What is convertible debt?

Convertible debt is when a business borrows money from a lender and repays all or part of the debt by converting it into common shares in the borrowing company at a future date. This debt is typically issued by a company with high growth rates and low credit ratings. This gives the borrower access to credit at a cheaper rate than conventional bonds.

For example, Canopy Growth Corporation's (NASDAQ: CGC) credit rating was downgraded by Fitch Ratings on June 27, 2022, which indicates there is substantial risk in lending to the company.

What does Canopy Growth's debt conversion mean?

Canopy Growth's shares fell by 19.7% since Thursday after it announced it would exchange C$262.7 million of its debt into common shares and cash. Under the agreements with noteholders (lenders), the company will acquire its 4.25% unsecured senior notes -- due in 2023 -- for C$259.9 million in shares and roughly C$3.1 million in cash.

The price used to value the shares will be based on the volume-weighted average trading price for the ten consecutive trading days, starting on Thursday 30th June. This will be subject to a floor price of US$2.50 and a maximum of US$3.50 per share. At the time of writing, the company's share price was US$2.81 in pre-market trading.

Constellation Brands Inc. (NYSE: STZ), Canopy's largest shareholder, has agreed to swap half of its C$200 million in notes for shares. The company already holds a 35.3% stake in Canopy Growth through its wholly-owned subsidiary Greenstar Canada Investment Limited Partnership.

Canopy Growth CFO Judy Hong said the transaction will help the company de-leverage its balance sheet and reduce interest payments by over US$8.44 million per annum. While this is a good way for the company to reduce costs in the face of economic headwinds, it is unfortunate news for shareholders. This conversion will increase the number of available shares, thereby reducing earnings per share, and diluting equity.