bjc,
If you calculate the difference between what Meyerson would get based on either strategy, ie hold warrants or convert into stock and hold, you get something like this.
Let's suppose they convert 1,000 warrants at $3.5 per share and buy stock. How does this compare to just holding the warrants? They made $2.25 profit and get taxed 20% (long term capital gains). They have $3.05 of their original $3.5 to invest so they can buy 870 shares of FTEL with the 1,000 warrants. FTEL rises $1 to $4.5, they make $870 profit and the IRS lets them keep $626 (short term capital gain of 28%). If they kept the original 1,000 warrants, at $4.5, they have a $1,000 gain. From that gain, Franklin gets 30% of the move from $4 to $4.5, and the IRS would get 20% of the remainder which leaves $680.
Let's suppose the price was $4.5 and Meyerson had the same decision. With the conversion of 1,000 at $4.5, they are able to clear $3.73 of each share, and now they can purchase only 829 shares of FTEL. If the price continues to $5.5, then they gain $829 but the IRS lets them keep $597. Holding the warrants at this point doesn't do as well, though. They only keep $700 for a one point move because Franklin gets 30% and of what's left, the IRS gets $140, leaving $560.
Take this one step farther and the pendulum swings back. If Meyerson waits until $5.5, it's better to hold than convert. A warrant at $5.5 is really only worth $4.09 after giving Franklin the 30% over $4 and the IRS 20% of the remaining profit (their original $1.25 is not taxable). They buy 744 shares now at the long term rate would increase only $535 with a one point rise. Just hold the warrants and they increase $560, same as before.
The number of conversion shares if the price is at least $4, holding the warrants will always yield $560 after taxes and 30% to Franklin. The formula for conversion (based on x=price) is: [(.8)((x-4)(.7)+2.25)+1.25]/x The (.7) is what part over $4 the warrant holder keeps where Franklin gets the other 30%. The (.8) is what the warrant holder keeps after the IRS is through (long term rates). The 1.25 is what the warrant holder in the first place and the 2.25 is the taxable growth that must be taxed if the price rises to at least $4. Let's say the price rises to $100. The warrant holder can convert 1,000 warrants into only 568 shares of FTEL. A one dollar rise would yield only $409 while the patient warrant holder would continue gaining $560, both after taxes.
The long term rates make all the difference. Short term rates are 40% higher than long.
Hope this helps.
WH |
