How long will this go on?
OK, so CC is selling, the buyers have backed off, and the shorters and insiders aren't buying. How long will the sell-off continue?
We need to examine CC's intentions, and the patterns of their transactions so far to try and answer this. I have been trying out several scenarios, and attempted to reconcile each scenario with the facts as we know them.
After examining the evidence, I must admit that CC apparently is interested in Valence primarily as a trading vehicle and use the preferred stock to lock in an annual return in the 40%+ range. They insist on being hedged at all times, if possible.
They hedged the initial Series A preferred shares in less than six months, and locked in a gain of about 25-30% in that time frame. Looking at the stock price last October to December, its apparent that CC sold short stock at an average price somewhere around 7.50-8.00. On an annualized basis, they locked in a return on the Series A of 50-60% ROR.
On the Series B preferred shares, they only had one week this spring where the stock price went over 8, so its apparent they never had a chance to short in the type of return they got on the Series A. It doesn't appear CC shorted much against the Series B, but again they had the floorless provision to protect them until the time when they could lock in a return of the size they wanted.
Some may argue that CC did short against the Series B this spring or earlier this summer, and I will re-examine this assumption later in this post.
When the floorless provision activated on July 27, the floorless bandits started shorting Valence. By the third week of August, CC and Valence were negotiating terms to remove the floorless provision. During these negotiations, CC said that they hadn't sold Valence shares during the month of August. According to my conversation with the CFO on August 25, he told me that the negotiations had broken off earlier because CC had "wanted three pounds of flesh" to remove the floorless. I received the impression that the negotiations had broken off several days earlier, say on August 20 or August 23. I still believe this is the case, especially since we now know that Alan Shugart, a director bought shares on August 24. I don't think he would have been allowed to buy shares when the negotiations were ongoing.
I now believe that CC started shorting their daily quota of 30,000 shares per day, immediately after the negotiations collapsed. On August 23, the stock closing bid dropped below 5 for the first day of eleven consecutive days of sub-five closing bids… I don't think this was a coincidence. During this time period the MM who I believe handles CC's orders was active selling, and was usually present in sizable volume on the ask. When the longs made their stand in the low 4s, and began pushing the price up, this MM shorted a ton of shares at 4.75 and other prices in the high 4s.
Its clear CC was selling all they could to put the pressure on Valence to settle on more favorable terms. But by September 10, the conversion price was ticking up, and CC had to make a decision. Should they convert? And if so, then how many shares?
At this point they had to convert at least enough shares to cover the shorts they had made on the stock at lower prices. But almost all their short sales since August 23 were less than these closing prices. They had to convert to cover all the short shares they used to drive the price down into the 4s…
This was likely slightly in excess of 400,000 shares based on 30,000 a day. If their intention was to drive the price down and improve the conversion price, and put pressure on Valence in the negotiations, then they would have shorted as many shares as they were allowed. Incidentally, the market action of the MM who appears to handle CC's sales, is entirely consistent with these volumes.
So CC had to convert around 400,000 shares to cover these low priced short sales.
But they apparently asked themselves, should we convert more ?
If they had shorted stock earlier in the year against the Series B preferred, then CC would almost certainly convert and lock in their 40% + annualized return on these earlier shorts. This is why I feel comfortable with my earlier assumption that CC wasn't significantly short against Series B preferred when negotiations fell through with Valence.
They probably looked at the recent closing prices of the stock, and decided to convert additional shares at the $4.47 price, that they would sell on the open market in the weeks ahead. They probably felt that they could hold the stock unhedged for some period of time, until they completed the sale of the low price converted stock.
This is where things get interesting. CC decided to convert 700,000 shares. They likely delivered (or held) about 400,000 of their shares against their short sales. Then they apparently immediately tried to sell the 300,000 additional shares on the market, limited only by their quota of 30,000 a day. And they seem to have been doing that for most of the last two weeks. Buyers have backed off, and won't take the shares except at a price just above 5. They know most of the selling is coming from just one market participant.
Given the last two weeks of selling, CC has now sold close to 300,000 of the converted shares. If they delivered 400,000 against shares they shorted in the August 23 to September 10 period, then they should now be almost out of shares. If they want to continue selling, they will need to short against their remaining unconverted preferred shares. I will review that scenario in the next post.
Summary:
Castle Creek has now apparently sold close to 700,000 shares in the last month, and should be close to disposing of the last shares from their conversion.
Paul
|
