Justin Lahart

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Merrill Jumps Into the Convertible Market

Justin Lahart

After the close, the big broker said it may raise $1 billion in a zero-coupon convertible bond offering. The bonds will mature in 30 years, although Merrill may force investors to convert the bonds into stock or take a cash payout in five years. Merrill also said that holders will be able to require it to repurchase the convertibles, commonly referred to as putting the bonds back to the company, on several occasions, but it hasn't yet specified when those put dates would be. Merrill's broker-dealer unit will be the sole manager of the offering.

Merrill was off 3.7% in after-hours trading Wednesday on Instinet. The offering, if converted into equity, would dilute current investors' stock holdings, though Merrill's $46 billion market cap suggests the damage shouldn't be great.

With the equity market lackluster and corporate bond spreads wide, convertibles have become a hot market. In 2001 U.S. companies issued $102 billion in convertible bonds -- nearly twice the 2000 tally.

"In terms of using it as a vehicle for raising capital, the convertible market seems like the place to be," says Banc One Capital Markets convertible strategist Rich Cunniffe.

Although some companies have lately run into trouble with convertible bonds -- Cox Communications (COX), for instance, recently felt compelled to offer a cash payout to investors who didn't put convertibles back to it -- high-quality companies continue to get very good terms, according to Cuniffe.

Shiny New Convertibles Convertible debt issuance on the rise ($billions)

Source: Thomson Securities Data

Cuniffe also noted that some companies are turning to the convertible market to meet their short-term financing needs. It's unclear if that is what Merrill intends here. But if the convertible has frequent put dates and a conversion ratio that, outside of a huge gain in its stock, virtually ensures that it gets the offering put back to it, it will be a good guess the broker thinks the convertible market is friendlier than the commercial paper market these days.

A number of firms, most notably Tyco (TYC) and Qwest (Q), have recently been shut out of the commercial paper market. While Merrill is clearly seen as a higher-quality credit than those two, its move to do a convertible may be an indication of just how strained the commercial paper market has got.