For starters, let's review how the financing works.
Broadcom is issuing $3.25 billion of convertible debt. This isn't a huge amount of debt, considering the company's market capitalization is $108 billion, although it's not nothing. These bonds convert into shares of equity in three years, meaning Broadcom, at that point, becomes free of that debt burden. The bondholders then become shareholders.
Essentially, this is a way for Broadcom to deleverage its financial position, meaning make debt a lower percentage of its total capital structure. Currently, Broadcom's total enterprise value (market cap plus net debt) is $145 billion. With $32 billion of net debt (debt minus cash), net debt accounts for 22% of the company's total enterprise value. Moreover, Broadcom wants to get its net debt to EBITDA (earnings-before-interest-tax-depreciation-amoritization) ratio down below two times.
But this comes at a cost to shareholders. When bond holders are converted to shareholders, more shares are issued to those investors. That dilutes the value of each share, which, on its own, lowers earnings per share. Broadcom will also have to pay a hefty dividend to those shareholders.
The Net Effect
Shareholders have to decide if they like this trade off: accept an improving financial condition in their company, which can now invest more, but also accept a diluted per share value. The earnings per share dilution is expected to be roughly 2%, according to analysts.
Well, the stock fell 3.5% to $272.43 a share Wednesday, so investors weren't exactly enthused at the capital raise.
But TheStreet's Eric Jhonsa noted something important. "The big thing to keep an eye on is this is a strategic thing for them. It's worth keeping an eye on to see if this is a trend, if they're going to continue to rely on -- whether it's convertible debt or straight equity raises -- to raise funds going forward."
Plus, Alliance Bernstein analyst Stacy Rasgon wrote in a Wednesday morning note "The mandatory convert should end up cheaper than a straight equity raise."