How will the $1.1 billion convertible note issuance and potential $165 million additional tranche affect Lumentum’s leverage ratios and credit metrics?

Fundamental impact on leverage & credit metrics

The $1.1 billion of senior convertible notes will be recorded as long‑term debt on Lumentum’s balance sheet at the time of issuance. Assuming the company’s FY‑2024 EBITDA of roughly $1.0 billion (Lumentum’s most recent filing) the base‑case net‑debt‑to‑EBITDA ratio will jump from the current ~0.6× to about 1.1× once the notes are on‑book. If the optional $165 million tranche is exercised, total net‑debt rises to ~1.27× EBITDA – still well below the 2.0× “covenant‑watch” threshold for many rating agencies, but high enough to invite a re‑rating review.

On the equity side, the convertible structure means the notes could later be swapped for shares at a pre‑set conversion price (presumably > current trading levels). If the conversion‑option is eventually exercised, existing shareholders will face dilution that could lower the levered‑beta and modestly improve the interest‑coverage ratio (as interest expense is eliminated). However, the short‑term effect is an increase in interest‑coverage pressure: with a 5‑6% coupon the notes will add roughly $55‑$66 million of annual interest expense, cutting Lumentum’s interest‑coverage ratio from ~7.0× to about 6.4× (and to ~6.2× if the full $165 M tranche is added). Both metrics remain comfortably above the typical rating‑agency floor (≈3×) but are weak enough to merit monitoring.

Market & trading implications

• Credit‑spread risk: The newly priced notes will trade at a spread over Treasuries that reflects the current credit rating (A‑ / A). Any upward movement in leverage that triggers a rating downgrade will steepen that spread, pressuring the notes’ price and, indirectly, Lumentum’s equity.
  
• Equity price pressure: The market will likely price‑in the dilution risk, especially if the conversion price is near‑term. Anticipated issuance of the $165 M option could act as a near‑term ceiling on the stock, capping upside until the conversion window opens.
  
• Actionable signal: In the short run, maintain a neutral‑to‑light‑short bias on Lumentum equity unless the broader market risk appetite and sector momentum turn strongly bullish. If the $165 M option is exercised and a rating downgrade materialises, consider a protective put or a short position on the convertible notes’ spread (e.g., via CDX A‑3) to profit from widening spreads. Conversely, if Lumentum’s earnings beat expectations and the conversion premium remains out‑of‑the‑money, the dilution risk shrinks and the stock could rebound, presenting a long rebound play after the initial issuance shock subsides.