Select Page

Two of our finest recommendations took a step forward yesterday after they announced that they're borrowing $1.1 billion, locking in very low interest rates for years, and backing up the loans with stock. This is what winners do.

Exact Sciences (EXAS: $88, down 5% this week) wants to raise almost $700 million and Ares Capital (ARCC: $17.29, flat) filed to sell $400 million in debt. These are convertible offerings that can turn into stock years down the road, which is why there some cheering on Wall Street. Investors remain wary of any situation that inflates the number of shares and dilutes their own holdings.

With both of these companies, management has reason to be confident that the stocks will appreciate enough to make everyone happy before the debt gets a chance to convert. Exact Sciences is one of our five best recommendations with a 39% gain YTD. Ares has been a little more subdued with its 11% YTD performance, but in the High Yield market that's a big move. Moreover, both stocks are within sight of record levels with every indication of going higher in the foreseeable future.

Today we are in conditions that reward convertible debt offerings. The company gets the cash. Today's shareholders get a little time for their positions to appreciate and only then do people who buy the debt get a chance to join the party. Doing the math, the Exact Sciences deal will create 6% more stock versus 5% for Ares. As long as the stocks rise that much before any conversion takes place, the drag balances out.

And in the meantime, Ares gets up to $400 million for retiring existing liabilities. They've already got close to $900 million in cash, so management evidently thinks the stock is a better currency right now, keeping the money in reserve. Reading between the lines, the company is agreeing to pay 4.6% in interest here in order to retire ultra-long-term promissory notes that charge 6.9%. This deal saves $5 million a year.

Whether lenders decide to exchange their interest payments and principal for stock is up to them, but we have to say that if they convert, it's because they realize Ares can make them more than 4.6% a year. The 9% dividend alone is proof of that.

For Exact Sciences, it's a similar story. They're amassing cash when they can, but this time they're lengthening the repayment term on existing convertible debt and only paying 1% a year. That's an amazing interest rate in any environment. In theory, Exact Sciences could simply park its $700 million in 7-year Treasury debt, collect 2.6% interest, pay off lenders and bank the remaining $11 million a year. You read that right. They get better terms than the federal government.

And by the way, Exact Sciences has come through the quarterly earnings period with no sign of dipping back below our $85 Target. It's time to raise our sights here. The new Target is $103 and the Sell Price rises to $70.