I confessed puzzlement yesterday about the price of YLO.PR.A … trading with an implied common conversion price of about $0.10, about half the current price of YLO. Assiduous Reader prefhound stepped up with two reasons:
- ex-dividend: as he says, the price drop on the 12/12 ex-date was extreme – the bid went from 2.30 to 1.80 after a dividend of $0.26563, a Drop Off Rate of 188% … but not so severe as September’s DOR of 670%!
- tax-loss selling: this is entirely reasonable when we look at YLO.PR.A in isolation, or even if we look at the whole YLO complex; but I feel the ratios should be better preserved
For more on the Dividend Drop Off Rate (in general, academic terms) see the May, 2011, edition of PrefLetter.
It’s the ratios that get me … say you’re an investor wanting to take a flutter on YLO. You can buy the common at $0.20 – and lots of people are; as many, in fact, as are selling at $0.20 – or you can buy YLO.PR.A as a common substitute at $0.10 / share. So why choose the former? The downside of the choice will only show up if the common goes above $2.00 before the end of March (assuming early conversion) or the end of 2012 (assuming late conversion) … if the buyers really do have conviction that this will happen, then why isn’t this showing up in the price?
And one thing that bothers me about the tax-loss selling idea is that it works a whole lot better in reverse. Say you own YLO common. You’ve taken a beating, but you want to maintain exposure. So, sell your damn YLO already and buy YLO.PR.A! Then you get your tax loss AND you maintain exposure AND you get the common cheaper. What’s not to like? The only thing I can think of that’s not to like (other than the potential for the common going above $2) is that this means you have to think about it, something I suspect many YLO holders are trying to avoid.
Assiduous Reader MC pointed out via eMail:
- Hard to borrow YLO, therefore hard to arbitrage the spread with a short YLO / long YLO.PR.A strategy
- Liquidity discount on the YLO.PR.A
- Fear of (forced?) selling of YLO common on conversion
With respect to the first point … that makes sense. Assiduous Reader SF tells me that his brokerage is issuing buy-in notices like crazy. This could also be a factor if we turn the question upside down: maybe it’s not YLO.PR.A that’s cheap, maybe it’s YLO that’s expensive, due to all the buy-ins.
We can all remember (or claim that we vaguely remember, anyway) the relatively recent example of Air Canada (?) common shortly before its reorganization. Remember? The company kept emphasizing that common shareholders would be wiped out, and the thing kept trading at around $1 anyway, due to buy-ins and people gambling that the buy-in pressure woud increase.
The third rationale doesn’t appeal to me much, since that should apply equally to both instruments; but it has occured to me that you can make an argument in favour of this mechanism based on differential awareness of the exchange … at this point, I presume that virtually all participants in the market for YLO.PR.A are aware of the potential for conversion, but I’m not sure how many of the common stock guys are. The Efficient Market Hypothesis, of course, says they all are, but maybe, just maybe, this is just one more hole to poke in the poor old thing.
So, in my continuing series of Worthwhile MBA Theses I suggest that some eager student look at as many similar situations as possible and see if the convertING instrument is always (mostly? statistically significantly?) undervalued relative to the convertED instrument. It’s certainly possible!
MC’s other two reasons sound good to me … but I’m still bothered by size of the deviation from fair value. You want to tell me these mean a discount of 10%, I’ll say fine. You say 20%, I’ll swallow hard and say OK. But 50%? Really?
The pref ex-dividend argument is still pretty powerful. It upsets the ratio because the common didn’t go ex and pref owners are more likely to sell regardless of ratio (or anything else for that matter).
Fear of forced selling on conversion could be significant: $400M face value of prefs will be 200M or 40% of common shares (divided into 2 batches). However, saving the $20M+ a year in dividends will improve cash flow to common by at least 10%, offsetting dilution somewhat. Anyway, will selling be “forced”? If it is forced, then the common should “see” it also.
Finally, prior to the ex-dividend date, both YLO.PR.A and B were converging toward 12.5X common+PV(Dividends). The only thing to have changed is the dividend went ex.
Anyway, it is amusing to note that since this question came up, the prefs have increased in price (a little) and common has eased off.
since this question came up, the prefs have increased in price (a little) and common has eased off
Don’t underestimate how many Assiduous Readers are following your words of wisdom.
Thank you,
Adrian