A conversion premium is the amount by which the price of a convertible security, such as a bond, exceeds its conversion value—the value of the underlying common stock into which it can be converted. This premium reflects the additional cost investors are willing to pay for the option to convert the bond into equity at a predetermined price.
Calculation of Conversion Premium:
1. Determine the Conversion Value: Multiply the current market price of the stock by the number of shares the bond can be converted into (the conversion ratio).
2. Calculate the Conversion Premium: Subtract the conversion value from the current market price of the convertible bond.
Example:
• Convertible Bond Price: $1,200
• Conversion Ratio: 40 shares
• Current Stock Price: $25
Conversion Value: 40 shares × $25 = $1,000
Conversion Premium: $1,200 (bond price) – $1,000 (conversion value) = $200
In this example, the conversion premium is $200, indicating that investors are paying an extra $200 for the option to convert the bond into stock at the specified terms.
MicroStrategy’s Convertible Senior Notes Offering:
On November 20, 2024, MicroStrategy announced the pricing of its $2.6 billion offering of 0% convertible senior notes due 2029. The initial conversion price is approximately $672.40 per share, representing a premium of about 55% over the volume-weighted average price of MicroStrategy’s class A common stock, which was $433.80 at that time.
This means investors are willing to pay a 55% premium over the current stock price for the option to convert their bonds into equity at a future date, reflecting their confidence in the company’s potential for stock price appreciation.
Understanding the conversion premium is crucial for investors evaluating convertible securities, as it indicates the additional cost for the conversion option and helps assess the attractiveness of the investment relative to the underlying stock’s performance.