The conversion feature of a convertible security (the call option) hardly has any value if the common stock underlying that convertible trades below the effective conversion price. Convertibles in this situation are usually referred to as “busted” convertibles because they trade at high premiums over conversion value. These “busted” convertibles will trade near or at their investment value (the bond value) and thus, have virtually no sensitivity to the movements of their underlying common stock.

Still, many fixed-income investors find these so called “busted” convertibles attractive alternatives to other corporate bonds because of their potential for capital appreciation should the issuing company’s fortunes turn around. Investors with a bullish outlook over the long term generally buy these convertibles with two objectives in mind: (i) receiving a generous yield; and (ii) the appreciation in the value of the convertibles, assuming the underlying stock advances.

We screened the Value Line database of over 540 securities (bonds and preferred stocks) for a list of “busted” convertibles, convertibles trading with premiums over conversion value greater than 50%. Below is a partial list, which includes convertibles with a current yield of at least 10%.

* Prices as of October 23, 2012

Selected Convertibles Highlights:

Alcatel-Lucent (ALU) is a leading telecom-equipment supplier and was formed as a result of Alcatel's November, 2006 acquisition of Lucent Technologies. The company develops and produces telecommunications, Internet, networking, and optics products and services. It also creates integrated end-to-end voice and data communications solutions. Roughly, two-thirds of the company’s overall sales are generated from outside of North America.

Sales rose 1.5% sequentially in the third-quarter, but were down 2.8% from the same period a year earlier. The company also suffered another setback in its bottom line. Share earnings were down from last year.

The convertible preferred stock is currently trading below its liquidation value ($1,000). Thus, upside equity participation is at its lowest level. Based on the company’s third-quarter performance, the convertible may continue to trade below liquidation value. However, the company continues to pay preferred dividends, although it can defer payment for up 20 quarters. The preferred current yield is 13.7%, while the common remains dividendless.

Molycorp, Inc. (MCP) is a rare earth oxide (REO) producer in the Western Hemisphere. The company's rare earths are critical inputs in many existing and emerging applications including clean energy technologies, such as hybrid and electric vehicles and wind power turbines; multiple high-tech uses, including fiber optics, lasers, and hard disk drives; numerous defense applications, such as guidance and control systems and global positioning systems; and advanced water treatment technology for use in industrial, military, and outdoor recreation applications. 

The company is expected to report third-quarter results in a few days. However, at the end of the first half of the year (June 30, 2012), sales of $189.1 million were up 50% from the year-earlier figure. However, share losses deepened.

The out-of-the-money mandatory convertible preferred provides a generous income. But, it is highly unlikely that the preferred will reach liquidation value by February 28, 2014, when the company will force conversion. Until then, holders of this preferred should continue to enjoy the high current yield (now at 14.5%) it offers.  

At the time of this article's writing, the author did not have positions in any of the companies mentioned.