Where to Get Yields of 10% and Up, if You Can Stomach a Little Risk
The $280 billion convertibles sector is replete with 10%-plus yields on many issues. There is a risk in these high-yielders, but they can offer nice appreciation potential and a good alternative to the issuer’s common stock.
Converts are bond/stock hybrids that can offer a combination of the downside protection of bonds and the upside potential of stocks. The ICE BofA U.S. Convertibles index is off 17% so far in 2022.
Convertible issuance boomed in 2020 and 2021 as growth companies and those hit hard by the pandemic took advantage of high demand to issue converts with rates as low as zero and high equity-conversion premiums. A high premium meant the issuer’s stock would have to rise 50% or so before it made sense for the holder to convert the bond to stock.
Issuers included Coinbase Global COIN –2.83% (COIN), MicroStrategy MSTR +3.75% (MSTR), Beyond Meat (BYND), Peloton Interactive PTON +0.30% (PTON), Wayfair (W), Redfin (RDFN), RealReal (REAL), DraftKings (DKNG), Carnival (CCL), and Affirm Holdings (AFRM). Many converts are down 40% or more and are “busted,” meaning the stock prices have fallen so much that the issues act like pure bonds.
Investors can play the sector through exchange-traded funds such as SPDR Bloomberg Convertible Securities ( CWB ), yielding 2.5%; mutual funds such as Columbia Convertible Securities (PACIX); and individual issues.
Many convert issuers are barely profitable—or are losing money—but BofA Securities convertible strategist Michael Youngworth sees some positives. “While this might appear challenging from a credit perspective, fundamentals don’t look so dire,” he says. Youngworth says issuers of about half of all busted converts have no other debt on their balance sheets, “meaning total debt, leverage, and interest costs remain relatively low.”
MicroStrategy’s zero-coupon convertible due in 2027 now trades at 33 cents on the dollar and carries a 28% yield to maturity. It is an intriguing Bitcoin play. The convertibles look covered by the company’s Bitcoin holdings, now worth about $2.1 billion, and a software business possibly worth $500 million. There is about $2.4 billion of debt.
Booker Smith, an analyst at Imperial Capital, says the converts are a much better play than MicroStrategy’s stock.
Coinbase’s 0.5% issue maturing in 2026 trades around 54 (face value is 100) and yields 16% to maturity. Wayfair’s 0.625% issue due in 2026 trades at 65 and yields 16%; DraftKings’ zero-percent issue maturing in 2028 trades at 63 and yields 8.5%; Redfin’s zero-percent bonds due in 2025 trade at 54 and yield 22%; and Beyond Meat’s zero due in 2027 trades at 25 and yields 36%.
The bar is lower for a convert in these companies than the equity. If the company merely survives, investors should win.
Buying converts can be tricky, as they trade over the counter and most were originally issued to institutions under Rule 144A. But many get registered Cusips, or identification numbers, a year after issuance and can be purchased by individual investors.