typical telecom company would pay on their bond.

Many telecom companies need to raise money to buy mobile phone licences

"It is a cheap way of borrowing money," Roddy Conway, a convertible bond analyst at J.P Morgan said. "Telcos need money so quickly and they can't go tap the equity market."

Once the share market has recovered, telecom companies can then borrow money there, having borrowed the short-term money they need in the bond market.

The conversion rate - the rate at which bonds are converted into shares - is usually set about 30% higher than the share price at the time the bond is launched. So the company is basically getting a higher price for their shares than if they were to sell them straight away.

A time to sell?

The disadvantage for the company is that they do not know when and if the investor is going to sell the shares.

"The risk that the issuer accepts is they cannot be certain that the shares will be sold. It is up to the holder to decide if they sell or not. They may treat it as a bond and demand redemption," one analyst at a US investment bank said.

Hong Kong conglomerate Hutchison Whampoa unveiled plans to sell a 1.1% stake in Vodafone group on Monday.

Hutchison had acquired a series of stakes in Vodafone, when it took over Orange.

Vodafone chief executive Chris Gent said that Hutchison had told him that it would only sell the stock after it had recovered from its current lows.

News that it was in fact to sell shares now, prompted shares in Vodafone to fall 6% on Monday.