Investors yesterday sold off on the news that Sterlite (SLT) is making a convertible note offering of $500 million, convertible in the US listed ADS. Yes, convertible notes have a dilutive effect on the stock.
Yesterday I also commented that the convertible note offering is being done to finance an expansion project and as long as the interest payment on the note is lower than the return on capital the company is able to generate, one should view this as a positive value creating news and that the investors are wrong to sell off on this news.
Today the company released a little more information on the convertible note offering that supports my view.
The convertible note will pay an interest of 4% per annum and will be convertible at $23.33 per share of the ADS. Please note that the share price closed yesterday (Oct 15, 2009) at $16.62. There fore , there is 40% premium built into the conversion price over yesterday’s close. The notes are not dilutive, yet.
Also it is worth noting that while one cannot quite estimate the return on capital on the expansion project, it may be instructive to look back at what ROC Sterlite is able to achieve on its current business. Its trailing 1 year ROC is close to 15%, much much higher than the 4% interest it is going to pay out on the note, assuming that the company will be able to maintain the similar levels of returns in the future.
Yes, this may be a big if, but it certainly does not justify the stock sell off that ensued. If you are a holder, there is no reason to sell the stock now.