What Is Dividend Enhanced Convertible Stock (DECS)?

Dividend enhanced convertible stock (DECS) is a type of convertible preferred stock that provides the holder with premium dividends in addition to an embedded option for the holder to convert the shares into a fixed number of common shares after a predetermined date.

Most convertible preferred stock is exchanged at the request of the shareholder, but sometimes there is a provision that allows the company, or issuer, to force the conversion. The value of a convertible preferred stock is ultimately based on the performance of the common stock.

Key Takeaways

  • Dividend enhanced convertible stock (DECS) is a type of preferred shares that can be converted to common stock at the owner's discretion.
  • DECS also pay a higher dividend to shareholders than ordinary preferreds.
  • Once the common share trades above the conversion price, it may be worthwhile for the preferred shareholders to convert their preferred stock to common shares.

Understanding Dividend Enhanced Convertible Stocks (DECS)

Dividend enhanced convertible stocks (DECS) obligate the holder to convert their security into the underlying company's common stock at some later time. For this reason, DECS basically function similarly to bonds that experience mandatory conversions to common stock at some point. A DECS’ mandatory common stock conversion time period is governed by the company that issues the offering, however, conversion typically occurs within a three to four-year span, following the initial purchase.

Unlike traditional zero-coupon convertibles, DECS provide an equity kicker and can be put to the issuer on certain dates, at prices reflecting the accumulation of the implied interest return. This put feature offers holders a measure of downside protection that limits an investor’s potential losses. In other words, the conversion comes at a predetermined fixed rate, and that conversion ratio begins to decrease once the price of the underlying shares reaches a certain level. But until that point, the conversion ratio is 1:1, and DECS shares may be issued at the same market price as the underlying stock.

DECS and Other Convertible Preferreds

DECS are not the only non-traditional convertible product that has come to market. Other similar models include:

Each of these hybridized models has its own set of unique risk and reward characteristics. But they share the same basic features, including an upside potential that is typically less than that of the underlying common stock, due to the fact that convertible buyers pay a premium for the privilege of converting their shares, and they enjoy higher-than-market dividend rates.

DECS, like most customized hybrid convertible models, originating from different investment banks, which benefit from these instruments, because unlike pure debt issuances like corporate bonds mandatory convertibles do not pose a credit risk later for the company issuing them, since they eventually convert to equity. Such convertibles also eliminate the downward pressure that a pure equity would place on the underlying stock, since they are not immediately converted to common shares.