Convertible bonds in Türkiye: Opportunity or risk?

The increasing financing needs of tech start-ups, as well as other companies in Türkiye, create a search for alternative sources besides the bank loans or angel investors’ investments. Debt instruments, more specifically convertible bonds, increasingly become a more attractive financing method since they allow the issuer to obtain cash up front for the shares to be issued in the future. The bondholder can either receive the nominal value and the interest of the bond or obtain a certain number of shares of the issuer by using the right to convert the bond. Accordingly, the hybrid characteristic of convertible bonds combines debt and equity securities features.

Convertible bonds are defined among the capital market instruments and regulated under the Communiqué on Debt Instruments (VII-128.8) (the Communique). However, both public and private joint stock companies may issue such bonds through different procedures.

Convertible bonds may either be issued through a public offering or a private sales. It is possible to sell domestically or abroad. It is also probable to sell in tranches with different conditions up to the issue ceiling approved by the Capital Markets Board of Türkiye (CMB), provided that it is within the issue limits determined under the Communiqué. Ceiling limits are determined individually for each offering by the CMB based on the financials of each issuer. Regarding domestic issuances, the ceiling shall be denominated in Turkish Lira whereas the international issuances can be denominated in Turkish lira or foreign currency.

Domestic sales without public offering may be performed in the form of sales to the qualified investors, or private placement, provided that the unit nominal value is a minimum TL 100,000.

For the issuance and public offering of convertible bonds, a prospectus should be prepared and the CMB’s approval is required.

The maturity of the convertible bonds cannot be less than 365 days and the conversion is realized over the nominal value of the relevant convertible bond and it may be fulfilled with the addition of interest, provided that it is stated in the prospectus.

Redemption of bonds before their maturity date can be made either through a redemption plan or an equity call option right to be exercised by the issuer company or the bondholder. In principle, the conversion transaction can be made through a capital increase. The issuer can also opt for a contingent share capital increase.

The bondholder has an optional right to request the price with its interest or to convert the bonds into the issuer’s shares. The advantage of this optional right is that the bondholders may choose the right to convert their bonds by evaluating the current status of the shares of the issuer or request the nominal value of the convertible bonds with its interest. It provides the opportunity to invest directly through bonds in companies that have embodied a high growth strategy. Even if the desired growth is not realized, convertible bonds can be considered as an equity investment with limited downside risks since the investor will receive the interest and the principal back.

The bondholder does not participate in the profit and loss risk of the company issuing the bond; even if the company makes a loss, it receives a certain amount of principal and interest. It would be accurate to say that the bondholder is a long-term creditor of the issuer. However, the bondholder has no rights over the assets of the company other than its receivables and cannot participate in the management of the company. On the other hand, the profits of the company are distributed so that the interest of the bondholders is paid first, and then the dividends of the shareholders.

Convertible bonds are generally a suitable financing instrument for already highly leveraged companies that need financing in line with an aggressive growth strategy. It allows issuers to borrow directly from investors at a very low interest rate without incurring the high costs of bank loans. Furthermore, the documentation of the issue is relatively light and there is no collateral requirement for loans.

As such, convertible bonds present an important opportunity in the market, given the right timing, the right macroeconomic conditions and the right issuer.