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By Root 2612 0

counter to an old maxim of Wall Street, which runs: “Never convert a convertible bond.” Why this advice? Because once you convert you have lost your strategic combination of prior claimant to interest plus a chance for an attractive profit. You have probably turned from investor into speculator, and quite often at an unpropitious time (because the stock has already had a large advance). If “Never convert a convertible” is a good rule, how came it that these experienced fund managers exchanged their Eversharp bonds for stock, to their subsequent embarrassing loss? The answer, no doubt, is that they let themselves be carried away by enthusiasm for the company’s prospects as well as by the “favorable market action” of the shares. Wall Street has a few prudent principles; the trouble is that they are always forgotten when they are most needed.* Hence that other famous dictum of the old-timers: “Do as I say, not as I do.”

Our general attitude toward new convertible issues is thus a mistrustful one. We mean here, as in other similar observations, that the investor should look more than twice before he buys them. After such hostile scrutiny he may find some exceptional offerings that are too good to refuse. The ideal combination, of course, is a strongly secured convertible, exchangeable for a common stock which itself is attractive, and at a price only slightly higher than the current market. Every now and then a new offering appears that meets these requirements. By the nature of the securities markets, however, you are more likely to find such an opportunity in some older issue which has developed into a favorable position rather than in a new flotation. (If a new issue is a really strong one, it is not likely to have a good conversion privilege.)

The fine balance between what is given and what is withheld in a standard-type convertible issue is well illustrated by the extensive use of this type of security in the financing of American Telephone & Telegraph Company. Between 1913 and 1957 the company sold at least nine separate issues of convertible bonds, most of them through subscription rights to shareholders. The convertible bonds had the important advantage to the company of bringing in a much wider class of buyers than would have been available for a stock offering, since the bonds were popular with many financial institutions which possess huge resources but some of which were not permitted to buy stocks. The interest return on the bonds has generally been less than half the corresponding dividend yield on the stock—a factor that was calculated to offset the prior claim of the bondholders. Since the company maintained its $9 dividend rate for 40 years (from 1919 to the stock split in 1959) the result was the eventual conversion of virtually all the convertible issues into common stock. Thus the buyers of these convertibles have fared well through the years—but not quite so well as if they had bought the capital stock in the first place. This example establishes the soundness of American Telephone & Telegraph, but not the intrinsic attractiveness of convertible bonds. To prove them sound in practice we should need to have a number of instances in which the convertible worked out well even though the common stock proved disappointing. Such instances are not easy to find.*

Effect of Convertible Issues on the Status of the Common Stock

In a large number of cases convertibles have been issued in connection with mergers or new acquisitions. Perhaps the most striking example of this financial operation was the issuance by the NVF Corp. of nearly $100,000,000 of its 5% convertible bonds (plus warrants) in exchange for most of the common stock of Sharon Steel Co. This extraordinary deal is discussed below pp. 429–433. Typically the transaction results in a pro forma increase in the reported earnings per share of common stock; the shares advance in response to their larger earnings, so-called, but also because the management has given evidence of its energy, enterprise, and ability to make more money for the shareholders.* But