At the peak of the tech bubble, several groups including Peloton issued convertible bonds with a zero coupon. The group known for its exercise bikes and its high-tech treadmills has raised a considerable amount of 1 billion dollars via this instrument. At the time, the market’s appetite for these companies that promised infinity and beyond was such that they could issue interest-free debt. As for the conversion option, it gives access to Peloton shares at 239 USD for a maturity of 2026. This shows how investors had a remarkably absurd view of Peloton’s situation, knowing that the share is currently around 10 USD, compared to 171 USD one evening in January 2021. The narrative was completely reversed in just a few weeks.
Features of the Peloton Convertible (Bloomberg screenshot)
In short, it is not the conversion clause that makes the interest of this bond instrument, unless you estimate that Peloton can rise to 239 USD by 2026. It is rather its senior character and its discount of 35 % on par. In other words, even without a coupon or conversion, it remains a debt security redeemable at maturity, within four years. If Peloton doesn’t go bankrupt by then of course!
It should however be noted that the liquidity is hyper-limited, so it is not easy to access the security market. This type of situation is therefore reserved for particularly sophisticated investors with access to prime brokers, who can bear high transaction costs and must also benefit from adequate taxation.
But in a simple posture of observer it is interesting to be interested in these products to take the pulse of the market. About a year ago, credit investors—supposedly much more conservative than equity investors—were willing to lend zero coupon to Peloton. Which remained an unprofitable startup with high cash-consuming power. Why ? Because they considered it very likely that the action would rise to 200 USD, which implied a capitalization of 80 billion dollars including the dilution linked to stock options. That’s really called playing with fire.
Thus, we can see that one twelve months only, the narrative can be completely reversed, and that even credit investors can act in an unreasonable way. A good opportunity to recall the wisdom of Warren Buffett: “to be shy when others are greedy and greedy when others are shy“.