What happened

Shares of Lannett Company (NYSE:LCI) fell as much as 21.3% today after the company announced a convertible debt offering with some extra considerations. The generic drug specialist will issue up to $86.25 million in senior debt notes due 2026, which is expected to provide net proceeds of up to $83.6 million once all fees are deducted. 

That's not unusual, but the debt offering gets complex quickly. Lannett entered into capped call transactions with the purchasers of the debt notes to potentially reduce the stock dilution that occurs when the debt converts into common stock. But the purchasers of the debt have also notified the company that they intend to enter into derivative transactions involving the stock (example: hedging the stock and buying the stock on the open market or in secondary markets), which could end up wiping out the benefits of reduced dilution by making the stock much more volatile.

As of 11:50 a.m. EDT, the stock had settled to a 16.2% loss.

A finger pointing to a declining stock chart on a touchscreen.

Image source: Getty Images.

So what

Essentially, investors are rightly voicing their concern that the debt offering and separate stock transactions planned by the purchasers of the debt notes won't be worth it. The complex financial engineering could increase the value of the transactions to the purchaser of the debt, and may slightly reduce eventual dilution of the company's stock, but all of that could come at the expense of all other shareholders in the long run.

For example, Lannett Company has to use a share of the proceeds from the debt offering to cover the capped call transactions. The remainder will be used to repay a portion of an existing term loan that had a net balance of $149 million at the end of June 2019. The term loan comes due in 2020. 

It would've been much simpler to take advantage of a rising stock price and raise cash through a stock offering. Case in point: The company lost $90 million in market cap today -- more than the impact from a dilutive stock offering. 

Now what

Investors rarely find comfort in complexity. Lannett Company appears to have gone far out of its way to possibly avoid the prospect of stock dilution once the new debt notes convert to shares. After all, it seems inevitable it will have to issue common stock to raise cash and repay the term loan in question by its maturity in 2020. 

All of that said, unless the derivative stock transactions taken by the purchasers of the debt notes drive volatility for the company's stock -- a very real possibility -- today's news should take a backseat to operational improvements by Lannett. That's what really matters in the long run for this small-cap stock.

This article represents the opinion of the writer, who may disagree with the “official” recommendation position of a Motley Fool premium advisory service. We’re motley! Questioning an investing thesis -- even one of our own -- helps us all think critically about investing and make decisions that help us become smarter, happier, and richer.