Convertibles are typically either preferred stock that can be converted into the shares of the issuer (convertible preferred), or notes or bonds that can be converted into equity (convertible debt) at a set exchange rate.
Option-pricing models are sometimes useful when valuing convertible securities, because both convertible debt and convertible preferred stock can often be valued as bundles of securities (i.e., as a combination of debt, equity and options). However, because the economic implications of the many different rights held by convertible security holders can be complex, more sophisticated models are often required, such as lattice (binomial) or stochastic (Monte Carlo) methods. As with warrants and restricted stock, an adjustment must be made for the illiquidity of such securities.
Both public and private companies issue convertibles, but, even if an issuer is public, its convertibles are usually not registered for public trading. For that reason, convertibles are considered to be illiquid and must be valued accordingly. The LiquiStat™ database provides evidence that can serve as a benchmark for what the discount from the theoretical values should be.
For more information on our valuations of convertible securities, contact Pluris today.