The Xero Limited (ASX: XRO) share price is down more than 4% after announcing the cost of its new US$925 million of convertible notes.
Xero is one of the biggest accounting software businesses in the world.
New Xero convertible notes
Xero announced it has priced the US$925 million of senior unsecured convertible notes that are due in 2031. Having an appropriate level of funding is usually important for a company’s growth and balance sheet.
Convertible notes are essentially bonds/debt that the business has issued, but they come with the ability for those notes to be converted in the future at a certain price. The conversion price is important because a low price can significantly dilute the underlying value of the business, which can be harmful for existing shareholders.
Interest rate and conversion price
The convertible notes will have an interest rate of 1.625% per year. Interest will be payable semi-annually in arrears on 12 June and 12 December of each year, beginning on 12 December 2024.
Xero revealed the initial conversion price of the notes is US$109.65 per Xero share, which Xero said represented a conversion premium of 30% to the reference Xero share price of A$126.85.
Considering the notes are due in 2031, a 30% premium may not sound like much for a 7-year timeframe. If the Xero share price rises significantly in seven years, the company may be giving away a lot of value.
The ASX tech share also revealed, to reduce potential dilution to existing Xero shareholders, the issuer has “entered into a new call spread transaction to raise the effective premium to 60%, equivalent to US$134.95 per Xero share.”
After deductions for commissions, professional fees, other administrative expenses and funding of the costs of the call option transactions, Xero expects to have net proceeds of approximately US$908 million.
Xero is going to use a majority of the money to repurchase (92% of) the existing notes which are due in 2025, for a total cash consideration of approximately US$618 million. The rest of the money will be used for potential acquisitions, strategic investments and general corporate purposes.
After buying back the existing notes, and including unwinding the existing call spread and initiating the new call spread, Xero said it will have an additional US$234 million of new proceeds.
What to make of this for the Xero share price
I’m not the Xero chief financial officer (CFO), so I can’t really judge how important it was to carry out this transaction. Xero’s CFO, Kirsty Godfrey-Billy said:
We’re pleased with the response and the very strong demand for this offer. This will provide us with flexibility as we continue to execute our strategic priorities.
With the company becoming more profitable, I’d have thought it may want to self-fund more of its growth, though having flexibility on the balance sheet may be useful, if it needs that level of external funding.
The notes’ interest rate is very low, but the conversion price doesn’t seem that high considering 2031 is seven years away and interest rates may come down materially by then.
With the Xero share price 4% lower, I’d call it one of the more attractive long-term ASX growth shares if it can keep growing subscriber numbers.
