Warrants and convertible bonds: when debt turns into equity
The answer
A convertible bond is a loan that the lender can turn into shares at a fixed price. A warrant is the right to buy new shares from the company at a fixed price before a set date. Both let a company borrow more cheaply today by promising possible shares tomorrow, and both create new shares out of nothing when exercised, which reduces everybody else's slice.
Why this costs you money
An investor holds shares in a company. The company reports profit up 22%. Earnings per share are up 4%.
Those 2 numbers are not contradictory, and the gap is the subject of this article. The company issued convertible bonds 3 years ago. The share price rose past the conversion price, the bondholders converted, and most of the profit growth went into the extra shares. Nobody informed the investor, because nobody had to: it was disclosed years earlier in a filing they did not read, and printed every quarter since as a second, lower earnings-per-share number they did not look at.
The second version costs more and happens in India constantly. A promoter is issued warrants at a price set from an average of the past 6 months. The share price then rises, the promoter pays the balance and receives shares well below market, and their stake goes up while every other shareholder's goes down. It is legal, and it is disclosed in a document most retail shareholders have never opened.
The cost in both cases is invisible. You do not see a loss. You see a smaller share of a bigger company, and the arithmetic happened in a filing years earlier.
How it works
Start with the convertible bond, because the warrant is a simpler version of the same idea.
A convertible bond is an ordinary bond with one extra clause. It has a face value, a coupon and a maturity date. The clause says the holder may exchange the bond for a fixed number of shares instead of taking the money back.
Three terms define it. The conversion ratio is the number of shares each bond converts into: a ₹1,000 bond converting into 20 shares has a ratio of 20. The conversion price is face value divided by the ratio, so ₹50 per share. The conversion premium is how far that sits above the share price on the day of issue: a ₹40 share and a ₹50 conversion price is a 25% premium.
The company borrows at a much lower coupon than it otherwise could — 2%, or even 0%, where a plain bond would cost 9% — in exchange for a promise to issue shares at ₹50 if the price goes above that.
The investor gets a bond, with a maturity date and a place in the queue ahead of shareholders, plus a share in the upside. If the price stays below ₹50 they take their money back at maturity. If it goes to ₹200 they convert and own shares bought at ₹50. That asymmetry is why convertibles are priced as a bond plus an option.
A warrant is the option on its own, with no bond attached: the right, not the obligation, to buy new shares from the company at a stated price before a stated expiry. If the share price never exceeds that price, the warrant expires worthless. Warrants are often attached to a bond issue as an incentive, and the 2 can usually be traded separately.
The most important distinction in this article is between a warrant and an ordinary exchange-traded call option. They look identical and behave differently.
| Warrant | Exchange-traded call option | |
|---|---|---|
| Who issues it | The company itself | Another market participant |
| On exercise | The company creates new shares | Existing shares change hands |
| Effect on share count | Rises | No change |
| Effect on other holders | Everybody is diluted | Nobody is diluted |
| Where the money goes | Into the company | To the option seller |
A warrant creates shares. An option moves them. That is the whole difference, and it is why warrants matter to a shareholder who has never traded an option.
Dilution is then arithmetic. A company with 100 crore shares earning ₹500 crore has earnings per share of ₹5. If convertibles and warrants would create 15 crore more shares, fully diluted earnings per share is ₹4.35. The company earned the same money. Your slice is 13% smaller.
That is why every set of accounts, under both Indian and US standards, reports 2 earnings-per-share numbers. Basic uses the shares that exist. Diluted assumes every convertible converts and every warrant is exercised.
What it tells you, and what it does not
A convertible tells you something about what the company could not do. Companies issue them when a plain bond would be expensive and a share sale would be dilutive at a bad price. That is not automatically bad — some of the most successful companies in the world funded themselves this way for years — but it should prompt the question of what the plain-bond alternative would have cost.
The conversion price tells you the price the company itself was willing to sell shares at. If insiders set it 40% above the market and the market later triples, they sold cheaply.
What none of this tells you is whether conversion will happen. A convertible only converts if the share price exceeds the conversion price near maturity. Below that the option is worthless and the company must repay cash it may not have. That is what happened across Indian companies in 2012. Diluted EPS also covers only the instruments that exist today, and companies that fund themselves this way frequently do it again.
The decision rule
Before buying a share, check the diluted share count, not the current one.
If diluted earnings per share is more than about 5% below basic, dilution is already contracted and you should value the company on the diluted number.
If the gap is growing across years, the company is funding itself by issuing claims on its own equity, and each round makes your slice smaller.
Unless the money raised generates returns above the cost of the dilution. A company that raises capital cheaply and compounds it well can dilute you 3% a year and still leave you far better off. The question is not whether dilution happened. It is what was bought with it.
For warrants issued to promoters the question is narrower. At what price, and set how? A warrant priced off a 6-month average during a depressed period, and exercised after a recovery, transfers value from other shareholders to the insider.
Try this now
Three minutes, on a company you actually own. This number is on every results announcement and almost nobody reads past the first one.
- Open the latest results for a share you hold. In India use the NSE or BSE announcement; in the United States the 10-Q or 10-K.
- Find the earnings per share line. There will be 2 numbers: Basic EPS and Diluted EPS. Write both down.
- Calculate the gap:
(Basic − Diluted) ÷ Basic × 100. That is the percentage of your earnings already promised to somebody else. - Find weighted average number of shares — basic and — diluted. The difference is the shares that do not exist yet and are already spoken for.
- Repeat for the same company 3 years ago and compare the 2 gaps.
- For Indian holdings, open the latest shareholding pattern on the exchange website and find outstanding convertible securities and warrants.
What you should see. For a large, established, cash-generating company, basic and diluted EPS are usually within 1%, and step 3 gives you almost nothing. For a growth company, a recently listed one, or one that has raised money from promoters through warrants, the gap can be 5%, 10% or more. That is the part of every future rupee of profit that is not yours.
Step 5 teaches the most. A gap that was 2% 3 years ago and is 9% today tells you the company funds itself by issuing claims on its own shares.
Three real cases
1. Tesla, February 2014 to March 2021 (United States) — the convertible working as designed Tesla issued $2 billion of convertible senior notes in February 2014. The longer part carried a coupon of 1.25% and matured on 1 March 2021, with a conversion price of $359.87 before Tesla's later stock splits. Tesla borrowed for 7 years at 1.25%, when a plain bond from a loss-making car company would have cost far more. The share price rose enormously, and at maturity Tesla settled by paying about $958 million in cash and issuing about 11.1 million shares. Existing Tesla shareholders paid for the cheap borrowing in shares.
2. MicroStrategy, 17 February 2021 (United States) — borrowing at zero MicroStrategy priced $900 million of convertible senior notes, with an underwriters' option taking it to $1.05 billion. The coupon was 0%. The notes mature on 15 February 2027, and the conversion price was about $1,432.46 per share, roughly 50% above the prior day's close of $955.00. More than $1 billion borrowed for 6 years at no interest at all. The entire payment to the lender is the possibility of buying shares at $1,432.46.
3. Indian FCCBs, 2011 and 2012 — when the conversion never happens Many Indian companies raised money abroad through foreign currency convertible bonds during the 2007 boom, with conversion prices set against elevated share prices. When those shares fell far below the conversion prices, the option became worthless and the bonds reverted to plain dollar debt repayable in cash. Zenith Infotech missed a $27 million redemption in September 2011. Sterling Biotech faced $183.84 million due by 16 May 2012. Suzlon Energy's bondholders rejected an extension in October 2012 and Suzlon defaulted, then reported as the largest FCCB default by an Indian company. The rupee weakened over the same period, making the dollar repayment larger in rupee terms.
The question that resolves it
A company announces a convertible bond issue and the share price falls that day.
A novice asks: why is the market unhappy about cheap borrowing?
An expert asks: at what price did the company just agree to sell its own shares?
A conversion price 20% above today's is management saying they would be content to issue equity at that level. A price 80% above is a much stronger statement. The issue also creates a mechanical seller: convertible arbitrage funds buy the bond and immediately sell the shares short to isolate the option, which is a large part of why the price falls on announcement day. Knowing that selling is mechanical, not an opinion about the business, is the difference between reading the event and reacting to it.
What would make this wrong
If convertibles and warrants did not dilute, diluted earnings per share would equal basic. Accounting standards in both countries require both numbers precisely because they differ.
The honest limits are 4. Dilution is not automatically bad: capital raised cheaply and invested well can leave every shareholder better off while owning a smaller percentage. Diluted EPS is a convention — it assumes conversion, and if the share price stays below the conversion price no dilution occurs. Companies can reduce the dilution, and US issuers commonly buy a capped call alongside a convertible issue. And convertibles can be safer than the shares: a convertible has a bond floor, so an investor in a company that halved has usually lost far less than a shareholder.
In India
The main convertible instruments are 3.
Foreign currency convertible bonds, or FCCBs. Issued abroad, usually in US dollars, and convertible into the Indian company's shares. They were heavily used before 2008 because coupons abroad were far below Indian rupee borrowing costs. They carry a risk a domestic convertible does not: if the rupee weakens, the repayment gets larger in rupee terms.
Compulsorily convertible debentures, or CCDs, convert on a set date whether the holder wants it or not. A CCD is equity that has not arrived yet.
Warrants issued through preferential allotment, which is where most retail shareholders meet this subject. Under SEBI's ICDR Regulations the allottee pays 25% of the price upfront and has 18 months to pay the remaining 75% and receive shares. If they do not, the 25% is forfeited by the company. The price is set by a formula based on an average of past market prices.
A promoter taking warrants is therefore buying an 18-month option on their own company, for 25% down, at a price fixed today. Adani Green Energy shows the scale. On 26 December 2023 it announced a preferential issue of warrants to promoter entities to raise up to ₹9,350 crore at ₹1,480.75 per share, exercisable in tranches over 18 months from allotment .
Every listed Indian company must disclose outstanding convertible securities in its quarterly shareholding pattern. That is the document to read.
In the United States
Convertible notes are a mainstream funding tool and the US convertible market is the largest in the world. They are used most by growth companies whose shares are volatile, because volatility makes the embedded option valuable and lets the company cut the coupon.
Two American features are worth knowing. Zero-coupon converts are normal: MicroStrategy's 0% notes are not an oddity, because when shares are volatile enough the option alone is worth the whole cost of the loan. And capped calls, options the company buys from banks alongside the issue, offset part of the share issuance on conversion.
American warrants appear most often in rescue financing and in SPAC structures.
Where they differ, and what that tells you
In the United States, convertibles are mostly a financing choice. In India, warrants are mostly a control and signalling event.
An American convertible is issued to institutional investors at a price set by the market on the day, through a competitive process. The buyers are professionals with no relationship to the company. An Indian preferential warrant issue is typically made to the promoter or a named investor, at a price set by a regulatory formula based on past market prices, with 25% paid and 18 months to decide. The buyer often controls the company.
That means watching 2 different things. In the United States, watch the arithmetic: conversion price, capped call, diluted share count. The process is competitive, so the terms are close to fair.
In India, watch the timing and the identity. A promoter subscribing to warrants after a share price fall, at a price based on a 6-month average of that fall, is buying cheaply from the company. That can be a genuine signal of commitment, and it is frequently reported as one. It is also a transfer, and both readings can be true at once.
The question that separates them is whether the promoter actually pays the remaining 75% and converts. Warrants allowed to lapse, with the 25% forfeited, say something quite different from warrants exercised in full. That outcome is disclosed, it arrives 18 months later, and almost nobody goes back to check it.
Carry this
- A convertible is a bond with an option to become shares. A warrant is the option alone.
- A warrant creates new shares. An exchange-traded option only moves existing ones. That is the difference that costs you money.
- Read diluted earnings per share, not basic, and watch whether the gap is growing.