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4:16 pm
January 2, 2012
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Graeme
| | Austin, Texas | |
| Member | posts 183 |
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Really interesting stuff. It's kind of like dealing with an call option, except you don't know the maturity date, but you do know the maturity price. You say it probably starts trading tomorrow? I am a preferred shares newbie. Do you buy and sell like any other security?
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4:15 pm
January 2, 2012
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somrh
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That seems reasonable.
FWIW, if I plug in 95% chance that the shares get redeemed in 10 years then I get p=26%. In that case my technique gives about $2.63. The downside here though is that I think we can safely say it won't get redeemed within the first year. So maybe an adjustment is needed. Your $2 price tag doesn't seem unreasonable.
Obviously there are plenty of unknowns here but the odd nature of these preferred shares suggests that we might be able to buy them for dirt cheap prices. I believe they (along with OSH) start trading tomorrow as the distribution occurred over the weekend IIRC. So we'll have to see what they end up selling for.
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3:43 pm
January 2, 2012
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compoundinglife
| | Seattle | |
| Member | posts 23 |
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Intersting way to look at it. I am looking at in slightly different way, mainly to make it easier to wrap my head around it. I am assuming a worst case scenario of 10 years for orchard to redeem the preferreds. This is a wild guess but I think based on the numbers in the spin off document its a good worst case scenario, considering the total value is only 20 million and they need to redeem them before buying back shares or paying dividend.
If you can purchase the shares at $1 and they are redeemed in 10 years that is a total return of 316% or 15.321% annualized.
At $2 per share its 108% or 7.599 annualized.
If you purchase them at $1 and they redeem in 5 years that is 32.99% annualized.
At $2 its 15.77 annualized.
Like alot of things in investing the key here is figuring out what you believe the odds to be. I feel the odds of the shares not being redeemed in 10 years is fairly low. In which case I am probably a buyer at prices under $2 because I feel 7.599 per year is a good worst case and the possibility of them getting redeemed sooner in my opinion is greater than 50% which would mean a higher time based return.
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3:04 pm
January 2, 2012
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somrh
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compoundinglife said:
Yeah this is a strange security.
…which is why I think no one will want it and why I'm interested.
…
I figured out how to modify my calculation by assuming the probability is a geometric distribution with p=chance of getting payment.
This gives a value of $1.04 for 5%. It's still pretty sensitive to initial conditions. $.49 for a 2% chance and $1.66 for a 10% chance. It's only $3.61 for a 99% chance so it works (excel gave me an error 100% but it's consistent with $4.15 discounted by 15% for one year.)
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2:48 pm
January 2, 2012
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compoundinglife
| | Seattle | |
| Member | posts 23 |
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Just read through the information here http://www.searsholdings.com/i…..2.2011.pdf
Yeah this is a strange security. As you mentioned it has liquidation preference of 4.16 but no coupon, no call date and no maturity. The only real condition is that the company can't buy back stock or pay a dividend to any shareholder until they are all redeemed. My guess is that this a way to spin off the debt from SHLD's books to shareholders in a way that does not drain the cashflow of the Orchard giving them basically as much time as they need to pay it back. It seems like the bonus is that any shares distributed to the SHLD float shareholders could get sold off and Orchard could buy them back on the open market at a discount. Since ESL is run for its investors I can't see them selling the shares for anything less that the liquidation prefernce. I also imagine BB would hold on to his as well.
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2:44 pm
January 2, 2012
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somrh
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compounding life, I didn't see your post until after I posted.
As far as I can tell, there is no matuirty date. They talk about a redemption date but it looks as though that will get set if/when they decide to redeem the shares.
See here.
In particular, look at Exhibit 3.2.
The only date referred to is a "Board Trigger Date" and this, as far as I can tell, seems to be related to the poison pill. Exhibit 3.1a has the definition of "Board Trigger Date".
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2:13 pm
January 2, 2012
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somrh
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That's what I can't figure out. Most preferred shares pay dividends. Sometimes the dividend gets suspended but the common can't pay dividends unless there are make-up payments. Some preferred shares have convertibility rights.
This one has none of that.
I believe the things will start trading tomorrow. It's part of the SHLD spin-off. Every 100 shares of SHLD will get the investor approximately 4 shares of OSH (Orchard Supply Hardware Class A common stock) and 4 shares of the preferred shares of Orchard Supply Hardware.
OSH has about $600M in assets and does about the same in revenues. I suspect that most folks bought SHLD for either Sears or Kmart. So many folks may not want their 4 shares of OSH and may sell them.
What I can't figure out is why anyone would want the preferred shares. If I'm going to keep anything in this, I'll keep the common stock. I'd consider the preferred shares if they paid a dividend but they don't. I have a feelilng that the preferred shares will get dumped harder than the common stock.
There will be about 4.8M shares of preferred and common shares. So if
they were to buy up the preferred, it would cost the company about $20M.
On the plus side, ESL investments will own about 61% of both Class A common and 61% of the preferred shares. So there is some interest in having the preferred shares be profitable.
So what I want to know is what the things are worth.
I did come up with one method which I think overstates its value to some extent due. Let's suppose that in every year there is a 5% chance that you'll get the $4.16. So the exptected value in any year is $.208. You can then discount this with a discount rate and sum up the value (I used 15%). This gives a price tag of about $1.37.
The problem with this is that it assumes that the probabilities are independent. But the probability of receiving $4.16 in year 20 is not 5% if the $4.16 has already been paid; it's 0%. So I suspect this method overstates the value.
It's also pretty sensitive to the choice in the percent chance. Changing the percentage to 2% gives $.55 and changing it to 10% gives $2.73. Changing it to 100% gives $27.31 which is obviously too much which is why I need to come up with a way to account for dependence but my brain isn't working right at the moment.
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1:53 pm
January 2, 2012
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compoundinglife
| | Seattle | |
| Member | posts 23 |
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Post edited 5:57 am – January 2, 2012 by compoundinglife
Some more information on the security and the corresponding entity/company would be good. From the sounds of it these are probably zero coupon preferred shares. Instead of paying a regular dividend the shares accumulate interest (normally at a fixed rate) and the holder is repaid their principle and interest at maturity. So the interest you collect is the stated value at maturity minus your cost basis. Hence zero coupon bonds and prefs should trade a discount to par based the interest rate and time to maturity.
You said "If the company ever decides to redeem them". This makes me think they are perpetual preferred shares, but I personally have never come across a perpetual pref that was zero coupon. Even in they are perpetual, in general they should have a call date which is when the company is granted the right to redeem them without a penalty if they choose to do so.
As far as valuation goes, the value of the security is going to fluctuate with interest rates and also the credit worthiness of the company. The issue in my mind with zero coupons is that one day you could find out the company is going downhill at which point your position could become worthless and in the meantime you have not collected any cash from them. If you are getting regular coupon payments that provides something to partially offset some of the permanent capital loss risk. As I mentioned with interest rates, if interest rates go up that will likely have negative impact on the current market price, so if you are not planning on holding to maturity it might be a good idea to stay away. One exception would be where the security is heavily discounted because the company is believed to be at risk in which case any good news could cause the price to go up.
One situtation where zero coupon bonds can be a big score is if they are close to maturity and the market is irrational. During the financial crisis there were situations where you could buy bonds that matured in the very near future for discounts to par because of fear or forced selling because the holders had to raise cash.
I only buy debt when it is heavily discounted and would be interested to see if these are in fact discounted significantly or if they are just trading at a fair valuation based on their rate and maturity.
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10:20 am
January 2, 2012
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Graeme
| | Austin, Texas | |
| Member | posts 183 |
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Any more info?
A starting point would be to…you know…at least not pay $4.16 for them :)
I thought preferred stock by virtue of being a preferred stock always payed a dividend?
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2:14 am
January 2, 2012
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somrh
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So have I got an investing opportunity for you fine folks. I've found some preferred shares which do not currently pay a dividend. Not only that, there was never any intention to pay a dividend on these.
Now at some point, one can receive about $4.16 for these if the company ever decides to redeem them. So how much are these things worth?
Any takers? Anyone want to buy one of these or does it sound like trash?
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