Conversion of preferred shares into ordinary shares. Three differences between preferred and common shares. What are Convertible Preferred Shares

The issue of preferred shares implies serious perpetual obligations of the JSC to make payments to investors, and this is possible if the company is confident in the stability of its financial position. As the analysis shows, foreign companies rarely and in small quantities run the risk of releasing indefinite preference shares... For the absolute majority of issues of such shares, companies stipulate their right to withdraw them after a certain period or convert them into ordinary shares. Formally, callable preferred shares are considered perpetual, but the issuer can redeem them, as is the case with bonds. Therefore, these shares are called revocable.

The right of the company to revoke preferred shares should be stipulated in the terms of the issue. At the same time, a specific date is stipulated from which the company can fully or partially redeem shares, or it is indicated in how many days the company is obliged to notify investors about the start of redemption. Usually, the notice will be sent 30 days before the start of the buyback. The notice specifies the redemption price, which provides for the reimbursement to the investor of the value of the security, the dividends due and a certain amount of the premium. Due to the fact that the redemption of preferred shares is the advantage of the company, and not the investor, the company pays a premium to the owners of the preferred shares for the right to repurchase, which is usually 1% of the share price.

The following valuation estimates can be taken as a basis for determining the value of the preferred share being repurchased:

• · Par value of a share. Setting the redemption price in the amount of the par value of a share is not entirely correct, since the market price of shares may significantly exceed the par. In this case, when buying back shares, investors will incur significant losses, since the size of the premium may not compensate for the difference between the market and par value shares;
• · The redemption price stipulated in the charter of the joint stock company. In this case, as a rule, the charter does not indicate a specific value, but provides a method for calculating the redemption price, the determination of which is based on the cost net assets per share;
• · The buyback price at the market value of the shares. In this case, stock quotes on the exchange and over-the-counter markets are taken as a base. The specific buyback price is set by the board of directors with the involvement of an independent appraiser or auditor.

In order to ensure the redemption of revocable preferred shares, in some cases joint stock companies create a redemption fund. In the terms of the issue of shares with a buy-back fund, the company is obliged to buy back shares if their price drops to a certain level. For example, it may be stipulated that the company deducts funds into a buyout fund in order to annually redeem 5% of the revocable shares if their price falls to the level of the offering price. This protects the owners of revocable shares. If quotes are growing, then the company may not buy back shares or buy them at market prices. If the quotes fall to a certain level, then the firm redeems them. In this case, the stock price stabilizes. As the buyback progresses, fewer and fewer shares remain outstanding, increasing the value of assets per share and increasing market value shares.

Many companies, when issuing callable shares, provide for the creation of a deferred fund. Unlike a buyout fund, it is formed by regular annual contributions in order to redeem the entire issue of preferred revocable shares within a certain period of time. The deferred fund is used to buy shares on the open market as well as to buy out shares directly from shareholders. The fundamental difference between a deferred fund and a buyout fund is that if a company has failed to purchase shares on the open market, it has the right to offer the shareholders to surrender them at a price of the deferred fund, which may be lower than the market price. A deferred fund, on the one hand, protects the interests of investors when shares are bought up on the open market, thereby providing market support when market prices decline. On the other hand, if the market price of the shares is higher than the price of the deferred fund, then when the shares are called back, the investor suffers certain losses. However, the remaining outstanding shares increase in value and may be paid a higher dividend as profits are spread over fewer shares.

Usually, the redemption of callable shares is a privilege of the company. But the investor does not have clear guarantees that these shares will necessarily be canceled. To increase the attractiveness of revocable preferred shares, in a number of cases, retroactive shares are issued, the right of redemption of which belongs to the investor. The owner of a share has the right to present it for redemption at a predetermined price, after notifying the company in advance.

In some cases, firms resort to the issue of convertible preferred shares, in the terms of the issue of which it is possible to exchange them for ordinary shares. In this case, the conversion period, the conversion price, the number of ordinary shares that can be received in exchange for one preferred share, and other parameters are established. By analogy with bonds, the conversion price at the initial stage is indicated below the level of market prices for ordinary shares, since otherwise the issue of convertible shares becomes meaningless. In most cases, when issuing convertible preferred shares, a company makes them revocable in order to manage the conversion process.

Buying stocks always creates the risk of losing money, but avoiding stocks altogether means that you are unable to make good profits. However, there is one safety that may help solve this dilemma for some investors: convertible preferred shares provide the assurance of a fixed rate of return plus the opportunity for capital appreciation. Here we look at what these securities are, how they work, and how to determine when a conversion is profitable.

What are Convertible Preferred Shares

These shares are corporate securities with a fixed income that an investor can choose to convert into a certain number of shares of the company's common stock after a given period of time or on a specific date. The fixed income component provides a steady stream of income and some capital protection for investors. However, the ability to convert these securities into shares enables the investor to benefit from the rise in the share price.

Convertibles are especially attractive to those investors who want to participate in the growth of high-growth companies while being insulated from price declines if the stock falls short of expectations.

Investor opportunities

To demonstrate how convertible preferred stocks work and how stocks benefit investors, let's look at an example. Let's say Acme Semiconductor issues 1 million Convertible Preferred Shares at $ 100 per share. These convertible preferred shares (since they are fixed income securities) give holders priority over ordinary shareholders in two ways. First, the convertible preferred shareholders receive a 4.5% dividend (assuming Acme's profits remain sufficient) before any dividends are paid to ordinary shareholders. Second, convertible preferred shareholders will be ahead of ordinary shareholders in returning capital if Acme ever goes bankrupt and its assets are to be sold. However, convertible preferred shareholders, unlike ordinary shareholders, rarely have voting rights.

By buying Acme Convertible Preferred Shares, the worst investors will ever receive $ 4.50 per annum in dividends per stake they hold. But these securities offer owners an even higher return opportunity: if convertible preferred shareholders see an increase in Acme shares, they may have the opportunity to profit from that increase by converting their fixed income investment into equity. On the date of the dump, shareholders of Acme's convertible preferred shares have the option to convert some or all of their preferred shares into ordinary shares.

Determining Conversion Profit

The conversion rate is the number of ordinary shares that shareholders can receive for each convertible preferred share. The conversion rate is set by management prior to issue, usually with management investment bank... For Acme, let's say the conversion rate is 6.5, which allows investors to trade preferred shares for 6.5 Acme shares.

The conversion rate indicates what price of common stock must be traded in order for the preferred shareholder to earn from the conversion. This price, known as the conversion price, is equal to the purchase price of the preferred stock divided by the conversion rate. So for Acme, the market conversion price is $ 15.38 ($ 100 / 6.5).

In other words, Acme common stock must trade above $ 15. 38 for investors to get from the conversion. If the stock converts and falls below $ 15. 38, investors will suffer a capital loss on their investment of $ 100 per share. If the common stock ends at, for example, $ 10, then the convertible preferred shareholders will receive only $ 65 ($ 10) common share in exchange for their $ 100 preferred share. ($ 100 represents the parity value of preferred shares.)

Conversion Reward

The convertible preferred shares may be traded at secondary marketand market price and behavior are determined by the conversion premium, the difference between the par value and the value of the preferred shares if the shares were converted. As shown above, the value of the converted preferred share is equal to the market price of the common shares multiplied by the conversion rate. Let's say Akme shares are currently trading at $ 12, which means that the value of the preferred shares is $ 78 (12 x 6 5). As you can see, this is well below the parity value. So, if Acme is trading at $ 12, the conversion premium is 22% [($ 100 - $ 78) / 100].

The lower the premium, the more likely it is that the market price of the conversion will match the total stock price up and down. Higher-end convertibles act more like bonds as they are less likely to have a chance for a profitable conversion. It means that interest rates can also affect the value of convertible preferred shares: for example, the price of bonds, the price of convertible preferred shares usually decreases as interest rates rise: a fixed dividend looks less attractive than rising interest rates. Conversely, convertible preferred shares become more attractive as rates fall.

The bottom line

Converts calls for investors who want to participate in stock marketwithout feeling like they are taking wild risks. Trading securities like stocks when the price of the common stock moves above the conversion price. If the share price falls below the conversion price, convertibles trade just like a bond, effectively placing the price floor under the investment.

We are often approached by shareholders with a desire to sell certain shares. Sometimes, when they hear the final value of their shares, they are very surprised. Their surprise is due to the fact that they really expected to hear a completely different figure. Moreover, both up and down.

It's not about our greed or the complete ignorance of shareholders, but about the conversion of shares. For many years of owning shares, shareholders simply did not know that since then their shares have been converted (and sometimes more than one). The shares of many companies have undergone changes, i.e. conversion.

The most "harmless" type of share conversion is when preferred shares are converted into ordinary shares one to one, ie. 1 preferred share simply became 1 ordinary share and the total number of shares in this case is easy to calculate. For example, such a conversion took place in companies such as Lukoil, Rosneft and a number of others.

But most often the conversion does not take place 1 to 1, i.e. for example, 1 share can be converted into 5 or vice versa - 5 into 1. And it happens that a company has completely changed its legal name or merged with another enterprise.

To understand all this "mess of conversions", we decided to lay out reliable information on the conversion of each specific issuer (enterprise) separately:

Conversion of Alrosa shares

The shares of Alrosa were fragmented; 1 old (active) promotion turned into 27005 new... But the final cost of the block of shares has not changed.

Conversion of Norilsk Nickel shares

The Norilsk Nickel enterprise was previously a Russian Joint Stock Company (RAO), now the company is called the Mining and Metallurgical Combine (MMC) Norilsk Nickel. All shares of RAO Norilsk Nickel were converted into MMC Norilsk Nickel in a ratio of 1 to 1, but provided that the shareholder wrote a statement for the transfer of shares (at one time, each shareholder was sent a written notice of the mandatory transfer of shares). Otherwise, the shares are invalid and it is impossible to sell the shares of RAO Norilsk Nickel now.

Conversion of Lukoil shares

Lukoil shares were converted easily. 1 preferred share converted to 1 ordinary share, i.e. 1 to 1.

Conversion of Rosneft shares

Rosneft shares were also converted easily. 1 preferred share in 1 ordinary share, i.e. 1 to 1.

But also several, once separate companies were converted to Rosneft, and here the proportions are completely different:

Sakhalinmorneftegaz:

1 ordinary share was converted into 2.98 ordinary shares of Rosneft

1 preferred share converted into 2.23 ordinary shares of Rosneft

Purneftegaz:

1 ordinary share was converted into 6.09 ordinary shares of Rosneft

1 preferred share converted into 4.57 ordinary shares of Rosneft

Stavropolneftegaz:

1 ordinary share was converted into 24 ordinary shares of Rosneft

1 preferred share converted into 16.8 common shares of Rosneft

Arkhangelsknefteproduct:

1 ordinary share was converted into 0.376 ordinary shares of Rosneft

1 preferred share converted into 0.263 common shares of Rosneft

Conversion of Rostelecom shares

In Rostelecom, the conversion of shares took place in 2012. Many shareholders have statements with the number of shares that does not correspond to the real number. The fact is that before the conversion there were several companies (by regions of Russia): Dalsvyaz, Dagsvyazinform, Volgatelecom, North-West Telecom, Sibirtelecom, Uralsvyazbinform, Central Telecommunication Company, South Telecommunication Company. All these companies were converted into one company - Rostelecom.

Moreover, all shares from common and preferred were converted only to common. It is best to check the conversion and find out the number of Rostelecom shares you own at the moment on the website of Rostelecom itself. For this it is enough in any search engine to introduce Rostelecom calculator. Rostelecom shareholders also receive voting letters, which indicate the number of votes. This is the number of ordinary shares owned by the shareholder.

Conversion of Sberbank shares

Most shareholders received their shares of Sberbank in 1993 in the form special certificates. 1 ordinary share in 1993 was converted into 1,000 ordinary shares, and 1 preferred share was converted into 20 preferred shares.

Conversion of TATNEFT shares

1 share of Tatneft in 1994 was converted into 100 shares. This applies equally to both common and preferred shares.

Conversion of MMK shares

1 share of Magnitogorsk Metallurgical Plant (MMK) was converted into 1200 shares.

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