Atanas,

The market values or fair values of BioMarin’s convertible bonds are on pg. 18 / 70 of the 10-Q quarterly report under “Fair value of fixed rate convertible debt”.

For Jazz, the convertible bond fair values are on pg. 18 / 95 of the 10-Q quarterly report in this section:

“As of June 30, 2021, the estimated fair values of our 1.875% exchangeable senior notes due 2021, or the 2021 Notes, our 1.50% exchangeable senior notes due 2024, or the 2024 Notes, and our 2.00% exchangeable senior notes due 2026, or the 2026 Notes, collectively known as the Exchangeable Senior Notes, were approximately $221 million, $633 million and $1.3 billion, respectively.”

Atanas,

1) Face value bond – market value bond = market value equity component is only true when the bond is first issued. This is because the equity component stays the same until the bond converts or matures, but the other components may change over time.

2) While this is theoretically possible, it’s not a very likely scenario because if the company’s share price has increased tremendously, the convertible bondholders would convert their bonds into shares.

For example, if the conversion price is $100, the bond holders bought their bonds when the company’s share price was $60, and now the company’s shares are worth $500, they would be crazy to hold the bonds and not convert them into shares.

Even if they think the company’s share price is going to crash, they could still convert now and sell before the share price crashes.

The usual assumption in models is that once the share price exceeds the conversion price, the convertible bond is converted into shares, so the debt component on the Balance Sheet is removed.

Atanas,

The company here is just saying that they based the equity component of the bonds on the total convertible bond face value upon issuance minus the value of the bond component.

The value difference is due to a much lower interest rate on the convertible bond vs. a much higher interest rate on “a similar debt instrument that does not have an associated conversion feature.”

The unamortized debt discount and the equity component of the bond do not have the same value because of the total amount of debt discount amortized so far.

If you look at the tables for 2018 and 2019, the total amortization over both years is about $40 million, and $84 million + $40 million = $124 million, which is very close to the $125 million they list for the equity component.

This is what we illustrated in the previous lesson on convertible bond accounting, where the equity component stays the same until conversion or maturity, even as the book value of debt keeps increasing due to the amortization of the debt discount.

Atanas,

The quoted price of a convertible bond reflects both the equity and debt components, so it represents the bond as a whole, not just one of the components. The PV of expected future cash flows method applies to just the bond component. If you use that, you have to value the equity component separately (see Module 15 on Netflix).

Yes, if Zendesk gives the price for the “convertible senior notes” without splitting up the components, it’s the price for the entire bond together.

Do you get the market value of the convertible bonds in Biomarin and Jazz yourself? I could not find the values on the statements. What is the calculation there? Thanks

1) Is the equation Face value bond – market value bond = market value equity component always true or only in year 0 for accounting purposes?

2) Is the following scenario both correct and possible?
Example: OID = market value of the equity component = unamortized debt discount in year 0 = 150 mill. In say, 5 years, the unamortized debt discount (what we use to subtract from the bond’s principal amount along with unamortized issuance fees to get the bond’s book value) is say 5 mill, but since the share price grew enormously, the fair value of the equity component is 700 mill?

We know that the book value of a convertible bond = face value of the bond – market value of the equity component – issuance fees = principal amount of the convertible bond – unamortized debt discount – unamortized issuance fees.

How is this statement by Zendesk on page 86 useful? We already have the book value of the debt component by using the equation above. And the equity component is 84 million, not 125 million, no?

“…the Notes were separated into liability and equity components. The carrying amount of the liability component was calculated by measuring the fair value of a similar debt instrument that does not have an associated conversion feature. The carrying amount of the equity component representing the Conversion Option was $125 million and was determined by deducting the fair value of the liability component from the par value of the Notes”

Thank you Brian.

Just a quick follow up on the fair value of the debt component of a convertible bond:
Can in it be based on the quoted price of convertible bonds in an inactive market (market approach)?
Or is this approach (market approach) relevant only for the equity component and the debt component is always calculated based on the PV of expected future cash flows (income approach)?

I am inspired by p. 82 of Zendesk’s financial report, it estimates the fair value of the bond (793) based on the “…quoted price of the convertible senior notes in an inactive market on the last trading day of the reporting period.” The company estimates the whole bond (not equity end debt separately) and classifies it as level 2, right?

Nadikatla,
The “Total Beta” concept comes from Damodaran. He recommends that we adjust the median of the listed company betas for the “market correlation factor” and “portfolio diversification factor.”

Market correlation would be calculated using regression of the total market value of companies in the sector against the index as a whole. You can think of it like the beta of the industry rather than an individual company.

We can’t easily determine the ‘portfolio diversification factor’ for the buyer. But we can assume the buyer doesn’t hold one company at 0% diversification. In this case a subjective assumption of 25% diversification is made.

To get total beta, you then might divide the median Unlevered Beta from the comps by the square root of the market correlation factor and multiply by (1 – portfolio diversification factor).

I wouldn’t worry too much about these concepts as it would be rare for them to come up in interviews or in practice.

1) Can you please what they mean and why they are used in Median “Total ” Unlevered Beta ?
2) Where Can I get Market Correlation?