'Hocus Pocus 2' Review Wi-Fi 6 Router With Built-In VPN Sleep Trackers Capital One Claim Deadline Watch Tesla AI Day Student Loan Forgiveness Best Meal Delivery Services Vitamins for Flu Season
Want CNET to notify you of price drops and the latest stories?
No, thank you

THE DAY AHEAD: Net stock weakness shows dangers of debt fad

Hot new Internet companies never seem at a loss for pulling in more capital. They all start with a big .com initial public offering. A few months later, the newly-minted Net companies tend to follow with a second offering of stock to the public. Now, the latest financial fad is convertible bonds.

This mad dash to the debt works out just fine as long as Internet stocks do well. But lately they haven't (chart).

Could the Net debt binge backfire?

Amazon.com Inc. (Nasdaq: AMZN) raised a massive $1.25 billion in January and opened the floodgates. Now CNet Inc. (Nasdaq: CNET), which raised $173 million; DoubleClick (Nasdaq: DCLK), $200 million; Beyond.com (Nasdaq: BYND), $55 million; Mindspring (Nasdaq: MSPG), $130 million; Sportsline (Nasdaq: SPLN), $150 million; and NetB@nk (Nasdaq: NTBK), $100 million; are also feeding at the convertible debt trough.

Who can blame them? For many of these companies convertible debt issues are the next best thing to free money -- as long as the prices of their shares keep rising.

Convertible bonds feature fixed interest payments to coupon holders of around 5 to 7 percent of the value of the note, paid in two chunks a year. Later, the company calls the bonds and investors to convert the securities to stock at a certain price. Many Internet companies set the conversion price at a 20 percent to 30 percent premium to their stock prices when the bonds are issued and raise more cash than they could with a secondary offering. In the end, a company still issues shares, but can put the earnings dilution off for a bit. "It's a cute way of issuing equity," said Steve Seefeld, president of Convertbond.com, an online bond tracking firm.

Debt issues are also easier to pull off.

Bruce Smith, an analyst with Jeffries & Co. said the roadshow for the sale of convertible debt takes about one-third of the time because the issues are sold privately to institutions. "There aren't a lot of SEC hoops," said Smith.

Amazon.com is the best example of how the convertible bond issue can work in a company's favor. Last month, Amazon was in striking distance of calling its notes due 2009. Amazon put in a rare provision where it has the right to call the bonds whenever its stock trades above $234.08 for 20 of 30 consecutive trading days.

Amazon was close to calling the bonds, but when the company on April 28 announced first quarter earnings and projected slower sales growth in the second quarter, shares dropped. Although it looks like Amazon will have to make that first semi-annual coupon payment of $29.6 million in July, most analysts think Amazon shares will trade in that magic $234 range in 1999, even though they are nowhere near that level now.

If Amazon shares trade at that lofty level, the online retailer can call the bonds and wipe the debt off its books. Amazon will then issue more shares. Earning dilution? Who cares? The company is expected to lose $1.70 a share in 1999 and $1.27 a share in 2000. With its new cash, Amazon can acquire smaller firms and invest in upstarts such as Pets.com, HomeGrocer.com and Drugstore.com.

"It's a no-brainer for a company growing as fast as Amazon, but if a stock plummets this turns into real debt," said Bill Schaff, a fund manager for the Information Technology 100 Fund.

Schaff said he expects a lot more Internet companies to issue convertibles as investment bankers push the debt as a way to finance growth.

But not all Internet companies can be Amazon.

"There will be some companies that get killed," said Schaff. Until then, the debt binge continues. Amazon.com last week said it was going back to raise another $2 billion in debt, common stock and preferred stock.