How to treat convertibles/hybrids in a DCF
Hi!
Apologies in advance for the noob question.
How do you treat/value convertibles (e.g. convertible preferred shares, convertible notes) in a DCF for a private company to derive price per share? The issue is that the fair value of the convertibles depends on the share price. Since it is a private company, there is no observable market price. How to solve this issue?
Thank you for your help!
Also interested - Rover-S I know you are immensely knowledgable in this area, do you have any insight?
If they are in the money (equity value / share > strike price) then stock. If not, then debt. There’ll be some circularity involved here which is ok.
So you would first calculate implied share price with the assumption that the hybrids are pure debt, then compare strike with the implied share price to decide if the hybrids are converted to equity?
Probably a dumb question but for a private company, what do you use for the value in the denominator of equity value / share?
How is strike/actual share price calculated in the hybrid’s docs?
I was just wondering as it may come up in an interview, it was more of a theoretical question. So you would base it on the documentation?
Just calculate EV, subtract financial net debt and see if the convertibles are ITM. If so: treat as equity (or create debt-like item).
Thanks so much for explaining! Got it.
Separate but related question: how would you go about treating convertibles when calculating a WACC?
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