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 620 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 August 12, 2011

Hutchinson Technology (HTCH) is the leading manufacturer of suspension assemblies for (magnetic) hard-disk drives, which contributed 98% of 2010 sales. The company also developed a medical device that uses an optical technology to measure local oxygen saturation of hemoglobin in tissue.

The company reported shipping 118 million suspension assemblies during its fiscal 2011 third quarter (which ended June 26, 2011). This was a 15% increase over the same period a year earlier, and higher than management’s previous forecast of a 10% rise. Value Line believes the strong demand will continue into the fiscal fourth quarter. As a result, sales are expected to reach $280 million for the year, and the share loss should also be reduced.

The 8.5% convertible notes due 2026, which are not callable before January 15, 2015, offer a generous 10.4% current yield advantage over the common and an 11.4% yield to maturity. However, if the common stock price equals or exceeds $12.90 a share between January 15, 2013 and January 14, 2015, holders could be forced to convert into common shares. The convertible is also putable on January 15, 2015, offering a yield to put of 16.3% yield to the nearest put date.

ATP Oil & Gas (ATPG) engages in the acquisition, development, and production of oil and natural gas properties in the Gulf of Mexico, the United Kingdom, and the Dutch Sectors of the North Sea. As of December 31, 2010, ATPG had estimated net proved reserves of 126.4 million barrels of crude oil or other liquid hydrocarbons equivalent (MMBoe), of which 83.9 MMboe were in the Gulf of Mexico and 42.5 MMBoe were in the North Sea. The company also owns leasehold and other interests in 51 offshore blocks and 88 wells, including 24 subsea wells in the Gulf of Mexico. The company also has interests in 13 blocks and three company-operated subsea wells in the North Sea. ATP Oil & Gas has reserves of approximately 75.1 million barrels of oil and 307.8 billion cubic feet of natural gas.

Over the past nine years, ATPG reported profits from operations in just 2007 and 2008. The company, however, saw some improvements in sales in the first half of this year. In fact, sales of $339.4 million were up 75% from the same period last year. The share loss, on the other hand, widened to $3.21 from $0.18 in 2010.

The common stock is very volatile, with a beta of 1.95. ATP also pays no dividend. On the other hand, the preferred, which is higher than the common in the company’s hierarchy, offers a generous 10.7% current yield. That, plus the free conversion feature make these preferreds a worthwhile addition to yield-oriented portfolios, with capital gain potential if the common rises.

Clearwire Communications (CLWR) provides wireless broadband service in the United States, Mexico, and Europe, covering 92 markets. As of March 13, 2011, the company had 6.15 million subscribers, and experienced a 12-month growth rate of 533%. The company owns 2.5GHz licenses in the U.S. and Mexico, and 3.5 GHz spectrum in Europe, covering 131 million potential customers.

The recent news that Sprint Nextel, one of its major investors, plans to increase its stake in the company drove up CLWR shares a few points. However, Sprint could face competition from other powerhouses like AT&T (T - Free AT&T Stock Report) and Verizon Wireless (VZ - Free Verizon Stock Report) which are also investors in Clearwire.

Clearwire stock is highly speculative, and investors could be better served via the company’s 8.25% convertible notes due 2040.

The convertible currently yields 16.8%, with a yield to maturity of 17.6%. The note is not callable before December 1, 2017. It is also putable on that date for a yield to put of 26.0%. However, since our pricing date (8/12/11), the common has bounced back about 20% to $2.31 (on 8/18), which has also caused the convertible to trade about 10 points higher. These higher prices would have reduced the yields quoted.
  

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