Zeev, as you may be aware, you have unleased a torrent of posts on several Harken threads re your dire predictions about the end game of "floorless" securities. In my earlier post to you today, I asked a number of questions and while appreciating the fact that you responded, I was disappointed that you didn't address more of my questions.
Zeev, I know you are a prolific poster on a number of SI's threads but sincerely hope you will have the opportunity to read the several thoughtful posts on YAHOO's HEC thread that have undoubtedly been prompted by your initial post here. While I don't want to stir this pot beyond what is appropriate, I do feel the issue needs more than a cursory review by all HEC'ers. The poster on YAHOO is "drjoedoom." The posts are numbered: 1929, 1953, 1972, 1974. In part, for your convenience (and any exclusively S.I. readers), I have taken the liberty of stringing these four in-depth posts together where Joe has addressed what I believe is the whole controversy. For one who is long Harken, I find his approach logical, thoughtful, and informed but can't help but wonder if I'm missing something or he has.
Below, I will post his first two posts. Then, I will post the last two on the next screen. I, as I'm sure a number of other investors in Harken would greatly appreciate your critiques of these serious posts and your pointing out if and where, drjoedoom is, off-base in his analysis.
Thanking you in advance,
Gator II
PS While Joe points out that his analysis is a layman's, in a subsequent post, he does admit he is employed in a large commercial bank's fixed income department. As they, not equity securities, are his primary focus, he perhaps is being overly modest concerning his ability to analyze especially as preferred and convertible debentures are classified as hybrid fixed income instruments.
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"Floorless" Preferred [Headline]
Jul 1 1998/10:13AM EDT
"...my analysis of the "floorless" preferred... Here's a layman's
analysis, FWIW:"
"I've reviewed the language in the 10-Q on the $15 MM series F preferred."
"My inital impression is this:
Shareholders asked for an end to dilution and they got it -- but there's no free lunch.
The "floorless" preferred is also "capless." In other words (and I'm
simplifying here a bit), the holder of each $1000 face amount is
entitled to $1000 of stock based on the then-current price. If the stock is $1, the holder gets 1000 shares; if the stock is $1000, the holder gets 1 share. There is a 5% per annum discount built into the purchase arrangement, which is the only upside the holder seems to have. HEC can redeem this issue for cash if the conversion price is low enough.
So: HEC gets an equity investment of $15 MM. As time passes, there is 5% per annum dilution related to this $15 MM. If HEC's share price rises, the holder of the preferred does NOT participate, except for the 5%. On the other hand, if HEC's share price falls -- AND HEC DOESN'T HAVE THE CASH -- the holder gets an increasingly bigger part of the company.For a company worried about dilution and confident of its access to cash, this seems an OK (admittedly risky) solution. The key seems to be not to do it in size. If the floorless is too big, the holder has an incentive to short the stock, driving the price lower. I assume that this tactic could be successful only if the preferred were large relative to the market cap (which this one isn't). Also, the company's final safeguard is its option to pay cash. The smaller the deal, the higher the likelihood that cash will be available.
Given HEC's sales of interests in the Bolivar drilling, I'm confident
they could raise a modest amount of cash pretty easily, without even
tapping the markets. If it has to go to the markets, HEC should be able to raise $15 MM of equity to retire $15 MM of equity.
The "death spiral" scenario seems a remote possibility that becomes more real if HEC fails to find much oil, can't raise additional funds, etc.
But as one poster said (in effect), "If we're screwed, we're screwed.
What's new?"
Joe
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More on Series F preferred [Headline]
Jul 1 1998/9:28PM EDT
"Everything I see in the details on the Series F Preferred
suggests that it was an attractive BULLISH speculation for the buyer. No need for short-selling conspiracies:"
1. Worst case, the stock drops and the buyer gets back the initial
investment or stock worth that amount. Almost certainly, it'll be cash. Since a cash refund provides a 0% return, I don't think the buyer is betting the stock will go down.
2. If the stock goes up, the buyer would get "stock worth that amount"
plus 5% per annum. But that's not all.
3. Prior to maturity, the holder can't convert unless the stock
appreciates 15% either (a) within a month, from a 5-day low, or (b)
within a week, from a 1-day low. Presumably, the buyer imagines
converting after a >15% rally.
[Admittedly, if the stock is driven down to, say $1 per share, 15%
appreciation would not be much and conversion could occur then. But
given management's option to pay cash if conversion occurs at a low
price, it's clear that the expectation is that the holder would be
converting in a rallying market.]
4. By early 1999, the strike is "fixed" at 90% of the most recent low
5-day average bid. So if the market is rallying, the investor would
convert -- gladly -- at a 10% discount to a recent trading low.
5. The holder of the preferred has the option to double up -- same $$,
same price, same # of shares -- a feature attractive to a bull.
[Again, this feature could be used in the "death-spiral" scenario to
help cover a short. The credibility of HEC's option to pay cash is
criticial.]All in all, the Preferred seems to be a great deal for the bullish investor. Worst case -- cash back. Best case, >60% return -- 105% of principle invested at a 10% discount to the recent low after a >15% rally (5% + 10% + 15% = 30%) -- times two if the investor doubles up. Now you may wonder why HEC management did it. I suspect that my original impression was correct -- they were trying to avoid further dilution.
Consider HEC's position:
Worst case, the stock goes down and HEC redeems the convertible for
cash.
Even worse case (!), the stock drops a bit then rallies to around $5,
and the holder converts at an effective $4.25 (5% premium + 10% discount
= 15% off $5).
Best case -- and this must be what management is expecting -- the stock rallies substantially and the holder converts $15 MM-plus-5% worth of stock at a 10% discount to the early 1999 low 5-day average low bid.
Actually, given the double-up option, it would probably be $30 MM-plus. The result would be less dilution than simply selling the shares today. If the stock is, say, $12, we'd rather have the holder of the preferred own 3 MM (1.5 MM x 2) shares at $10 than 3 MM shares at $5.
This was done pretty quickly. I apologize in advance for errors and
would appreciate your thoughts and comments."
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