Lehman analysts see CoCo dilution accounting rule very likely, perhaps within next 6-8 weeks

By Ronda Fears

Nashville, July 6 - A new accounting rule requiring issuers of convertibles with contingent conversion features to estimate potential dilution to reported earnings per share, as if the bonds were converted, is highly likely and could take place in the next six to eight weeks, said Lehman Brothers analysts in a report Tuesday.

Venu Krishna, Lehman's head of U.S. convertible research, and Bob Willens, Lehman's tax and accounting analyst - authors of the report - are holding a conference call on the matter Wednesday. The proposal to that effect, from the Emerging Issues Task Force, is pending with the Financial Accounting Standards Board.

The call is scheduled for 11 a.m. ET.

Lehman's analysis shows that 134 convertibles with contingent conversion features caused a dilution of 5% or higher when the if-converted earnings per share methodology was applied. The convertible research team first looked at the matter in mid-September and again in late January as rising stock prices increased the prospects of the CoCo triggers being hit.

Based on the latest estimates, the analysts found the 10 most dilutive convertibles with stock prices below the CoCo triggers are the Cleveland-Cliffs Inc. 3.25%, Veritas DGC Inc. floater, Navigant International Inc. 4.875%, Affiliated Managers Group Inc. floater, Sunterra Corp. 3.75%, FEI Co. 0%, Mesa Air Group Inc. 6.25%, Radisys Corp. 1.375%, Serena Software Inc. 1.5% and Lattice Semiconductor Corp. 0%.

The analysts also noted that where issuers have multiple CoCo convertibles outstanding - 30 in all - the dilutive impact will be additive.

The Emerging Issues Task Force recently made a tentative decision proposing that issuers of CoCo convertibles use the "if-converted" methodology to calculate their reported GAAP earnings per share, irrespective of the CoCo trigger being hit.

Currently, issuers of CoCo convertibles capture any dilutive impact of the convertibles only when the CoCo trigger has been hit, delaying the recognition of any dilution.

Willens believes that the likelihood of FASB enacting the proposal is "very high," according to the report.

"In addition, we expect the time frame for enactment of the proposal to be within the next six weeks to two months," the analysts added. "Further, it is our understanding that if enacted, there will not be any grandfather protection."

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