CFOs have a surprisingly wide range of options for accessing the capital markets these days, especially considering that just over a year ago a global pandemic was roiling markets. This open access across products provides options, flexibility and pricing tension that can be leveraged to optimize financing solutions.
The last 15 months have been a historic period in the capital markets. A broad market shutdown and massive secondary sell-off across securities in February and March 2020 were followed by record new issue activity across debt and equity markets.
The Cboe volatility index (VIX) peaked at record highs in February 2020, but abated to more normalized levels by mid-May, and it is currently trading near the 10-year average. Perhaps even more surprising has been the willingness of investors, banks and other market participants to innovate against this backdrop with products such as special-purpose acquisition companies (SPACs), direct listings and even adjusted traditional IPO features and structures.
Public companies find many capital options
Public companies have had an interesting path to navigate. The initial period of market shock in February/March 2020 was followed by a stiff rally, particularly for companies deemed to be "winners" in the new normal or less impacted by pandemic realities. Many issuers took advantage of surprisingly strong conditions to bolster their balance sheets, playing offense given the surprisingly strong pricing conditions. The convertible debt market was the first to return and did so in record size, followed by the straight debt markets. IPOs and SPACs took center stage in the second half of 2020, starting a six-to-nine-month run that has been incredibly profitable for both existing and new investors.
Here in mid-2021, we continue to experience a capital markets transaction renaissance. March, by most accounts, was the most active month in the history of the convertible debt market ꟷ investors continue to have appetite for new product, and issuers are obliging. While rates have expanded, some debt market access remains robust. As audit and blackout seasons finished in March and April, IPOs were expected to return to the forefront.
With access across the capital markets, many companies are contemplating areas that will define their views on the need for capital:
- Funding organic growth and projects
- M&A pipeline and potential capital needs
- Refinancing requirements/obligations
- General views on market and balance sheet risk
What to consider when accessing capital markets
Identifying capital needs helps determine how much funding is needed. But how should it be raised, and when? Considerations that follow the initial review of capital needs can be similarly critical:
- Comfort with debt securities in capital structure, future repayment obligations and covenants
- Appetite for/ability to pay cash coupons
- Stock price trajectory expectations
- Sensitivity of management, board and investors to dilution
The convertible debt market has enticed both historical issuers and new entrants in record numbers over the past year and a half. Convertible securities have attractive features including:
- Very low cash interest expense
- Mitigated equity dilution exposure
- No covenants or ratings required
- Defined use of proceeds not required by investors
- Ability to raise capital on accelerated basis (concept to pricing ~1 week)
The economic and messaging components of these securities are appealing. The ability to raise capital with limited cash cost and dilution, without a defined use of proceeds, allows companies to de-risk future capital requirements without feeling much "pain" today. Call spread overlays further mitigate dilution, often raising the effective conversion price of these securities to double the current share price. However, we all know there is no free lunch in the world of finance. As such, it is important to weigh all costs of these transactions, which include both the cost of the call spread as well as potential dilution if the stock price appreciates beyond the effective conversion price.
Having access across the capital markets is a luxury that may not be guaranteed in the future. With the economy expected to expand over the near to medium term, we can expect CFOs to be aggressive in the capital markets, de-risking growth by financing at an attractive cost. Enhancing capital structure and cost of capital is a multi-faceted exercise that issuers can contemplate as they evaluate the pros and cons of financing alternatives.
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The views expressed by the authors are not necessarily those of Ernst & Young LLP or other members of the global EY organization.
