Tech companies becoming big bond fans

PMC-Sierra, Lucent Technologies and Novellus Systems are just a few tech companies that have tapped the debt markets--where companies go to borrow money--in recent days. And Wednesday, Nortel Networks and Network Associates announced plans to raise $1 billion and $300 million in convertible bond offerings, respectively.

Indeed, it's been a record year already for convertible issues, and tech companies have played a big role. According to Merrill Lynch, there have been $63.7 billion in convertible bond deals so far this year, surpassing 2000's tally of $60.4 billion. Convertible bonds are hybrid securities that companies sell to investors, who can convert them into shares of stock at a future date under certain conditions.

Analysts say the race to the debt markets makes sense for companies that want or need to raise cash.

For starters, the alternative of raising money by selling stock through secondary offerings is difficult in a market slump. Companies don't want to sell cheap shares anyway, and selling more stock puts them at risk of diluting the shares' value. Meanwhile, interest rates are low, which affords many tech companies a favorable deal.

For Lucent, it's pretty clear why the company had to tap into the convertible bond market: It is mired in a well-publicized cash crunch and needs the $1.75 billion it raised last week. In fact, Lehman Brothers Steven Levy said Lucent's convertible bond deal was "icing on the cake" and should allay Wall Street's worries a bit.

Other companies' motives lead to a little more speculation--especially if they already have a lot of cash, like PMC-Sierra and Network Associates, which ended its June quarter with $650 million.

Communications chipmaker PMC-Sierra is the most recent example of a company that sparked a fair amount of speculation about its outlook because of a convertible bond offering. The company raised $225 million last week in a convertible bond deal.

Under the terms of the deal, PMC-Sierra pays a 3.75 percent interest rate and can convert the bond into shares at $42.43 apiece. There's also a "make whole" provision, which dictates that PMC-Sierra must pay the first three years of interest even if it converts the bonds early.

By nearly all accounts, it was a good deal for PMC-Sierra, which was recently added to the Standard & Poor's 500 index. But shortly after PMC-Sierra closed its convertible deal, Wall Street analysts started wondering about the reasons behind the move. After all, PMC-Sierra ended its June quarter with $344 million, so it didn't really need the cash.

In a statement, the company said it raised the cash for "working capital and other general corporate purposes." PMC-Sierra didn't return calls for further comment.

"The rationale is that you take money when you can get it, not when you need it," said Paul Brandeis, an analyst with Needham. "It's cheap money."

Brandeis said PMC-Sierra was raising cash because peers such as Applied Micro Circuits and Vitesse Semiconductor had more than double the cash that PMC-Sierra had before its convertible bond deal. Call it balance sheet envy.

In addition, PMC-Sierra, which reported a pro forma net loss of 8 cents a share on sales of $94.1 million in the second quarter, is burning cash slowly and plans to maintain research and development expenditures, Brandeis said.

Other analysts found it odd that PMC-Sierra was raising cash when its balance sheet was strong. The company has said it's not planning any mergers and acquisitions. It didn't take long for Wall Street analysts to wonder if PMC-Sierra saw even rainier days ahead. "The big question in my mind was: Why now?" said Jeff Rosenberg, an analyst at William Blair.

Companies used to take advantage of soaring stock prices to cash in on convertible deals. Convertible bonds were popular with dot-coms back in the go-go days of 1999, a time when they could convert the bonds to overvalued stock. PMC-Sierra's shares have plunged from $246.25 last September.

Analysts were speculating about whether the deal indicated that PMC-Sierra anticipated deteriorating business conditions beyond 2001. On its second-quarter conference calls, executives noted it would take a few quarters for customers to burn off excess inventory.

"We believe the decision to capitalize on this opportunity, even considering the attractive terms of the deal, highlights the lack of visibility that extends beyond the near term but well into 2002 as well," Rosenberg said.