|Shares Out. (in M):||392||P/E||0.0x||0.0x|
|Market Cap (in M):||450||P/FCF||0.0x||0.0x|
|Net Debt (in M):||0||EBIT||0||0|
This is another simple idea from me and is in regards to the arbitrage between the pref A price at CIT and the ability to short options. CIT has announced a proposed restructuring of the company that will result in the common stock receiving approximately 2.5% of the outstanding shares in the company and the pref A stock receiving 0.4% in the company. With 392 million common shares out and 14 million pref A shares, we can see that the parity ratio between the common and the preferred is 1:4.48 (i.e. you will get the same amount of value for each 1 share of prefs that you own as you would if you owned 4.48 shares of common). If the company is not successful in its restructuring plan and goes into bankruptcy, both the common and the prefs will be wiped out, but I expect the prefs to trade a bit better than the common.
My proposed trade is to short 4 calls for $0.60 each for each 1 share of CIT Pref A that you purchase. In this case, you would take in $2.40 in call premium at the outset and spend $1.90 for the CIT stock for a net inflow of $0.50. We can now say that there are essentially three outcomes in that the offer could be successful and CIT common could trade north of $1, the offer could be successful and the common could trade under $1, or the offer could fail and the company would enter bankruptcy. Let's examine all 3:
1) CIT's offer is successful and the common trades above $1. In this case, you are long 4.48 shares of CIT's new common and short 4 shares through your short call position for a net long position of 0.48 shares worth something more than $0.48 (because the stock is trading above $1). In this case, you've made your initial $0.50 from selling the calls net of the prefs and you've got at least $0.48 in value from your long stock.
2) CIT's offer is successful and the common trades below $1. In this case, you are long 4.48 shares of CIT's new common stock (worth something - I estimate fair value at $0.50 per share) and your short calls expire worthless. You've made 4.48 * new common price + $0.50 from your initial net premium inflow.
3) CIT's offer fails and the common trades way down on bankruptcy. Your short calls should expire worthless and you should still be able to sell your Pref A's for something - maybe $0.25 each. In this case, you've made $0.75 - the $0.50 initial call premium and the $0.25 that you can liquidate the Pref As for.
Note that CIT is also planning to do a reverse split of its stock post the restructuring. This is typically very good for poeple who are short calls at $1 due to the lower bounding at $0 and the normal distribution for call pricing.
Restructuring plan or bankruptcy
|Entry||10/02/2009 01:14 PM|
Why not simply buy the prefs and short 4.48 shares of common for each pref? Seems like there is a nice spread right now.
|Entry||10/02/2009 01:26 PM|
|Entry||10/02/2009 04:03 PM|
4 reasons: (1) you can't find borrow, (2) you don't have recall risk, (3) you can later benefit from the reverse split to come and the dynamics of being short options into that, and (4) I like being short volatility at ~100% into a balance sheet / cap structure improvement that should cause vol to collapse
|Entry||10/03/2009 02:03 PM|
For those so inclined I suppose a "Texas hedge" of simply going long the pref's could have interesting risk / reward if you don't mind losing all of your capital.
|Subject||RE: Neat idea...|
|Entry||10/04/2009 10:44 AM|
What do you think fair value of the prefs is in the case that the restructuring proposal passes? What odds do you put on the proposal passing and why? Thanks
|Entry||10/04/2009 10:27 PM|
What's the risk the ratio of 1:4.48 for the common/pref is changed somehow?
|Entry||10/05/2009 09:47 AM|
I actually think that the risk is that the ratio is more favorable to the prefs, because the 2.5% to the common and 0.4% to the pref As is based on the maximum % of bonds tendering. In the event that the exchange is approved, changes in the % of bonds that tender drive changes in the portion of the new equity that goes to the prefs; regardless of what portion of the bonds tender, the common always gets 2.5% of the newco with the exchange. Accordingly, if something less than 100% of the bonds tender, the pref As are likely to actually get more than 0.4% of the company and you may be able to get an exchange ratio as high as 6:1.
|Subject||Report of Goldman in talks to provide financing|
|Entry||10/05/2009 01:08 PM|
Am I right to conclude that you also think that CIT common is a very good short here? From reading your write-up, it seems that the most likely scenario is that the company will either declare BK, in which case the common will be decimated..or the tender will be accepted, in which case you think that the common is worth around .50. Is that a fair assessment?
Also, I assume that you've seen the reports re Goldman supposedly being in negotiations with CIT for a $3 billion dollar loan. If that loan were to happen, would it change your thesis at all? To put the question another way- do you think that this (or any other development) could allow CIT to come out of this situation without huge near term dilution of its common stock (at best). TIA
|Subject||RE: Report of Goldman|
|Entry||10/05/2009 02:24 PM|
I do think that on a fundamental basis CIT is overvalued. That being said, I don't underestimate the ability of uninformed investors and penny stock chasers to place an irrational value on a stock for an extended period - witness GM at $0.65 when everyone involved repeatedly states that the common is absolutely worthless. Accordingly, I have recommended an arb trade here to reduce the risk of crazy retail investors.
As regards GS giving them a loan, I think it's a non-event. The company needs to redcue debt, increase equity, and push out maturities. A new $3bn loan only helps them meet some of the near-term maturities and does not address the larger issues. I would not be surprised to learn that the loan is only being considered for the company either post-restructuring or as a DIP. I see no way around enormous diluition.
In the event that they do make it rhough without dilution, you would have a stock with roughly $7 per share of TBV before this Q losses or subsequent losses. If they are lucky, they trade to $7 (highly unlikely) and you lose $6 per short call. I would also expect the prefs to trade to par ($25), so you would now have the following payoff:
+$0.50 from option proceeds in excess of pref stock cost
- $24.00 from $6 lost on 4 $1 option contracts
+ $23.10 from your $1.90 pref stock going to $25
$-0.40 loss on $1.90 gross long or roughly -25% in the ultra-downside scenario. I put the odds of this scenario at under 1%.
|Subject||A fourth outcome to consider|
|Entry||10/05/2009 03:57 PM|
a) CIT common experiences a strong technical rally, say to $3
b) CIT A lags the common b/c nobody thinks the common price reflects fundamental value
c) You get assigned (early exercise) on your CIT calls. Your PB tells you that you now face buy in on the underlying shares
It's worth considering....
|Subject||RE: A fourth outcome to consider|
|Entry||10/05/2009 04:15 PM|
The probability of being assigned calls that have well over a year to maturity and a volatility of 70+% during that one year is exceptionally low even if they are massively in the money. My rough calcs suggest that there would still be approx 10% premium in the calls vs their cash value from exercising and selling the stock.
|Subject||RE: RE: A fourth outcome to consider|
|Entry||10/05/2009 04:52 PM|
What is your rough calculation?
Using a CIT stock price of $3 and a 70% volatility input, I get the options to be worth $2.55, or only 5 cents above parity-- but that assumes zero cost to short the stock. If you assume the borrow is even a little big tight-- say -10%-- the move is to immediately exerice.
Considering that the current average borrow rate for CIT street-wide is -45%, the odds of early exercise on a big common spike seem quite high.
|Subject||RE: RE: RE: A fourth outcome to consider|
|Entry||10/05/2009 04:54 PM|
The option value in the last post should have been $2.05, not $2.55. Sorry.