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Strategies & Market Trends : Floorless Preferred Stock/Debenture -- Ignore unavailable to you. Want to Upgrade?

To: Larry Brubaker who wrote (1030)	11/7/1999 12:13:00 PM
From: DanZ	Respond to of 1438

GUMM. Larry, Thank you for looking at the Citadel financing and for your feedback. Technically you are correct that convertible debt that has no lower limit on the conversion price is "floorless". However, as you noted in your conclusion, it is more important to consider whether the lender has an economic incentive to short the stock, because this in essence is what makes some floorless debentures bad for shareholders. You pointed out some of the reasons that the Citadel financing shouldn't be bad for the stock, and I would like to add a few more. Because Citadel owns warrants, they have an economic incentive for the stock to go up. It would be counterproductive for them to depress the stock. As you noted, GumTech unilaterally (assuming no default) controls whether payments to Citadel are made with cash or stock. The interest payments on the notes can be paid with stock, and redemption of the notes and the preferred stock can be paid with stock. Dividends on the preferred stock must be paid with cash. The amount of stock that could be issued in lieu of cash interest payments is negligible. The only time that Citadel can receive a large amount of stock at one time is if GumTech redeems with stock, 50% of the notes or preferred stock on the first or second anniversary. In this case, Citadel can only sell 5% of their shares on any one day, and the amount that they can receive is limited to 200% of the average daily volume in the 20 day period before the redemption. While trading during these periods might be a little odd, Citadel can't dump stock on the market and it is likely that their selling will be easily absorbed by the market. I'd also like to note that GumTech received a very favorable rate on the financing considering their size. Citadel must have felt that the terms fairly compensated their risk or they wouldn't have done the deal. My guess is that Citadel reviewed the results of the first clinical study during their due diligence process are were convinced that Zicam works as described in the study results. Depending on GumTech's cash flow and stock price on the one and two year anniversaries, the company might elect to redeem 50% of the notes and preferred stock with cash rather than stock. If this occurs, the conversion feature won't even come into play. Either way, I am confident that management will act in the best interest of shareholders. Citadel stands to make a lot of money on this deal, primarily because of their interest in the warrants. If things work out for the company like I'm expecting, Citadel's 300,000 warrants exercisable at $12.44 per share could return many times more than they will make on interest and dividends. Thanks again for looking at the financing in such detail, and best of luck in your trading. Dan