Question

The board of directors of Amber International Limited (‘Amber’), a listed company, has decided to raise HK$2,500 million for the acquisition of a piece of land located in Shenzhen, China, for property development. The board of directors is considering raising the requisite funds through the issue of either (i) 3% cumulative convertible preference shares (2018–23) or (ii) 3% guaranteed convertible registered bonds (2018–23).
Required
As Amber’s financial controller, advise the board on:
i the merits and demerits of issuing the preference shares and the registered bonds to be issued by Amber;
ii additional features/rights, which could be added to make the preference shares and the bonds more attractive to investors; and
iii which proposal Amber should adopt for raising the new capital.
Give reasons to support your answer

Answer 1

i. Convertible Cumulative preference share:

Merits:

• Flexibility in paying dividends. It means company will pay only when it had profits otherwise carry forward
• Cost of cumulative preference share is lower than cost of equity

Demerits:

• They are preferential while paying dividend & payment of capital at the time of winding up before making payment to equity.
• Convertible Cumulative preference share may or may not convertible into Equity as they have an option

Registered bonds

Merits:

• Cost of bonds is lower than the Equity
• Tax benefits
• Guaranteed conversion

Demerits:

• No flexibility in paying interest, Compulsory payment of fixed amount (interest)
• Preferential payment than preference and equity holders

ii) Attractive additional features
Convertible cumulative preference shares:

• They have an option to convert into Equity, they can be benefited if the equity value is more than redemption of preference shares or else they can get their redemption value.
• They will get voting right in some scenarios.
• Getting fixed dividend

Registered bonds:

• They have a right to get fixed interest
• Converted in to fixed no. of equity shares after maturity date (2023)
• Cost of equity is more than the bond, They will enjoy this benefit after conversion

iii) Amber should adopt 3% Guaranteed convertible registered bond because of the following reasons.

• Both have same tenure (2018-23) But, Cost of registered bonds is lower than the cost of preference shares as bonds have tax benefits. For example: Tax rate is 30% cost of bonds is 2.1% [3% *(1-30%)] where as cost of preference share remains be the same as 3%
• No outflow of cash at the time of maturity because of guaranteed conversion