Contingent conversion
Capital MarketsA convertible term that opens the right to convert only once a stated condition is met, so being in the money is not by itself enough.
Also written: contingent conversion feature, conversion trigger
A plain convertible lets the holder convert at will. A contingent conversion feature makes that right conditional, and the conditions are standard enough to be worth knowing by name. A price condition requires the shares to close above a set percentage of the conversion price, commonly around 130%, for a stated number of trading days in a quarter. A bond price condition opens conversion when the notes themselves trade below a stated fraction of their conversion value. There is usually a window near maturity in which the condition falls away, and a list of specified corporate events, of which a change of control is the one that matters most.
The issuer's motive is straightforward. Delaying the moment at which the notes behave like equity keeps the reported share count and the reported dilution lower for longer, and the feature was designed around that accounting outcome.
Under IAS 33 the shares are contingently issuable, and the condition is tested at the reporting date as though the reporting date were the end of the contingency period. Met at that date, the shares enter diluted earnings per share. Not met, they stay out even where the instrument is comfortably in the money. US GAAP is stricter and includes shares under a convertible whose trigger is a market price condition regardless of whether that trigger has been reached, so the same instrument can produce different diluted share counts on the two bases.
The practical instruction for a valuation is to read the terms before reaching for a method. A convertible that looks like equity on price alone may not be convertible at all today, and a bond that looks safely out of the money may convert anyway if the transaction you are modelling trips a corporate event trigger.
Worked example
Illustrative. A convertible with a conversion price of 10.00 carries a price condition of 130%, so the right to convert opens only once the shares have closed above 13.00 for the required number of days.
At a share price of 12.00 the notes are in the money by two euros a share and the holder still cannot convert. Under IFRS the shares stay out of diluted earnings per share at that reporting date, while under US practice they would be included.
A takeover at 15.00 a share trips the change of control trigger instead, and the conversion right opens regardless of where the price condition stood.