George,
I am of the belief that if they choose, the preferred shareholders (at least the Series C holders) can liquidate their entire holding of preferred shares without selling long. That is, they need not hold common shares and expose themselves to market risk at any time unless they desire that risk.
As long as they hold their investment in preferred stock their investment is stable: each share is worth exactly $10,000. Assuming that they do not need their funds for other purposes, the only reason to divest is if someone will give them (substantially) more than $10,000 for that share.
Converting their investment into common shares exposes them to market risk unless they sell them immediately. Holding common shares has not been a wise strategy for the last 3 months. I see no reason for them to employ that strategy.
Selling short strikes me as the most expedient manner of capturing the substantial premium. While there is no market for preferred shares (at least not one that I know of), there is a market for the common shares. Each and every day the preferred shareholders know the common share equivalent to their $10,000 preferred share. In fact, the Series C holders even know what the common share equivalent will be 3.5 weeks from now (actually they know the worst case). Some days the price of a common share is too low to divest a preferred share, other days it is very attractive.
Example: On 9/25/98 a Series C preferred share was worth 10,160 shares of common stock. The closing price on that day was $2 1/8, which was not the high for the day. The market was offering the preferred shareholder $21,591 for their $10,000 preferred share. The easiest way to make the transaction is to sell short 10,160 shares. The preferred shareholder bought this preferred share in 2/98 and now "sold" this share in 9/98 for an annualized return of 223%, with absolutely no market risk.
When this short sale is covered is a separate issue. They can convert on the same day as the sale and cover immediately if they choose. They could also wait a while before covering. They are good for replacing the "borrowed" shares sold short, and they know the worst case conversion price they will receive for the next few weeks. By waiting a few more days (or weeks) they can convert at the same price, but "accrete" a few more common shares. This accretion sweetens the deal even more.
The question that puzzles me is "why would they ever cover?" I think the answer is that their broker is obligated to make sure that the preferred shareholders don't sell more common shares than the Prospectus specifies that they can deliver. The amount they can deliver is proportional to the number of preferred shares they still own and inversely proportional to the conversion price.
If the short sale was not covered in the near term, the huge annualize return would vanish once the conversion price increased unless they converted and held the common shares long. (This becomes an implicit short against the box, I believe.) However, these shares have already been sold, and are not available to be sold a second time. Holding these shares for a long period of time does not improve their return one iota. But these shares do count toward their 5% limit.
It appears to me that the only way big money can be made on Series B shares is to convert (when the price is attractive) and hold them long until they can be sold long for a big profit. Delayed covering of a short sale related to a Series C conversion interferes with their ability to hold the B conversion shares and has no financial benefit.
I think a better use of Series B shares is to settle for a very modest return (10-15%) obtained by selling and converting immediately. The selling of these shares would not be to capture a substantial premium, but instead to drive down the conversion price for the Series C shares. The B shares can be sold at a small profit and increase the value of the Series C shares enormously.
Whether this speculation has any relation to real life, I do not know, but I've managed to convince myself that it is plausible. It might even include a feedback mechanism. I'm interested in dissenting opinions.
Greg |
