SOFI Convertible Note: Part 3

Disclosure: The author owns securities in the referenced company or companies. This is not financial advice or a recommendation, and not a substitute for due diligence. 

Because this is a newer convertible note structure for me, I reviewed SOFI with a few friends who do IG bonds. Spoiler: I now find the FV vs CECL discussion so ridiculous I refuse to acknowledge it going forward (special note to those folks if you read to the bottom). 

Also, all of my convert posts ARE BULLISH, NOT BEARISH from the point of view of my cost basis and specifically when I posted which was $7.25. They are designed to identify trigger points for those:

a) Looking to accumulate

b) Using options to accumulate (so sellers of puts, not sellers of calls)

BACKGROUND:

This convertible note occurred at: $7.27/share (which creates the breakpoints)

Conversion: $9.45 (meaning they raised money at $9.45 when the stock was lower)

Holder Conversion Benefit: $12.27 (holders can freely convert)

Cap Call: $14.54 (stockholders are protected up to this share price, the company owes cash, stock, or a combo)

This is a newer convert structure similar to UBER’s 2023 converts. Still, it has unique attributes.

WHAT MAKES SOFI’S CONVERT UNIQUE?

A) Steps and triggers. This uses a newer convert structure similar to UBER’s 2023 bonds, but that is not like most convertible bonds. 

B) The number of shares. 90m is 9% of shares outstanding, 3d of volume. For contrast, while Uber raised $1b, its share price meant it was only <13m shares or 1d volume & <2% of shares outstanding. While dilution is already incorporated, volume is a b**ch.

C) Free Convertibility Period. Relative to the Uber Convert, this bond gives 6m instead of 1m. This will create some gaming if the bonds are not converted.

D) Corporate action language. Both UBER & SOFI have fairly extensive corporate action language. This is important, b/c it is one of the few ways that SOFI - if it doesn’t get a MOASS could get to the $25 price for 2026 (I'll do a separate post).

CLARIFICATION FOR CONVERSION: 

Section 5.01(C)(ii)(1) allows for conversion at any time the stock trades above $12.27 for 20 of 30 trading days (does not have to be consecutive within the 30 days).  This is a very poorly written version of the way I usually see this clause. As such, it created initial confusion for me, so my apologies.

Link to 8K filing with terms: https://d18rn0p25nwr6d.cloudfront.net/CIK-0001818874/0fe0c10e-249e-45f2-9400-4e5ff3ae137e.pdf

HOW IS IT POORLY WRITTEN EXACTLY?

The reason it’s poorly written is 3 reasons. 

A) First, the sentence structure differs dramatically from other convertible bond covenants which are more direct. 

B) Second, it sets the conversion period to the last interest payment leaving a full 6 months for what it’s calling the “Freely Convertible Period.” In contrast to UBER’s. 

C) Finally, I didn’t want to believe it b/c of the implied cost of capital.

WHAT'S WRONG WITH THE IMPLIED COST CAPITAL?

Section 5.01(C)ii(1) implies that if the share spikes up and holds $12.27 as an average price for 20 of 30 trading days very quickly, then this debt was quite expensive. With the stock down here, it's a nothing burger. It gets annoying as the stock gets to $12.27 though.

For a convert, the implied cost of capital to the company is the equity appreciation (dilution effect) plus the rate on the convert (1.25%). Current 5yr IG Bank debt is <6%. On the quick math:

2027 implies ~9%

2029 implies ~6%

SHOULD I BE MAD AS A SHAREHOLDER?

Not necessarily. The dilution is done and equity holders participate in the upside. 

A) While net interest margins are whatever you lend at adj for your capital cost, you do have higher turnover in a declining rate environment.

B) The stock isn't anywhere near $12.29 right now*, so a 6% 5-year rate isn't out of the norm. (* at the time of this post)

C) SOFI has infra buildout and using equity to fund that is reasonable. 

HOWEVER....Shareholders should note the following:

A) While dilution has occurred, should this hit $12.27 and the actualization/realization of the dilution would involve 3 days of trading volume. 

B) Since convert holders typically do not convert immediately, this will be an overhang on the stock every time it happens it gets close.

C) While folks suggest the capped call protects you, it's done over $14.54 

D) The 2027 bond redemption provision seems the more helpful buffer provided a MOASS doesn't hold before that time. 

WHAT IS THE FLOOR PROVISION ALL ABOUT? 

The bondholders have a floor provision that ensures the bonds move with the stock. These bonds do not trade!!! But if the bondholders began to feel the bonds would trade at a discount of more than 2% to the implied price of the stock’s upside, they get to convert regardless of the price. (section 5.01.C.ii2). You do this if you think the stock will get MOASSed and hold and you want to be able to sell into it. 

ANYTHING ELSE? (Yes 3 things)

There are a lot of rather specific provisions related to corporate action in this Convert. While it is similar to UBER, the way it's written has inspired me to write a different post. It's not been a stated strategy of management though.

ALSO, if you know debt well enough to wax philosophic about FV you should be able to read this convert filing well enough to know the whole FV vs CECL issue is a total red herring. I'm done with FV vs CECL discussions.

Finally, the outsized Put/Call Activity on the August monthlies was likely related to FED uncertainty, not this convert.

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