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VIDEOKeep an EYE on Convertible Bonds
Abbott Labs acquisition makes profits visible.
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One of the beautiful things about convertible bonds in this environment is what's known in the trade as the "poison put." Virtually all convertible bonds, in the event of a cash takeover, can be sold back to the issuer at 100% of par (face) value.
In the aftermath of last year's convertible devastation, not many bonds are trading anywhere near 100%. Advanced Medical Optics (EYE), for instance, had 3 convertibles outstanding, totaling nearly $1 billion of face value.
The illiquidity of the market makes it impossible to say precisely where these bonds were trading before today. But a reasonable estimate is that the shortest-dated bond (holders have the right, in the absence of a transaction, to put this bond at 100% next year) was trading somewhere in the mid-80s, while the two longer-dated convertibles were far, far lower, in the 40s and 50s.
With the announcement that pharmaceutical power Abbott Labs (ABT) is buying EYE (which closed below $9 on Friday) for $22 cash, these bonds all become put-able at 100. If you bought one of these bonds below 50, that means your return will be comparable to what you would have made in the stock. You did this while owning a far safer investment, one that stood to pay you 100 upon maturity even if the stock went lower, as long as the company remained solvent.
I expect we'll see many more events like this over the next year or so, but often with far lower equity premiums than Abbott is paying for EYE. This is one of the beautiful things about buying severely busted (i.e., well below par value) convertible bonds.
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