Equity host with a liablity component

[Leo]

Have you ever come across preference shares issued, with a equity host and a liability component? For example, the principle amount can only be redeem by a fixed number of ordinary shares, however, the instrument carries PIK interests compounded annually, which will be converted into a variable number of ordinary shares at fair value. There is a maturity date where the conversion will happen. No cash option.

In such a case, wouldn't the principal treated as an equity and the PIK interests as a liability? If that's the case, how the amount of liability should be determined?

[Leo]

In this case, the principal amount should be treated as equity and the PIK amount as liability.

For example, a convertible prefs with principal amount of 1 million, paying a PIK cumulative interests of 10% every year. Principal convertible into fixed amount of shares and PIK amount into a variable amount of shares, mandatorily at end of year 3. No repayment in cash.

Assuming the market rate is also 10%.

Then, question arises as how to determine the equity and debt. Two options with totally different outcome (see screenshot). Any ideas or suggestions guys?

[Leo]

A strict application of a compound financial instrument would lead me to the journals on the right. However, I'm trying to find a economic rational.

[Leo]

Just putting this up the chain.

[Leo]

Just moving it up in case.

[Marek Muc]

Please don't