Did ifmx do a convertible preferred offering last year? Someone sent me this article via email. Sorry for the length, I tried to only include the ifmx relevant stuff. I know a little about this type of desperation financing and it almost always causes the share price to plummet for the existing shareholders. The preferred shareholders always win big first by shorting the stock and then converting at a lower price, causing dilution. The worst thing is the institutions always stay away until the dilution plays out. The common holders lose 50% of their value routinely. I didn't get into ifmx until Dec - did you long term holders know about this? I never saw it discussed on this board. Anybody who wants the entire article or questions about convertible preferred offerings send me a pvt msg.
Michelle
FLOATING BETWEEN A ROCK AND A HARD PLACE
A certain breed of convertible preferred stock may lead weak issuers to an ill-advised choice.
By Ellen Jovin
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Informix was in turmoil last August. The chairman and other senior officers at the Menlo Park, Calif.-based database technology company had resigned, and a pending restatement of its financials would reduce reported revenues between 1994 and 1997 by hundreds of million of dollars. Adding insult to injury, $662 million Informix needed cash.
"The company clearly was going to have trouble continuing to sell to its customers with the financial cloud hanging over it," says Informix's former treasurer Margaret Brauns, who is now chief financial officer at Red Brick Systems, a $43.3 million data warehousing company in Los Gatos, Calif. "So all [the] usual sources of capital simply were not available to the company."
Enter New York-based Fletcher Asset Management, a private investment management
company. Fletcher stepped in with a private placement deal that gave Informix a $40 million
cash infusion, as well as the time and space it needed to right itself. The company issued
preferred stock, convertible into common shares at a price that floats with the market price
of the company's common stock.
Specifically, the conversion price would be equal to 101% of the common stock's average
price for the 30 trading days ending five trading days prior to the conversion, with a $12
upper limit on the conversion price. In addition, Informix issued a warrant to acquire up to
an additional 140,000 shares of Series A convertible preferred stock at an aggregate exercise price of up to $35 million.
The structure meant that if the common stock price at conversion was lower than at issue
date, Fletcher would get more shares. If the stock price was higher, Fletcher would get
fewer shares.
But the type of convertible preferred deal that Informix did is not always the rule. And while
this financing strategy has been a boon to some companies, it has brought disaster to others
whose common stock price has nosedived soon after a deal was done. This fact has not
been lost on short sellers, and some stock manipulation is occurring.
Also, unlike Informix, many issuers add a little wrinkle to the structure, in which investors
get discounts at conversion of as much as 20% to 40% off the stock's average trading price. Such discounts give investors built-in profits.
Expensive Deal
In late December, Informix's stock price descended to a year low of 4, and then began to climb again. On February 13 Fletcher converted its preferred stock, including shares acquired through the exercise of the warrant, and ended up with 13.7 million common shares of the company, or 9% of its outstanding stock. While Fletcher did not disclose the conversion price, the number of shares acquired suggests a 4 5/16 conversion price--an expensive bit of financing for Informix, whose stock price has ranged from 4 to 17 1/8 over the past year.
Nonetheless, the deal provided the company with cash at a time when it needed it and lacked other financing prospects. In recent years, similar private issues of what is known as floating convertible preferred stock have raised hundreds of millions of dollars for companies unable to go a more traditional financing route.
Kell Benson, former chief financial officer of Zenith Electronics and now managing director of corporate finance at Fletcher, says that his boss, Alphonse Fletcher Jr., originated the
structure. Fletcher, chairman and chief executive officer, does most of his floating convertible preferred deals under Regulation S of the Securities Act of 1933, which, along with Regulation D, exempt issuers from registering securities. "The convertible preferred is much safer than common stock," Fletcher says, from the investor's point of view. "Yet it still has a lot of upside if the stock actually takes off." By definition, in the event of bankruptcy, preferred shareholders' claims come before those of common shareholders.
For treasurers, however, some cautionary words are in order. Discount deals, perhaps, top the danger list. Regulations S and D allow them, too. Benson frowns on the notion of a discount deal. "It is certainly allowed under the regulations," he says, "but I don't think it is good for the company or its shareholders. To us it is very important that everybody--the company, the shareholders and Fletcher--benefit by paying market price for the common stock into which we convert."
The investors who participate in discount deals automatically make a profit when they convert, since the conversion price is below the prevailing market price. However, what really hurts corporations that undertake such financings is the short-selling threat that conversions encourage. Armed with a discount and automatic profit, investors face no downside from shorting the company's stock for an even bigger gain, especially since the issuers are generally in financial trouble.
The short-selling can further weaken an already falling stock price. Then, after ceasing the short sales, investors convert at a low stock price, covering their short sales by converting into common shares or buying common stock on the market. At that point the market often runs up again, providing them with a big profit in a short period of time.
Why, then, would a treasurer ever be drawn to this type of financing? Public issues are typically not an option for companies that are losing money, on the verge of a restructuring or in other situations inherently unattractive to investors. The floating convertible preferred offers a company a way to get some equity on the balance sheet quickly, before a bank yanks its line of credit or an exchange moves to delist it.
In addition, a growth company that is no longer a candidate for a secondary public offering might consider such a security. After all, it provides the company with quick cash while pricing the equity in the future, when potentially higher market prices would make it less dilutive. "An investor is going to be more flexible and faster to move in this case than he would be if he were just buying common stock and were at the full risk of the market," Fletcher says.
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How A Floating Convertible Preferred
Is Supposed To WorkA company with a positive business outlook issues $10 million of convertible preferred stock to a single institutional investor. After a 45-day holding period, the preferred shares are convertible into common stock, whenever the investor chooses, at the average share price over the last 20 trading days prior to conversion. There are upper and lower caps on the conversion price: the investor won't have to pay higher than $15 under any circumstances, and he won't be permitted to convert at less than $5.
At the time of issuance, the company's common stock, which is undervalued, is selling for $10 per share.
Three months later, after a gradual decline, the company's stock price begins to rise.
Twenty trading days later, with the stock price at $16, the investor converts at an average conversion price of $13 and sells his shares for a profit of $3 per share. By using a structure that encouraged him to sell into a rising market, the company had to issue fewer common shares than it would have at any point during the preceding months.
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The Anatomy Of Shorting
A Floating Convertible Preferred A company with a negative business outlook issues $10 million of convertible preferred stock to a group of 25 investors. After a 45-day holding period, the preferred shares are convertible into common stock, whenever an investor chooses, at a conversion price that is 90% of market price at the time of conversion.
At the time of issuance, the company's common stock is selling for $10 a share.
One group of investors immediately begins short-selling the company's common stock. The stock's short position soars, and the selling activity drives its stock price down. Other preferred stockholders panic and convert, selling their common shares and driving the stock price down even further. The short-sellers cover their positions as the stock price descends, pocketing the difference between the current price and the price at the time they initiated the sale.
The stock price hits $1. The short-sellers cease their selling activity and convert their preferred shares at 90% of the market price, or $.90. They cover any remaining short positions with newly converted common stock. In addition to the profits from their short sales in a declining market, the investors earn an automatic $.10 profit per share that they sell upon conversion. If they hold on to their investments and the company recovers, they will own a large percentage of its outstanding shares. |
