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The conversion feature of a convertible security (the call option) hardly has any value if the common stock underlying that convertible trades below the effective conversion price. Convertibles in this situation are usually referred to as “busted” convertibles because they trade at high premiums over conversion value. These “busted” convertibles will trade near or at their investment value (the bond value) and thus, have virtually no sensitivity to the movements of their underlying common stock.

Still, many fixed-income investors find these so called “busted” convertibles attractive alternatives to other corporate bonds because of their potential for capital appreciation should the issuing company’s fortunes turn around. Investors with a bullish outlook over the long term generally buy these convertibles with two objectives in mind: (i) receiving a generous yield; and (ii) the appreciation in the value of the convertibles, assuming the underlying stock advances.

We screened the Value Line database of over 650 securities (bonds and preferred stocks) for a list of “busted” convertibles; convertibles trading with premiums over conversion value greater than 50%. Below is a partial list, which includes convertibles with a current yield of at least 8%.

 

Issue

Recent Price*

Conv Curr

Conv

 

Com

Convertible Securities

Size(SMM)

(% of Par)

Yld(%)

YTM(%)

Industry

Ticker

Network Equipment 7.25s2014    

25.82

89.750

8.1

11.7

TelSrv

NWK  

Eastman Kodak 7s2017           

400.00

85.880

8.2

10.5

PrcIns

EK   

Cohen (Alesco Finl) 7.625s2027 

21.00

86.380

8.8

9.5

REIT 

IFMI 

Clearwire Comm 8.25s2040 (144A)

650.00

93.750

8.8

9.1

Entert

CLWR 

Penson Worldwide 8s2014 (144A) 

60.00

90.250

8.9

12.2

FinSvc

PNSN 

Hutchinson Technology 8.5s2026 

40.00

86.880

9.8

10.5

PrcIns

HTCH 

CompuCredit 5.875s2035         

140.00

44.000

13.4

14.5

FinlSv

CCRT 

Evergreen Solar 13s2015 (144A) 

165.00

67.500

19.3

28.6

Power

ESLR 

* Prices as of May 13, 2011

Highlighted Convertibles:

Eastman Kodak Company (EK) is the world's largest producer of photographic products. It operates in three business segments: Consumer Digital Imaging, Graphic Communications, and Film Products. Last year, the company derived 59% of its total sales from overseas.

In the past three fiscal years, Eastman Kodak has been struggling to keep its head above water. Sales are on a downward trend and operating costs are high. Still, the company’s bottom line showed some improvement in 2010, finishing at a loss of $0.26 a share, versus an $0.87-a-share deficit in 2009. Too, new developments—transforming to a more digital-based business model and investments in inkjet printers—could signal a new direction for the company. Indeed, it is expected to return to profitability over the coming three to five years.

Meanwhile, Eastman Kodak’s 7% convertible notes due 2017 represent a safer avenue to invest in this weakened company. Dividends have been discontinued on the common stock, but a cut in interest on these convertibles could bring about some control of the company by bondholders.

Clearwire Corporation (CLWR) provides wireless broadband service in the United States, Mexico, and Europe. As of December 31, 2010, the company had 4.38 million subscribers. It owns 2.5GHz licenses in the U.S. and Mexico, as well as 3.5 GHz spectrum in Europe.

Clearwire is a young company. It was founded in 2003 and sold 24 million shares in its initial public offering in March, 2007. It has yet to show a profit, but it’s developing at a rapid rate. In 2010, the company’s subscriber base grew from 688,000 to 4,384,000, as it joined forces with Sprint Nextel (S). Since the start of last year, the company has broadened its domestic market coverage from 44.7 million to 119 million potential customers. Adding to its existing assets, Clearwire believes that it can cover 130 million potential customers. In sum, Value Line analyst David Reimer sees the company being profitable by 2015.

The stock is still very speculative, but it has wide recovery potential over the pull to 2014-2016. The issue does not offer a dividend, but the company’s 8.5% convertible notes due 2040 can provide income and an added degree of safety to this growing communications entity.

At the time of this article's writing, the author did not have positions in any of the companies mentioned.