What Is A Death Spiral Convertible? Michael Burry Sounds The Alarm For Meme Stock Fans

Zinger Key Points
  • The term is most commonly used in reference to high-yield convertible bonds issued by companies that are in financial distress.
  • Bed Bath & Beyond, which may be on the verge of bankruptcy, announced a convertible preferred share issue on Monday.

Michael Burry, the millionaire born out of the subprime mortgage crisis back in 2007 and known for constantly deleting his tweets (and his account), gave meme stock investors a bit of homework.

What Happened: The “Big Short” investor told meme stockholders in a since-deleted tweet that it was time to “look up what a death spiral convertible is.”

So, AMC Entertainment Holdings Inc AMC and GameStop Corp. GME holders, Benzinga is here to tell you.

A death spiral convertible is a type of convertible security that is structured in such a way that the conversion price decreases over time, making it increasingly likely that the security will be converted into common stock.

This downward trend in the conversion price, or "spiral," can create a negative feedback loop that drives the price of the convertible security down further, hence the name "death spiral."

Read Also: Bed Bath & Beyond Latches Onto 'Lifeline' But Retailer Is Still Knocking At Bankruptcy's Door: Why This Analyst Says Shares Are Worth A Quarter

The term is most commonly used in reference to high-yield convertible bonds issued by companies that are in financial distress.

When a company's stock price falls, the conversion price of the death spiral convertible also decreases, leading to increased conversion and dilution of the company's existing shares. This, in turn, puts additional downward pressure on the company's stock price.

Investing in death spiral convertibles is considered highly speculative and carries a high degree of risk — which brings the topic to Bed Bath & Beyond Inc BBBY.

Bed Bath & Beyond, possibly on the verge of bankruptcy, announced a convertible preferred share issue on Monday.

In addition to the net $225 million the company raised through an underwritten offering of convertible preferred stock, buyers will have the right, under certain conditions, to purchase an additional $800 million in preferred and common stock.

The Wall Street Journal summarized it: “Convertible securities and associated warrants typically specify a fixed number of shares and are only exercised if a company’s share price rises above a certain price after a specific date.”

“When a company instead specifies a dollar amount, bad things often happen to existing shareholders. At its recent low, Bed Bath & Beyond’s market capitalization was $148 million, and even that seemed to be supported mainly by meme stock logic.”

Bed Bath could avoid bankruptcy if the stock dropped to that level when warrants are exercised, but current common shareholders might own less than 13% of the business if the convertible preferred shares are valued the same as the common stock.

It should be noted that Bed Bath & Beyond had not yet defined the precise terms under which it would convert its preferred shares into common stock or exercised its warrants.

Price Action: Shares of Bed Bath & Beyond are trading 5.36% lower at $2.48, according to data from Benzinga Pro. The stock rose to nearly $7 in after-hours trading on Monday.

Read next: Is 'Big Short' Investor Michael Burry Signaling Something Ominous With This Old Market Chart? 'Maybe'

Photo: Roman Samborskyi via Shutterstock

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Posted In: NewsPenny StocksEducationOfferingsTopicsMarketsGeneralMeme StocksMichael Burry
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