Toxic Convertible

Toxic Convertible

Used by companies that are in such bad shape, that there is no other way to get financing. This instrument is similar to a convertible bond, but convertible at a discount to the share price at issuance and for a fixed dollar amount rather than a specific number of shares. The further the stock falls, the more shares you get. Popular in the mid to late 1990s. Also known as death spiral convertibles or floorless convertibles.

Death Spiral

A loan that investors give to a publicly-traded company in exchange for convertible bonds. The convertible bonds give the investor a right to buy shares in the company at a low, agreed-upon price. However, issuing these bonds creates more shares outstanding when they are converted, which results in a drop in the share price. The low share price encourages more bondholders to convert their bonds to equity, which causes a further drop in price and the process continues. Because of this disadvantage, companies only engage in death spirals if they badly need cash.
References in periodicals archive ?
Section VI reports on the current state of the toxic convertible and concludes.
As a conjecture, management may truly believe that the capital raised through a toxic convertible will be enough to save the company ("prettiest baby syndrome").
However, there seems to be no real call by shareholder groups to eliminate toxic convertible sales.
Toxic convertibles have gained notoriety mainly due to their ability to harm existing shareholders and their contribution to firm demise.
Accordingly, this paper seeks to contribute to the literature on toxic convertibles by attempting: (1) to provide a description of their particular features; (2) to examine the rationale for their use in the context of theories of agency and information asymmetry in the corporate finance literature; and (3) to evaluate possible corrections to design flaws that would mitigate their most pernicious effects on issuing firms and make them viable sources of financing for some firms.
Toxic convertibles are a particular class of instruments called private investment in public equities (PIPEs).
Finally, recent investigations, by the Securities and Exchange Commission (SEC) into toxic convertibles helps to alleviate malfeasance associated with trading toxic convertibles.
Newkirk, Associate Director for the Division of Enforcement, is quoted as saying, toxic convertibles "present the temptations for persons holding the convertible securities to engage in manipulative short-selling of the issuer's stock in order to receive more shares at the time of conversion," and said the $1 million penalty "shows the Commission's determination to address these abuses.
To the extent these comments relate to toxic convertibles, in particular, Hillion and Vermaelen (2004) attest to the same development.
As a fixed debt, this payable no longer represents the limitless dilution and uncertain risk of a toxic convertible debt, and the settlement gives the Company the option of satisfying the debt by either issuing stock or making cash payments.
Goodlander, who personally holds all of the remaining outstanding shares the Company's Series A Convertible Preferred Stock, is negotiating with a Committee of outside Directors of the Company the terms under which the toxic convertible provisions of both the Series A and Series C Convertible securities would be removed or, in the alternative, the terms on which he would agree to convert the securities at their current contract rate into common stock, subject in either instance to required regulatory and shareholder approvals, if any.
None of the securities to be issued in the private placement will have toxic convertible features.