Why is the Flight Centre (ASX:FLT) share price down 6% today?

Investors have booked a trip with Flight Centre’s newly-issued convertible debt.

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The Flight Centre Travel Group Ltd (ASX: FLT) share price has been on a jagged ride lately.

At the time of writing, shares in the travel retailing giant are changing hands at $20.28, down 6.33% on yesterday’s close.

Flight Centre shares are on the move today after the company successfully priced an issue of convertible debt overnight.

What was announced?

Flight Centre advised it had successfully issued an offering of $400 million in senior unsecured convertible debt for maturity in 2028.

The convertible notes (or bonds, as they are also known) will pay a coupon of 1.625% per annum, paid semi-annually.

This means bondholders will receive two payments at an interest rate of 0.8125% on their principal per year.

Flight Centre intends to use the net proceeds – about $393 million – to pay down existing debt and take advantage of the current ultra-low rates on fixed-rate debt financing to help fund its growth vision into the future.

A part of the debt repayment is allocated to the Bank of England Covid-19 Corporate Financing Facility.

This facility was afforded to the company last year and comes due in March 2022.

What is a convertible bond?

A note or bond is a type of debt instrument that is issued by a company to investors in order to raise money.

When executives are faced with financing decisions to grow the company or stay solvent, they generally have three choices: use cash on the balance sheet, issue more or new shares, or undertake a debt load.

Corporate bonds and notes are just a way for investors to lend a company money by purchasing the bonds. They then receive interest payments and their money back in full when the debt matures in 7 years.

Issuers must be of a high credit rating, and also have sufficient operating cash flows to service the debt obligations when they fall due.

Convertible notes are a particular type of bond that has a special option embedded into its fine print.

It allows investors the option to ‘convert’ their debt asset into equity if Flight Centre’s share price hits a certain level.

With this particular note issue, the conversion price is $27.30 per share. At that point, bondholders will have the opportunity – but not the obligation – to obtain Flight Centre shares at that price.

What does it mean for the Flight Centre share price?

Generally, all parties involved are fans of convertible debt.

For companies, it provides a lower-cost financing solution, as investors will accept a lower rate of interest for the chance to convert their bonds to equity later.

Companies also love convertible debt because when bonds convert, the debt is wiped clean off the balance sheet.

For investors, convertible notes are a very cheap way of obtaining equity, whilst providing some cover over the downside risk.

If Flight Centre’s shares don’t perform well, investors don’t have to convert and they will still earn a 1.625% return and receive their principal back in full.

This equates to a gross return of $2,985 at the tenor. However, if the share price does take off, then investors can convert at a ratio of 1:27.50, meaning if the share price hits $40, they can purchase the shares at a 31% discount.

Unlike fixed income, the upside potential in shares is unlimited, meaning the gross return is infinite (in theory).

However, conversion can dilute the holdings of other shareholders, as more individual shares are issued.

Flight Centre share price snapshot

The Flight Centre share price has gained 27% this year to date and 47% over the past 12 months.

This is well ahead of the 19% gain of the S&P/ASX 200 index (ASX: XJO) over 12 months.

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The author Zach Bristow has no positions in any of the stocks mentioned. The Motley Fool Australia’s parent company Motley Fool Holdings Inc. has no position in any of the stocks mentioned. The Motley Fool Australia has recommended Flight Centre Travel Group Limited. The Motley Fool has a disclosure policy. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.

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