Originally Posted by
Roger
Threw out the Black and Schoals option model and did some fresh clean sheet thinking as you suggested above the other day and reluctantly have to agree with your first post above now that the SP has come down 30 cents in recent weeks. Realistically best case is those 2667 shares are worth say $5 = $13,335 which gives a 33.5% gain over 18 months....who knows I suppose it could theoretically be worth a bit more in Sept 18 more but let's not go there until they get some more runs on the board.
Worst case is they're issued at a 5% discount to vwap so provided you can sell them for what they're issued to you at the bonds give a 5% capital gain as a minimum.
The running yield at 6.5% is okay notwithstanding you have to pay a small premium to the issue price of $1.00. Anything you pay over $1.05 at present, (say hitting the offer at $1.065) is a cost of the effective option element, in that case 1.5 cents get's you a look at the possibility of making a capital gain, maybe 33.5% less the initial premium paid now 6.5% = 27% net gain if they're $5 or maybe 20% - 6.5%, net gain 13.5% if they're $4.50. To look at it that way you have to accept that you are okay with getting slightly less than 6.5% on the bond value of your investment for the next 18 months. Some people aren't okay with that and demand a circa 10% return for any type of investment that has a capital risk of any kind to it, (these bonds rank behind bank debt and the new collaterised debt obligations the company is issuing) and I can see their point of view but I am happy with 6.5 / 1.06 5 = 6.1% running yield.
Throwing all the option pricing theories in the rubbish bin for a minute, (some would say they belong there but I couldn't possibly comment) and using pure gut instinct I think with the shares where they are currently ~ $3.60 your assessment of no more than $1.08 - $1.10 which represents paying a real effective option price right now of 3-5 cents, (remember you are more or less guaranteed a 5% premium so paying $1.05 now is the low water mark in my opinion) for the possibility of a net capital gain of 13.5% - 27% in eighteen months seems about right. My calculations were originally based on a share price of $3.90 so with the shares having come down ~ 30 cents, (glad I sold my shares) in recent times one has to be more realistic about the option value. All that said at current prices in my opinion, convertible bonds on offer for $1.065, a real option cost of only 1.5 cents per bond, they're the better and more one sided investment, (have very limited downside).
On the other hand non risk averse shareholders might argue that getting the full gain from here $5 / $3.60 = 38.9% without paying any premium up front for their investment gives them a better potential return than the bond investor who stands to make a potential 27%. (Note SP needs to be at a 5% premium to the floor exercise price of $3.75 = $3.95 before bondholders start to participate in the SP uplift).
The recent 30 cent SP drop has dramatically affected the bonds value because effectively the entire move down was from just before the threshold at which point the bonds start enjoying SP capital gain.
In effect the bonds were a high conviction BUY when I was buying at up to $1.0825 when the SP was $3.90 but are just a BUY at $1.065 now with the SP at ~ $3.60.
Hope this almost endless ramble makes some sense to people trying to decide between bonds and shares.