Roger, this is my analysis of Zitel's "loan:"
I have not read the 78 pages of the 8-K, but just from the first paragraph posted (#7446) on this thread, it is clear that the lenders got a lot of option value from this deal. Among other things, they got a long-dated call at $26.975. One can look at Bloomberg to see that calls with these strike price have considerable value, even for much shorter expiration dates. The other option, also long-dated, which allows the lenders to buy the stock at 90% of the "market price" (as defined in the 8-K) also adds considerable value to the deal, from the point of view of the lender.
The lenders can exercise the options at any time after only 90 days, which means the options are worth more than European-style options with a 90-days expiration period. (Remember, the value of an option increases with the time to expiration.) And even these 90-day options would have substantial value. To see this, let us look at three scenarios that exhaust the possibilities for European-style options with a 90-day expiration:
A) If the stock price p remains below $29.972 (= $26.975/0.9) at expiration, the investors can buy shares at 0.9 * p, for a profit of 0.1 * p.
B) If the stock price p rises above $29.972 at expiration, the investors do even better, since they can buy the stock for $26.975 and sell it for a profit greater than 0.1 * p. Of course, in this case p is also greater than it would be in scenario A.
C) Zitel goes bust before the 90-day period expires, so the stock is worth zero.
Considering only the first two scenarios, the investors have an expected return greater than 11.25% (10% as discussed above plus 1.25% = 5%/4) return on their money in 90 days. To see this, first assume that even in scenario B the profit will be 0.1 * p. In this case, assuming no drift for the stock price, and taking expectations, the expected return would be 11.25%. Since in scenario B the profit is greater than 0.1 * p, the expected return must be greater than 11.25%.
11.25% in 90 days corresponds to an annualized interest rate of 53.1%. So 53.1% is an underestimate of the expected annualized return on the loan.
The only way lenders can lose money on this deal is if Zitel goes bust in the initial ninety days, and they cannot recover the whole loan amount in bankruptcy proceedings. Of course, the investors can hedge themselves against this possibility by purchasing cheap out-of-the money puts, which would slightly reduce their returns in scenarios A and B.
Under scenario A, if the stock price drops so much that the profit of 0.1 * p becomes small compared to the initial loan amount, returns will be small, but still decent. For example, if the stock is at $1.00 per share after 90 days they can buy it for $0.90 and sell it immediately with a $0.10 profit, which would represent a 0.4% (= $0.10/$25) return. This, added to the 1.25% interest earned on the period, would amount to a 1.65% return in 90 days, or 6.7% on an annualized basis, still a respectable return when compared to 3-month T-bills.
The conclusion is that there are only two reasonable interpretations of this deal:
1) It is a criminal transfer of value from shareholders to third parties;
2) Zitel is in such a disastrous financial condition that there is a substantial likelihood of it going bust in the next 90 days, in which case the astronomical returns offered to lenders are justified by the risks they are assuming.
I am inclined to believe the first alternative is the one that applies in this case. Regardless, the outlook for the stock is extremely bearish.
Best regards. |
