Shares of AMR (AMR) dropped 3.8% Tuesday after investors took flight at the prospect of a big, dilutive convertible note offering.
AMR, parent of American Airlines, the world's largest airline, said it would sell $300 million worth of 20-year notes that are convertible into AMR shares. The notes will pay 4.5% annual interest. The details of the offering imply a conversion rate of $22.05 a share, which represents a 40% premium over Monday's closing price.
The news was bullish in that it showed AMR has regained relatively low-cost access to the capital markets, something it lacked not long ago. AMR said it would use the cash to fund general corporate purposes.
But investors sold AMR shares Tuesday as they considered the prospect that holders will convert their notes to shares, thereby increasing the supply of AMR stock and trimming per-share earnings. If all the notes were converted to AMR stock, AMR's float would expand by 13.6 million shares, or 8.7%.Besides the dilution fears, shares of AMR also fell because of a common arbitrage play that occurs after a convertible note sale. Traders buy the new paper to cover their short sales, which are bets that AMR's stock will fall. Meanwhile they short or sell the underlying stock. Short interest in AMR is high after the company's stock doubled last year and hit a 52-week high on Jan. 27. According to Multex, 30.5% of its shares are short as a percentage of its float. With major institutions moving in and out of shares to cover shorts, AMR was off 60 cents to $15.15 by midday, on volume of 11 million shares. That's already more than double its usual daily volume of 4.7 million. The convertible sale may have some equity investors feeling skittish, but it's also a sign of how AMR's turnaround has improved its access to the capital markets. "Generally this is seen as a positive because they're raising further liquidity and able to do so without putting up any of their remaining unsecured assets as collateral," said Philip Baggaley, debt analyst at Standard & Poor's. "They certainly have significant upcoming debt maturities so this effectively prefinances some of those." Indeed, market conditions were much tougher in August, when the airline shelved a planned $250 million convertible note offering. Standard & Poor's gave that sale a CCC rating, two notches below American's corporate rating of B-minus. "As they have recovered from their problems and reported improved results, their access to capital markets has improved. They can get better prices" for the convertible offering, said Baggaley.