Microchip offsets ratings pressure with US$1.35bn mandatory
Microchip Technology is seeking to raise US$1.35bn from the sale of a three-year mandatory convertible preferred plus capped call, a high equity content security in a shareholder-friendly wrapper.
JP Morgan, Bank of America and BNP Paribas are marketing the mandatory across Thursday's session at a 7.75%–8.25% dividend and 17.5%–22.5% conversion premium for pricing after the market close. J Wood Capital Advisors is acting as independent financial advisor.
The chipmaker is using the bulk of the proceeds to refinance commercial paper but is also purchasing a capped call to offset dilution from the mandatory up to a premium share price.
While the capped call equity derivative is commonplace on plain-vanilla convertible bonds, the mandatory-plus-capped-call combination is rare given the cost of the derivative and that the goal is to sell equity, albeit at a premium.
“This (security) will turn into equity, it’s just a question of how much,” said one banker involved in the offering. “The capped call increases the price of the minimum threshold.
“Rating agencies have taken a view that minimum threshold be set at maximum share price, typically double, for full equity credit.”
Early on Thursday, Moody’s downgraded Microchip’s senior unsecured rating to Baa2 from Baa1, citing weak financial profile and sharp earnings erosion while acknowledging that the company's debt leverage will decline by one turn to 5x as a result of the mandatory convertible/CP refinancing. The ratings agency pointed to US$1.2bn of debt maturing in September 2025 as an overhang to liquidity.
Microchip separately is in the process of securing a new US$2.25bn revolving credit facility to replace an existing US$2.75bn facility that matures in December 2026.
Early in Thursday’s session, Microchip shares fell 5.7% to US$51.44, near their US$50.21 annual low struck in February.
The company separately revealed it had engaged investment bank Macquarie to sell its wafer fabrication facility (or “Fab 2”) in Tempe, Arizona. This move forms part of Microchip's previously announced restructuring plans.
Microchip nevertheless said it is seeing a pickup in demand at its Fab 2 chip facility in Arizona while acknowledging it is still working through excess inventory.
"We are seeing evidence of recovery in business as bookings saw meaningful improvement in January and February 2025 over the first two months of the December 31, 2024 quarter ... and our backlog has been stabilizing," the company said in a securities filing.
Capped call
At the current share price (and below), the US$1,000-par mandatory would convert into 19.91 shares per security in three years; at US$60.25, the 20% upper threshold, it would convert into 16.20 shares. Microchip is using the capped call to extend the less dilutionary outcome up to US$70.29, assuming a 40% upper strike on the capped call.
Moody’s gives 100% equity credit to the mandatory convertible preferred.
Stanley pioneered the mandatory-plus-capped call structure with a US$345m raise in 2013 and MTS Instruments followed with a US$1.35bn raise in 2016 – uncommon and seldom used, but not unprecedented.
The capped call-enhanced mandatory provides Microchip a buffer against dilution to grow earnings.
For investors, the attraction of the mandatory is a pickup in yield over the underlying common shares. In the case of Microchip, the mandatory provides a roughly 450bp pickup over the 3.54% yield on the common, at the current share price and assuming pricing at the midpoint of premium talk.
Helping to broaden distribution, the Microchip mandatory will trade on Nasdaq under the ticker “MCHPP”.
Microchip is using the bulk of the proceeds to repay US$1.296bn of commercial paper borrowings outstanding as of December 31. The company currently pays 4.6% on its CP program.