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Strategies & Market Trends : Roger's 1997 Short Picks -- Ignore unavailable to you. Want to Upgrade?

To: Bearded One who wrote (6989)	11/14/1997 8:10:00 AM
From: Pancho Villa	Respond to of 9285

Bearded One, RE: AOL convertible bedt. Cool back of the envelope analysis! Don't know if the extra work is worthed here but one could throw in a couple of refinements: 1. The interest AOL could have gotten in a non-convertible should be close to the average yield for debt of similar characteristics for companies with the same Moody's rating as AOL. Let's assume this is indeed as you said around 7%.(I am big in theory not so good in the practical aspects. Where could one get the Moddy's inf. for free in the net?). 2. from the difference between this and 4% (i.e., 3%, you calculated an annual savings of $10.5 million during five years. Instead of multiplying times 5, one could take into consideration the time value of money and calculate the present value of an annuity of $10.5 Million during 5 years discounted at 7%. From an annuity table the factor is 4.1002. So the present value of the options is: 10.5*4.1002=$43.05 million. From this the option price is: 43.05/3.3=$13.04. Now, I do not trade options so you take over from here... Pancho

To: Bearded One who wrote (6989)	11/14/1997 9:05:00 AM
From: Daniel Chisholm	Read Replies (2) \| Respond to of 9285

So AOL effectively bundled cheap 5 year $104 call options with their debt issue, in return for a subsidized (4%) interest rate. I disagree with Roger that the "overhang" of 3.3 million $104 call options will effectively cap AOL's price at $104. What about their outstanding employee stock options? Aren't they of greater number, nearer maturity and lower strike price? Personally I don't think AOL justifies a share price of $104, but I don't think the effect of this convertible debt will be material. What can we expect the holders of these cheap call options to do? Unless they are interested in possessing cheap call options, one can expect them to hedge, e.g., turn around and sell expensive call options (i.e., on the standardized options market), or take an appropriately sized fractional short position. I don't think there's anything really sinister here, it is just another way of AOL effectively raising capital by (synthetically) issuing new shares. Since AOL's stock price is extremely high, this does not dilute existing shareholder value, in fact it will likely be accretive. In return for all exisiting shareholders sacrificing about 3% dilution, they get about $3 per share of cash. As in any pyramid or Ponzi scheme, existing entrants benefit (in fact they depend on) new entrants participating. - Daniel