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🔫 The name's Convertible Bond

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If you take just one thing from this email…

Alibaba is raising $5 billion through convertible bonds, which are like regular bonds but with a twist: they can be converted into shares if the company's stock does well. This strategy helps Alibaba raise money pretty cheaply. It will use that money to buy back a bunch of its shares, which should help its share price go up.

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I know more than 90% of the LittleLaw audience is UK-based (like me).

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- Idin

🔫 The name’s Convertible Bond

(so sorry about that title — just had to do it 🙃)

James Bond Snl GIF by Saturday Night Live

Credit: Giphy

What's going on here?

Alibaba, the Chinese e-commerce giant, is planning to raise $5 billion by issuing “convertible bonds”.

What’s a convertible bond?

First, what is a bond?

Imagine you lend your friend £100 for five years. In return, your friend agrees to pay you back the £100 after five years and also promises to give you £5 every year as a thank you for lending them the money.

So, every year for five years, you get £5, and at the end of five years, your friend pays you back the £100.

Well, that’s how bonds work — they’re like loans investors give to companies which are repaid by the company on a specific date. Until that date, the company typically pays you interest (in this example, that’s 5%).

Now, what is a convertible bond?

Imagine you lend another friend £100 for five years, and they also promise to pay you £5 every year. However, this friend gives you an extra option: if their business becomes really successful and their share price goes up, you can choose to convert your £100 loan into 10 shares of their company at a pre-set price.

So, you get £5 every year for five years (your 5% interest), plus at the end of the five years, you can choose: If the company does well and each share becomes worth £15, you can convert your £100 bond into 10 shares (now worth £150 total). If the company doesn't do well, you just get your £100 back.

A convertible bond is like a regular bond, but with a bonus option — depending on the movement of the stock price, you can convert your bond into shares and potentially make more money.

Why is Alibaba doing this?

  1. Buy back shares: The company wants money to buy back some of its shares. This can help improve its share price — reducing its supply of shares should result in a price increase (we wrote about share buybacks here).

  2. Flexible financing: Because convertible bonds offer that “conversion” benefit, they usually pay a lower interest rate than regular bonds. This makes them cheaper for companies to offer (plus it means the value of their shares isn’t immediately watered down from the company issuing brand new shares).

  3. Keep up with competitors: Alibaba's biggest competitor, JD.com, recently issued $1.75 billion in convertible bonds. So there’s a trend among Chinese tech companies to raise money in this way.

(If you want to see an investor’s deeper analysis of Alibaba’s reasons, this video is cool)

How did markets react?

Not so well — Alibaba's share price dropped over 5% after the announcement.

Investors were worried that the company had taken on too much debt.

The price shift was also a reaction to the fact that these bonds will probably convert into shares in the future and water down the existing share price.

What’s the role of lawyers in the issue of convertible bonds?

  • Capital Markets: Lawyers in this area draft and review the bond offering documents (called a circular or prospectus) which detail the terms of the convertible bonds. They ensure it’s all accurate and compliant with relevant securities laws. They also help with the process of listing the bonds on a stock exchange (like the London Stock Exchange) so the bonds are tradable.

  • Corporate: These lawyers manage issues related to the corporate formalities of the issuing companies. For example, they will get necessary shareholder approvals and draft board resolutions to authorise the companies issuance of the convertible bonds.

  • Banking & Finance: Lawyers in this area cover the financial aspects of convertible bond issuances, advising on the terms of the bonds (like how the bonds can be converted into shares, the interest rates paid to investors, and the conditions for early repayment). They ensure the bond aligns with market standards and complies with relevant financial regulations.

  • Tax: Tax lawyers review the tax treatment of convertible bonds for both issuers and investors to make sure they are tax efficient and follow relevant tax laws.

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