What are Dividend Enhanced Convertible Stocks (DECS)?
Dividend Enhanced Convertible Shares (DECS) are a type of convertible preferred stock that provide the holder with premium dividends in addition to an embedded option for the holder to convert the shares into a fixed number of ordinary shares after a predetermined date.
Most convertible preferred shares are exchanged at the request of the shareholder, but sometimes there is a provision that allows the company, or the issuer, to force the conversion. The value of a convertible preferred stock is ultimately based on the performance of the common stock.
- Dividend Enhanced Convertible Shares (DECS) are a type of preferred stock that can be converted to common stock at the owner’s discretion.
- DECS also pays a higher dividend to shareholders than ordinary preferences.
- Once the common stock is trading above the conversion price, it may be helpful for preferred shareholders to convert their preferred stock into common stock.
Understanding Dividend Enhanced Convertible Stocks
Dividend Enhanced Convertible Shares (DECS) oblige the holder to convert their value into ordinary shares of the underlying company at some later time. For this reason, DECS work basically similar to bonds that undergo mandatory conversions to common stocks at some point. The mandatory DECS common stock conversion period is governed by the company issuing the offering, however, the conversion generally occurs within three to four years of the initial purchase.
Unlike traditional zero coupon convertibles, DECSs provide an equity incentive and can be priced to the issuer on certain dates, at prices that reflect the accumulation of implicit return on interest. This sell function offers holders a measure of downside protection that limits an investor’s potential losses. In other words, the conversion is done at a predetermined fixed rate, and that conversion rate begins to decline once the price of the underlying shares reaches a certain level. But until then, the conversion ratio is 1: 1 and DECS shares can be issued at the same market price as the underlying shares.
DECS and other preferred convertibles
DECS are not the only nontraditional convertible product to hit the market. Other similar models include:
Each of these hybrid models has its own unique set of risk and reward characteristics. But they share the same basic characteristics, including upside potential that is typically less than that of the underlying common shares, due to the fact that convertible buyers pay a premium for the privilege of converting their shares and enjoy a higher value than the share. market. dividend rates.
DECS, like most custom hybrid convertible models, originating from different investment banks, which benefit from these instruments, because unlike pure debt issues such as corporate bonds, mandatory convertibles do not pose a subsequent credit risk for the company that issues them, as they eventually become shares. . Such convertibles also remove the downward pressure that a pure capital would exert on the underlying security, as they are not immediately converted to ordinary shares.