Bristow (converts) BRS 5.5%
November 14, 2008 - 12:43pm EST by
2008 2009
Price: 29.55 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 600 P/FCF
Net Debt (in $M): 0 EBIT 0 0

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Bristow (Ticker "BRS") operates the world’s largest fleet of helicopters servicing offshore oil and gas drilling rigs and production platforms.  Given the nature of the trade, it is not worth spending much more time describing the business.  In September 2009, holders of the company’s 5.5% mandatorily convertible preferred stock will receive shares of common stock, with the number of shares dependent upon the average common stock price in the days leading up to the conversion date.  I have based the analysis on October 31 prices, though the return profile is similar with current prices.  The spread/yield moves a lot so nimble execution in getting the trade on is imperative.  The common stock as of October 31 was $24.77, having peaked at $58.03 on May 15, 2008.


As long as the stock price remains below $35.26 leading up to the conversion of the preferred, a preferred holder will receive 1.4180 shares.  Should the stock rally back substantially and into a range of $35.26 to $43.19, the preferred shareholders receive between 1.4180 to 1.1576 shares of common, and in the highly unlikely event that the stock rallies above $43.19, the conversion ratio remains locked at 1.1576.  Along the way, the preferred holders get four dividends of $0.6875 each, or a total of $2.75.


I first discovered the preferred when looking at the common stock, thinking that it looked inexpensive given my expectations for continued high activity levels in offshore oil and gas exploration and production.  So I could have just bought the common stock, or, alternatively bought the preferred un-hedged, thereby receiving some exposure to the common and eventually receiving actual shares of common in September 2009.  However, a hedged position offers a better risk-reward in my view.


Should the common stock stay below $35.26, the appropriate hedge ratio would be 1.418 shares short common stock per share of preferred stock owned.  With the preferred stock at $32.50 per share as of October 31, an investor would get $2.75 of dividends, and, if the common stock were to stay at its October 31 level of $24.77, value of $35.12 per share of preferred ($24.77 * 1.4180).  So total value received over the year would be $37.87, or the $35.12 upon conversion plus the dividend of $2.75.  Having paid $32.50 for the preferred stock (as of October 31), this is a yield of 16.5%.  The profile of the trade using this 1.418 hedge ratio at various common stock prices is summarized in the table below.



Stock 0 Stock 0 31-Oct
    No Div w/ Div       Price     Floating Conversion Range  
Conversion Ratio 1.4180 1.4180 1.4180 1.4180 1.4180 1.4180 1.4180 1.4180 1.4180 1.3158 1.1576 1.1576
Common Stk Price $0.00 $0.00 $18.00 $20.00 $22.00 $24.77 $28.00 $30.00 $35.26 $38.00 $43.19 $50.00
Preferred Payout (per share):      
Value of Conversion $0.00 $0.00 $25.52 $28.36 $31.20 $35.12 $39.70 $42.54 $42.54 $50.00 $50.00 $57.88
Dividend $0.00 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75
Total Payout $0.00 $2.75 $28.27 $31.11 $33.95 $37.87 $42.45 $45.29 $45.29 $52.75 $52.75 $60.63




As the table illustrates, the main risk to the trade at the hedge ratio implied by the current conversion ratio is that the stock prices recovers above $35.26.  The return of the trade goes negative at a common stock price of $39 or above.  The credit profile of the company is attractive and in my view the common stock is cheap at its current levels.  Given these considerations, I set up the trade with a somewhat lower hedge ratio of 1.20x.  The profile of the trade changes somewhat and is summarized in the following table:



Stock 0 Stock 0 31-Oct
Full Hedge Scenario (1.418x) No Div w/ Div       Price     Floating Conversion Range  
Conversion Ratio 1.4180 1.4180 1.4180 1.4180 1.4180 1.4180 1.4180 1.4180 1.4180 1.3158 1.1576 1.1576
Common Stk Price $0.00 $0.00 $18.00 $20.00 $22.00 $24.77 $28.00 $30.00 $35.26 $38.00 $43.19 $50.00
Value of Conversion $0.00 $0.00 $25.52 $28.36 $31.20 $35.12 $39.70 $42.54 $50.00 $50.00 $50.00 $57.88
Preferred Dividend $0.00 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75 $2.75
Value of Hedge $35.12 $35.12 $9.60 $6.76 $3.93 $0.00 ($4.58) ($7.42) ($14.87) ($18.76) ($26.12) ($35.78)
Total Payout $35.12 $37.87 $37.87 $37.87 $37.87 $37.87 $37.87 $37.87 $37.87 $33.99 $26.63 $24.85
Gain on Prefered $2.62 $5.37 $5.37 $5.37 $5.37 $5.37 $5.37 $5.37 $5.37 $1.49 ($5.87) ($7.65)
Yield 8.1% 16.5% 16.5% 16.5% 16.5% 16.5% 16.5% 16.5% 16.5% 4.6% -18.1% -23.5%


Clearly in this highly volatile environment, it is imperative to place a greater weighting on the outlier events when assessing the risk/reward of a position.  On one end of the scale, if the whole company implodes and both the common and preferred go to zero immediately, meaning that the company doesn’t pay the next dividend payment due on December 15, 2008, the trade would only lose $2.78 per preferred share or 8.5%.  The other end of the distribution would be the scenario under which the stock goes wild before conversion in a year, perhaps due to an acquisition.  Using a common stock price of $50, roughly double the October 31 stock price, and an assumption that I am unable to adjust the hedge ratio on the way up, the position would become over-hedged and the trade would lose $2.15 per preferred share or 6.6%, which includes the $2.75 of dividends.


Prior to the massive market dislocation that we have experienced, risk/reward opportunities like this would have the “too good to be true” feel.  When discussing the Bristow position with a seasoned convertible bond arbitrageur (I am more focused on equities), his take on the position was that in a more normal market environment this would be the biggest position he’s ever had but at this point the market is so ugly that it is only average in cheapness.  He focuses more on the Greek letters underpinning the embedded call option in the security whereas I rest more upon more crude measures such as how much the trade could lose in the worst possible outcome.  It was nice to have confirmation from a veteran bond trader that this is not in fact “too good to be true”.  Obviously no one is going to take much comfort that someone (posting under a name like "tomahawk" no less) has confrimed the validity of the trade by talking to an un-named convert guy.  So of course anyone interested in the trade will do his or her own analysis.



preferred holders recieve common stock in September 2009 and $2.75 in dividends along the way so there is no real catalyst over the course of the year. on the downside scenario that both securities go to zero and no preferred dividends are paid, the trade loses a little money with a full hedge ratio. not sure exactly what catalyst would precipitate that other than the entire world collapsing onto itself and forming a nano-quark or some such astro physics particle.
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