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Convertible Bonds of Countrywide Financial Corporation Case Solution

Solution Id Length Case Author Case Publisher
2547 1168 Words (6 Pages) Ravi Jagannathan, Zhi Da Kellogg School of Management : KEL323
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The new securities have different settlement features as compared to the old debt security. The new security would be converted to cash and stock while the old security would only be converted to stock. The payment of cash along with conversion to a stock would protect Countrywide to dilute its shareholding (SECP US). The cash may payment along with shares tends to reduce the conversion rate which may be higher in the old security thereby resulting in dilution of ownership as more stocks would be issued upon conversion. The lower dilution would allow the company to report better profitability and earnings results per share.

Following questions are answered in this case study solution

  1. What could be the reasons behind the exchange offer? 

  2. Why should the market care about the method of EPS computation? 

  3. How are the conversion proceeds determined in the case of the new convertible security? Is this a common practice? 

  4. Would you accept the exchange offer? 

  5. Will the call and put features affect the pricing of the new convertible security? 

  6. What will be the conversion proceeds in $ terms on October 20th, 2004? 

  7. What is the reason behind the sudden increase in the convertible bond trading on October 20th, 2004? 

  8. What is the cost to the investors and the company?

Case Analysis for Convertible Bonds of Countrywide Financial Corporation Case Solution

2. Why should the market care about the method of EPS computation? 

The EPS computation is an important element of the company's profitability and considerably derives the stock price of the company. Higher EPS would help to build a positive expectation about the company’s stock price (Nirmal Bang). In the case of Countrywide, the company reported EPS of 92 cents which fall short of the analyst expectations of $1.01. In this regard, the stock price of the company adjusted accordingly. Moreover, the convertible security also has an impact on the EPS whereby a high conversion ratio would result in a diluted EPS which is less than the actual EPS. 

3. How are the conversion proceeds determined in the case of the new convertible security? Is this a common practice? 

The conversion proceeds of new security have two elements. Firstly, cash is paid which is equivalent to the lessor of the accredited principal amount of the new security, and secondly the number of common stock equal to the product of the conversion rate & average stock price (adjusted by the cash payment) divided by the stock price. Generally, the cash conversion is made of the settlement when the company is expected to perform well in the future thereby allowing the company to pass on the benefit of the healthy financial performance to the existing shareholders. If it is expected that the company's performance may remain under check on account of various external or internal factors, the company is more motivated to attach solely for settlement upon conversion. 

4. Would you accept the exchange offer? 

The stock price of Countrywide during the period when the exchange offer is valid seems to perform better as compared to the previous levels. The stock was trading at $34.3 at the start of the period when the exchange offer was valid and increased to the level of $37.5 during the mid of Sep close to the maturity of the exchange offer.

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