Someone goes bankrupt on AMD

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You may have heard something about AMD losing out on something connected with the now-bankrupt firm Lehman Brothers.

Should you care?  Unless you’re a stockholder, not really (and maybe not even if you are).

Let me explain:

Back in April, 2007, AMD issued a little over $2 billion in debt to help pay for buying ATI.  To get people to buy this debt, it made this debt convertible, meaning that debt holders would be given the choice when the debt came due in 2015 to either get the money they paid back, or get shares of AMD instead at a rate of about $28 a share. 

Why would people want such a deal?  In a way, it’s like having a little lottery ticket attached to your bank account.  If AMD’s stock price in 2015 were a lot higher than $28, let’s say $50, you would get a big bonus because you could buy AMD stock at $28 and immediately sell it for about $50.  If the stock price were less than $28, like a lottery ticket without the right numbers after the drawing, the option wouldn’t be worth anything, but the debt holder would still get his money back. 

I say “about $50,” it would probably be more like $45, because AMD would normally end up issuing new stock, and when more shares of stock cover ownership of the same company, each individual share of stock would be worth less (at least in the short-term) because the new stock would mean each individual share of the company would represent a smaller share of the ownership in the company.  This is called “stock dilution.”

At the time, stockholders were nervous about the stock price of AMD, it was about $14, so to keep those stockholders from getting even more nervous, AMD spent $182 million at that time, to buy a “capped call” from AMD.  Essentially, AMD bought insurance against the possibility of stock dilution.  If AMD had to issue new stock, Lehman Brothers would hand back old stock so that the total number of shares would remain the same. 

Last September, Lehman Brothers went into Chapter 11 bankruptcy, so in a nutshell, they’re not going to make good on this transaction.  Part of the arrangement was that if either party went bankrupt, the other part could cancel the arrangement and then try to get a refund.  That’s what AMD did. 

Will AMD get its money back?  They’ll probably end up getting some of it back eventually, but that may take years.  This is significant in that AMD no longer has insurance against stock dilution, and that could cause some really big problems: in 2015, assuming its stock price is more than $28 then.  

If you’re saying to yourself, “The stock price is $2 now!  AMD may not even be around in 2015!! Isn’t this quite academic?” well, it was enough to knock the stock price down 10% yesterday, and six plus years is a long, long time from today. But yes, this isn’t the highest priority item on AMD’s to-do list, and yes, it is more than a little like worrying about the viability of the Social Security (or non-US equivalent) when the ship you were on has sunk, and you’re in the water fighting off sharks.  You want to live long enough to have those kinds of problems. 

However, this is a benign example of what the financial people fear.  If companies effectively need what is third-party financial insurance or credit to do not far-future, but day-to-day business, and those resources die or dry up or get cut back or even just get more expensive, lots of otherwise healthy businesses (never mind the more sickly) die.  This is now beginning to happen in the memory industry, most of the participants are going to have to get government bailouts in one form or another within the next six months, or they’re just going to run out of money and die.  Qimonda just got one; the Taiwanese and Korean memory folks are lining up for help, too.

If you sell less product, that’s bad.  If your access to credit gets cut back, that’s bad.  If they both happen at the same time, that can be deadly.

Ed

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