Israeli tech companies pouncing on free Wall Street money

The word 'hybrid' has become a mainstay since the onset of the Covid-19 pandemic. Workplaces have become hybrid and HMO treatments are hybrid, so there is no reason hybrid fundraising shouldn’t blossom as well. Over the past two months, Israeli tech companies have shaken the dust off convertible bonds, a means of raising money that was popular following the burst of the dot.com bubble. Convertible notes are a hybrid tool, neither debt nor equity, but something in between. A bond with a call option.

Since August, Israeli tech firms Wix, Nice, SolarEdge and Nova have raised $2 billion in convertible bonds. All did so at zero interest, with the bonds convertible in five years. The companies are receiving a loan for free and in five years, depending on the state of the stock and the preferences of the investors, the debt will be returned or converted to stock.

Each company sets the conversion price with its investment bank, which in the current round raised by the Israeli companies saw an increase of 30-40% compared to the current valuation. Not a very ambitious goal over a five-year period. This is the cheapest possible type of money for the companies and a sort of structure with a floor for the investors, who are immune to losses.

Yet there is still something surprising about this current rush to convertible bonds. Traditionally, it is a tool used in a time of crisis. That is what happened in 2001 when shares of tech companies were at a low and they needed money. Convertible bonds fulfilled that need by preventing the dilution of investors at a low price. On the other hand, investors were willing to risk purchasing them as they provided a floor for the investment, which was the price of the stock at the time. Convertible bonds originally come from the world of funding for early-stage private tech companies in need of money when seed and angel investors still can't quite determine the value of the startups.

The current situation is opposite from that. Tech shares have surged by tens and even hundreds of percent. Wix and Fiverr, for example, have jumped by 125% and 660% respectively. In theory, this creates a classic opportunity to raise funds by selling regular shares. "We raised money through convertible bonds simply because we can. There is currently a lot of money in the market which is searching for somewhere to go and it isn't necessarily coming from stock investors, but rather from sophisticated debt investors,” says Ronen Faier, Chief Financial Officer of SolarEdge, which raised $550 million due to the high demand, the highest sum of all Israeli companies. "There have been 60 such raises just this year, with companies receiving more than $10 billion in total. This is a growing market in a zero interest environment.”

The shares of SolarEdge, which provides a power optimizer, solar inverter and monitoring systems for photovoltaic arrays, have tripled since the start of 2020, reaching a value of $15 billion. This increase has made it one of the top five most valuable Israeli companies.

Faier highlighted the advantages of convertible bonds for companies. He explained that it is a deal that can be done quickly —within two weeks—doesn't require a debt rating, and unlike regular debt raising, there are no financial covenants. The future option covers all scenarios. "Even though there is nothing currently in the pipeline, opportunities for M&A may arise, but the stock market will have already cooled down," explained Faier.

"The world has turned on its head," said Yaniv Abadi, founding partner at Beta Finance. "Convertible bonds were born out of the need to bridge between the gaps in interest sometimes created between the company raising funds and the investors. The companies that didn't want to, or couldn't, pay the high coupon that the investors wanted, gave them a gift - a call option. Since the start of the Covid-19 pandemic, there are two trends that have brought convertible notes back into the game. Firstly, it is clear today that interest rates are expected to remain at zero for a long time. The second is the hype around tech shares. Considering those factors, even zero interest is attractive to an investor as long as it comes with an option for tech shares."

And there are two more advantages to convertible bonds, one for the companies and the second for the investors. The company can initially avoid registering the call options as stocks and thus prevent dilution and a blow to earnings per share, a critical index in a time of crisis. Tech companies that traditionally arrive at the stock exchange with a distributed control structure are more sensitive to the dilution of shareholders, so for them convertible bonds is a preferable tool compared to selling shares. According to U.S. accounting regulations, this is permitted if a company states that it intends to redeem the bonds prior to the date of conversion, which often happens. For the investors, especially the sophisticated ones, the advantage derived from the possibility of trading in options near the date of the IPO. The investors don't wait to profit off the conversion to shares, but play between the standard deviation on the options and the bond, and in parallel complete short sale deals to hedge themselves. That is why the shares of a company raising funds through a convertible bond will usually drop prior to the deadline of the funding round, and later on the effects of opening the short position balance out.

Raising via convertible bonds isn't just limited to tech companies. Cruise company Royal Caribbean, of which Israeli Eyal Ofer is a significant shareholder, raised last week $500 million in convertible bonds. In this case the bonds do carry interest, but considering the magnitude of the blow the company suffered in the coronavirus crisis, annual interest of less than 3% doesn't seem very high.