Fundamental change
Capital MarketsA convertible indenture's change of control clause, giving holders a put at par and a temporary increase in the conversion rate.
Also written: fundamental change provision, change of control conversion
Almost every convertible indenture defines a fundamental change, covering a change of control and normally also a delisting or a restructuring that leaves holders with something other than freely traded shares. It matters because it turns a document nobody reads into a line in the funding table of a live deal.
Two rights typically follow. The holder gets a put, the right to require repurchase at par plus accrued interest, which is a cash claim the buyer has to fund. And a conversion window opens in which the conversion rate is temporarily increased on a grid printed in the indenture, indexed to the effective date of the transaction and to the price per share being paid.
That increase is compensation rather than a windfall. A holder converting because of a takeover surrenders the remaining time value of an option they paid for through a below market coupon, and the grid is the document's way of paying for it. It is deal specific: the same instrument produces a different uplift at a different price or a different date.
The consequence for a buyer is that the shares delivered are not the face value divided by the stated conversion price. They are more, sometimes materially more, and the figure has to be built from the grid rather than read off the balance sheet. Which of the two rights holders take is arithmetic: they convert when the shares they would receive are worth more than par and put the notes back when they are not, so a buyer models both outcomes and funds the one that will happen.
Worked example
Illustrative. A target has 120 of convertible notes at a conversion price of 10.00, so 12 million shares on the base terms, and an offer values each share at 15.00.
Converting on the base terms delivers 180 of value against a put that returns 120 in cash, so the holders convert. An uplift of ten percent from the grid gives 13.2 million shares worth 198.
A liability carried at 120 has therefore cost 198 of consideration. Had the offer been below the conversion price the holders would have put the notes back instead, and the cost would have been 120 of cash at closing.