Shares of U.S. exploration and production company Centennial Resource Development (CDEV -5.92%) fell by roughly 8.5% in morning trading on Wednesday. That decline followed even larger losses from the day before. The news driving both days' sell-offs of the energy stock, however, was basically the same.
After the close on Monday, Centennial Resource Development announced plans to sell $150 million worth of exchangeable senior notes that will mature in 2028. The proceeds from the debt issuance are slated to be used for the repayment of debt that comes due in 2025. It will also reduce its borrowings on a revolving credit line. These are positive moves for its balance sheet, which, given the energy company's modest size and heavy leverage, was a major concern during oil's deep 2020 price decline.
That said, there are a couple of issues to consider here. For starters, the notes are exchangeable for stock, which could lead to shareholder dilution. Investors tend to frown on that, which helps explain Tuesday's price decline. After the close that day, meanwhile, Centennial Resource Development provided the pricing for this issuance, which not only brought up the dilution issue again but also outlined the problem more clearly.
According to the company, the 3.25% notes have an initial exchange rate of "159.2610 shares of common stock per $1,000 principal amount of notes, which represents an initial exchange price of approximately $6.28 per share of common stock." The stock currently trades at around $4.50 or so, meaning that any exchanges aren't likely to happen right away, but that doesn't change the longer-term issue.
A little back-of-the-envelope math shows that if the notes are fully converted into stock, that would create 23.9 million new shares. Centennial Resource Development had 278.6 million shares outstanding as of 2020, so the potential dilution here is roughly 8.6%. That's not insignificant, so it's understandable that investors were in a dour mood over the plan. And that 8.6% dilution also happens to be pretty close to the magnitude of the decline in the stock price that took place in early trading Wednesday.