Mandatory convertible
Capital MarketsAn instrument that converts into shares at maturity whether the holder wants it to or not, so it counts as equity from the start.
Also written: mandatory convertible preferred, mandatory convertible bond
An ordinary convertible gives the holder a choice, which is why the whole apparatus of dilution tests exists. A mandatory convertible removes the choice: at maturity, usually two or three years out, it converts into shares regardless of where they are trading. The holder is not lending with an equity option attached, they are buying equity on deferred terms and collecting a coupon while they wait.
Because conversion is certain, the instrument never sits on the debt side of an enterprise value bridge the way a straight convertible does. It belongs in the share count from the outset, which is the opposite of the treatment straight preference shares receive, since those are a fixed claim ranking ahead of ordinary shareholders and are added in the bridge.
The number of shares is usually not fixed. A typical structure sets a lower and an upper conversion price with a band between them: below the lower price the holder receives a fixed maximum number of shares and takes the full fall, above the upper price they receive a fixed minimum number and give up part of the rise, and between the two they receive whatever number delivers a fixed cash value. For a model that means the diluted count is a function of the share price rather than a constant, so it has to be recomputed at your own implied price rather than lifted from the accounts.
Issuers reach for these when they need equity credit from a rating agency without printing ordinary shares at today's price, which is why they cluster around large acquisitions and around balance sheet repair. Agencies grant meaningful equity credit precisely because conversion is not optional.
Worked example
Illustrative. A mandatory convertible raises 200 with a lower conversion price of 20.00 and an upper conversion price of 24.00, converting in three years.
At maturity, shares at 18.00 deliver the maximum 10 million shares, worth 180, so the holder has taken the fall. Shares at 30.00 deliver the minimum 8.33 million shares, worth 250, so the holder has given up part of the rise.
Anywhere between 20.00 and 24.00 the share count adjusts to deliver 200 of value. In every case shares are issued, which is why the instrument sits in the diluted count from day one rather than in net debt.