Chinese firms historically raised capital in the U.S. via IPOs. But, with tensions between the U.S. and China increasing, both governments became more likely to disallow the IPOs. So Chinese firms resorted to issuing convertible bonds in the U.S. market, with e-commerce groups Alibaba and JD.com and the travel site, Trip.com issuing $8.3 billion of the bonds in May 2024. Alibaba priced its bonds with a coupon rate of just 0.5%, JD at 0.25%, and Trip at 0.75%, well below the average at the time of 3.125%. U.S hedge funds were keen to buy the issues, presumably because of the favorable conversion terms compensating for the low coupon.
A commentator said, “the cost of capital (for these companies) has become incredibly compelling.” Not true.
The full cost to shareholders of these companies is hidden. If and when the holders convert into equity, the loss will not be reported under accounting principles. Hedge funds see a convertible bond arbitrage, but the companies are seeing an accounting arbitrage. Convertible arbitrage funds saw an average 5.1% increase returns to that point in 2024. If these are mark-to-market returns on convertible bonds, the issuing companies are incurring a corresponding contingent liability, but that is not reported. Review the treatment of convertible bonds by U.S. companies in 2021 in the Vignette in Chapter 9.
(Of course, convertible arbitrage comes with risk. In the case of issues by foreign companies, currency risk adds to the risk of the bonds not being in the money at the time of potential exercise. Hedge funds thus hedge the trade by shorting the corresponding equity.)
Source: Financial Times, Jun 15, 2024.