Snapchat's Capped Call Transactions.
Going over Snapchat's Capped Call Transactions.
Introduction:
Navigating today’s financial markets requires strategies that balance risk, cost, and opportunity. One such approach is the capped call transaction, a structure that pairs the purchase of a call option with the sale of a higher-strike call to limit upside while reducing net cost. Commonly used in convertible bond issuance, capped calls help mitigate dilution risk and manage volatility. By setting a defined profit ceiling, they offer companies and investors a more controlled exposure to equity performance. LINK TO REFERENCE
What's Going on?
Snapchat issued a bunch of convertible notes (debt that can turn into stock), and to protect itself from stock dilution if those notes convert into shares, it bought something called Capped Call Transactions.
What's a Capped Call?
Think of it as a hedge against equity dilution. If Snap’s share price rises, convertible bondholders may opt to exchange their debt for equity, potentially diluting existing shareholders.
To mitigate this, Snapchat purchases a capped call option, which allows it to repurchase shares at a predetermined strike price. This protection applies up to a certain threshold; beyond that cap, the upside benefit ends.
Table: Snapchat's Capped Call.
| Convertible Notes | Capped Call Cost | Cap Price (per share) |
|---|---|---|
| 2025 Notes | $100.0 million | $32.12 |
| 2026 Notes | $102.1 million | $32.58 |
| 2027 Notes | $86.8 million | $121.02 |
| 2028 Notes | $177.0 million | $93.90 |
| 2030 Notes | $68.9 million | $33.48 |
What's The Normal, Best, & Worst case scenario for this?
Downside Risk:
In the most unfavorable outcome, Snap’s stock remains below all applicable conversion strike prices, rendering the capped call options entirely out of the money. As a result, the approximately $534.8 million in premiums paid for these instruments would expire without value. Consequently, Snap would experience the full dilutive impact of the convertible notes upon conversion.
Normal‑Case Scenario:
If Snapchat stock were to rise moderately, within the range of $40 to $50, it would exceed the conversion prices of certain convertible note series while still remaining below the cap levels for others. For the 2025, 2026, and 2030 convertible notes, where the cap prices are around $32 to $33, the associated capped call options effectively mitigate dilution up to those thresholds.
Meanwhile, for the 2027 and 2028 notes, which have significantly higher cap levels of $121 and $93.90 respectively, a stock price in the $40–$50 range allows the company to benefit from the full intrinsic value of the call spread (i.e., the difference between the stock price and the conversion strike), as these calls remain uncapped.
As a result, Snap benefits in two ways: it reduces dilution for the lower-cap series and enjoys full economic offset from the higher-cap series, at least until the stock reaches those upper cap levels.
Best Case Scenario:
In a highly favorable outcome, Snapchat stock experiences a substantial increase, potentially exceeding $150 per share. Under this scenario, each capped call option reaches its full payout potential, delivering the difference between the cap price and the strike price. This mechanism effectively offsets the dilution impact up to those predefined cap levels.
As a result, dilution is essentially fixed at those upper thresholds, allowing current shareholders to benefit from any additional upside beyond the caps. Notably, Snap secures this advantage through the relatively modest cost of the capped call premiums.
Summary:
Snap has strategically opted for a structure that involves an initial, clearly defined expense of approximately $535 million. In return, the company gains a measured level of protection against dilution, offering no coverage below the strike prices, partial mitigation in the mid-range, and complete protection once the stock surpasses the cap levels.
Comments
Post a Comment