Death Spiral Convertible Just Refuses to Die

So far, two hedge funds are leading the way in investing in death spiral deals. Over the past 12 months, Cornell Capital Partners has emerged as the top investor in death spiral transactions, sinking $175 million into 42 deals. In second place is NIR Group, which has invested $77 million in 40 transactions.

No other hedge fund comes close to Cornell Capital or NIR, says Robert Kyle, executive vice president of Sagient Research, the parent company of PlacementTracker.

Mark Angelo, the founder and president of Cornell Capital, a $500 million fund located in Jersey City, N.J., declined to comment. Corey Ribotsky, the manager of Roslyn, N.Y.-based NIR Group, did not return several phone calls. NIR Group has $486 million in assets under management.

PIPE deals, of course, come in all shapes and fashion. But almost every deal involves the sale of discounted shares to a group of hedge funds.

Death spiral PIPEs got their unsavory reputation because, unlike typical convertible bonds, which get converted into shares only when a stock rises to a fixed price, the conversion price for these notes keeps getting adjusted downward whenever the underlying stock falls. The drop in the stock price also means the buyers are entitled to receive more shares when the conversion occurs.

The floating convertible feature is intended to be an embedded hedge to protect investors in the event the stock doesn't rise in price after the deal. But, in the past, some unscrupulous hedge funds that bought the bonds saw the floating conversion feature as an invitation to make money by literally shorting the stocks to death. In many cases, those hedge funds violated contract provisions forbidding any shorting of the company's stock. (Nobody has lodged such allegations about Cornell or NIR.)

A short sale is a market bet that a stock will fall in price.