CB vs BW vs EB, How Conversion and Exercise Prices Affect Dilution

TL;DR

• A CB is a bond with an embedded right to convert into the issuer's shares under specified conditions. A BW pairs a bond with a separate warrant, which requires exercise to create shares. An EB grants the right to exchange into another company stock held by the issuer.
• Each instrument affects share count (dilution) and balance sheet differently, so calculate the impact using issuance terms and conversion/exercise prices.

1. Definitions: What differs between CB, BW, EB

• Convertible Bond (CB): A debt instrument that carries the right to convert into the issuer's common shares within a defined period and at defined rates per the issuance terms.
• Bond with Warrant (BW): A bond issued together with detachable warrants. A warrant is the right to subscribe for new shares at a set price in the future, and shares are created only upon exercise.
• Exchangeable Bond (EB): A bond that grants the holder the right to exchange into shares of another company that the issuer owns. This can be a way to dispose of owned assets.

2. Why it matters: issuer and investor perspectives

• Issuer: These instruments can lower borrowing costs or delay and control the timing and volume of equity issuance, while conversion or exercise can dilute existing shareholders.
• Investor: They combine bond-like protection with upside potential if converted or exercised. Exercise conditions, maturities, conversion prices, and strike prices are key to assessment.

3. Common misconceptions corrected

• Misconception 1: CBs and BWs always become equity. In reality, CB conversion depends on investors choosing to convert, and BW warrants only create shares if exercised.
• Misconception 2: EBs always dilute the issuer. EBs often exchange into third party shares the issuer already holds, which can avoid issuing new shares by the issuer.
• Misconception 3: Dilution is a simple ratio. Actual dilution depends on conversion/exercise price, conversion ratio, outstanding shares, and market price at exercise, among other factors.

4. Example calculation with hypothetical numbers

Scenario: Company A has 10,000,000 existing shares (hypothetical). It issues one of the following to raise additional funds.

• CB terms: total 10,000,000,000 KRW, conversion price 10,000 KRW

Example calculation: At conversion price 10,000 KRW, shares issued = 10,000,000,000 KRW ÷ 10,000 KRW = 100,000 shares. (Simple example; actual conversion ratios may consider fractional shares and adjustment clauses)

• BW terms: total 10,000,000,000 KRW, warrant strike 12,000 KRW, potential new shares from warrants = 10,000,000,000 KRW ÷ 12,000 KRW = approximately 83,333 shares. Shares are created only if warrant holders exercise.

• EB terms: total 10,000,000,000 KRW, exchange into B Company shares held by the issuer. If the issuer provides 100,000 B Company shares (already owned) for exchange, EB holders would take those shares and the issuer would dispose of that asset. In this case, A Company would not directly issue new shares, so existing shareholders might not experience dilution.

Note: For CB and BW, actual shares issued depend on conversion/exercise prices. For EB, dilution depends on whether the exchange uses owned shares of the issuer.

5. Practical checklist

• Verify conversion/exercise prices and adjustment clauses, including triggers tied to share price movements.
• Estimate potential dilution by comparing conversion/exercise-adjusted shares to current outstanding shares.
• Review bond terms such as maturity, coupon, and early redemption features alongside equity-related clauses.

This article is for informational purposes and does not constitute investment advice.