A contingent issuance refers to a potential future issuance of financial instruments, such as stocks, bonds, or other securities, based on the occurrence of specific events or conditions. The issuance of these instruments is not guaranteed and depends on the predefined events or conditions being met, as specified in the issuance agreement or offering documents.
Contingent issuances are often used to raise capital for a company or to finance specific projects, acquisitions, or other business initiatives. They can also be used to manage financial risks, such as interest rate risk or currency risk, by issuing securities with features that are triggered under specific circumstances.
Some examples of contingent issuances include:
- Contingent convertible bonds (CoCos): These are hybrid debt instruments that can be converted into equity under certain conditions, usually related to the issuer’s financial health or regulatory capital requirements. CoCos are often used by banks to strengthen their capital structure and meet regulatory requirements.
- Contingent value rights (CVRs): CVRs are financial instruments that entitle the holder to a potential future payment based on the occurrence of specific events or conditions. CVRs are often used in merger and acquisition transactions as a way to bridge valuation gaps or to provide additional consideration if certain performance targets are met.
- Contingent share issuances: In this case, a company may issue additional shares to existing shareholders or new investors if certain conditions are met, such as achieving specified financial performance targets or completing a specific project or acquisition.
- Warrants: Warrants are financial instruments that give the holder the right, but not the obligation, to purchase a company’s shares at a specified price within a specified period. The issuance of shares upon the exercise of warrants is contingent on the warrant holder’s decision to exercise the warrants.
Contingent issuances can provide companies with additional flexibility in raising capital or managing risks, as they can be structured to align the interests of the issuer and the investors. However, the contingent nature of these issuances also introduces uncertainty and complexity, as the future issuance of securities and the resulting impact on the company’s financial position and capital structure depend on the occurrence of specific events or conditions.
Example of Contingent Issuance
Let’s consider an example of a biotechnology company, BioPharma, that is developing a promising new drug to treat a specific disease. BioPharma is planning to finance the drug’s clinical trials, regulatory approval process, and marketing efforts through a contingent issuance.
BioPharma decides to issue contingent convertible bonds (CoCos) to raise the necessary funds. The CoCos have a principal amount of $50 million and a maturity date of five years. The bonds carry an annual interest rate of 5% and include a contingent conversion feature.
According to the terms of the CoCos, the bonds will automatically convert into equity (common shares) of BioPharma if the company receives regulatory approval for its new drug within three years from the issuance date. The conversion rate is predetermined, specifying the number of common shares that each bondholder will receive upon conversion.
The contingent issuance of CoCos allows BioPharma to raise the capital it needs for its drug development while aligning the interests of the bondholders and the company. If the drug receives regulatory approval and the CoCos are converted into equity, bondholders become shareholders in the company, benefitting from the potential upside of the new drug’s success. In this scenario, BioPharma also benefits from the conversion, as it no longer has to repay the principal amount of the bonds and can reduce its interest expenses.
If the drug fails to receive regulatory approval within the specified timeframe, the CoCos will not be converted into equity, and BioPharma will continue to pay interest on the bonds until their maturity date, at which point it will be required to repay the principal amount to the bondholders.
In this example, the contingent issuance provides BioPharma with the necessary funds for its drug development, while the conversion feature allows the company and investors to share the risks and rewards associated with the drug’s success.