Although we want to receive gross proceeds of at least $500 million, we may determine to complete an offering for a number of shares of common stock that results in a lower amount of gross proceeds. In that case, we would not be able to fulfill the remaining substantive condition required for us to compel the conversion of the Series G Preferred Stock into common stock, which would mean that our tangible common equity would not benefit from an increase in the number of outstanding shares of common stock resulting from such a conversion and that we will continue to have to accrue dividends payable on the Series G Preferred Stock. In addition, the lower level of proceeds may require us to implement additional de-leveraging strategies to ensure our compliance with the capital plans we submitted to our regulators.
This more or less speaks for itself. They can raise less than $500MM if they think it is in their interest. Whether or not this is in their interest depends on a few things. I will present my game-theory analysis and conclude what I think is in everyone's best interest and therefore what should logically happen.
Right now, the company has the right to compel Treasury to convert their $400MM in preferred equity to 380 million common shares, IF the company raises a cumulative amount of $500 million in common equity elsewhere by the Early Conversion Date which is April 7, 2011. Treasury can convert to 380 million shares any time they wish or can convert any portion.
This is effectively like selling common equity for $1.05 though it does not change total equity or affect the normal capital ratios or anything in the FDIC Consent Order. Since the stock price is currently only $0.30, this right to sell common stock at over a $1 seems like a very valuable asset. But lets looks at the details.
First, we should say that they probably need to raise some capital to satisfy their consent order requirements. However, I do not believe they need to raise the full $500MM. Let's assume that they can get by on less capital and perform other deleveraging transactions to meet the consent order requirements.
In order to simplify the discussion, let's assume the amount they wish to raise is really $300MM. That would cut down the dilution to common shareholders by a large amount. It is easy to see why. New investors will generally want to pay some fixed percentage (a discount naturally) of final tangible book value (TBV). I discussed this in this post. For example, if they desire to pay roughly 45% of final TBV, the two yellow lines in the table show that in the $500MM capital raise scenario, they will pay about $0.40 and the TBV will be $0.91. In the $300MM scenario (with full Treasury conversion), they will pay $0.60 and the TBV will be $1.31.
So the common shareholders come out better with the lower capital raise and less dilution. The Treasury also comes out better since their converted common shares are worth more. There is another difference between the two scenarios. This has to do with the fact that the effective Treasury conversion price of $1.05 (or so) is between the two final TBV values. That means that in the $500MM capital raise scenario, the Treasury conversion is anti-dilutive to book value. In the $300MM scenario, it is dilutive to book value. That means that if they do the $500MM capital raise scenario, the company would not only have the right to compel conversion; they would have the incentive to do so. In the $300MM capital raise scenario, they might not have the right to compel conversion but they also would not really have the incentive to do so since it would be dilutive to TBV. If they do the $300MM raise and Treasury does not convert, then investors would pay $0.70 and TBV would come out to be $1.56.
This is a bit simplistic since I am assuming that investors want to pay 45% of TBV in every scenario. The is probably not the case. But the point is that raising less capital and not having the right to compel conversion is not necessarily a problem. In fact, if they raise $300MM, then Treasury will likely decide to convert on their own since they will probably get more value that way when they exit their investment because final TBV would be $1.31 and, if it trades at TBV within a year or two, the investment would be worth roughly 380*1.31=$498MM which is greater than their $400MM investment with an additional margin of safety.
But what if new investors don't want Treasury to remain unconverted? Perhaps they don't want to have to pay preferred dividends or want the safety of being at the same level in the capital structure as the government. What if they demand to have the right to convert Treasury shares? Does this mean they have to do the $500MM raise? Now you have to think of the this from the Treasury's point of view. What if the company comes to you and asks you to either 1) convert some or all of the Series G shares before the raise or 2) lower the requirement to $300MM so that the company will have the right to compel conversion after the smaller raise.
What would you do if you were Treasury? If you refuse to do either of things you force the company to raise the $500MM and further dilute themselves and also your own position. You make it less likely that you will be able to exit the position without taking a loss on your TARP investment. You have been making a lot lately in public about how you are exciting your TARP investments with no loss or actual gains, showing that you were a good steward of taxpayer's money.
Do you give up anything really by making this concession? Not really. You will be forced to convert anyway since the Company can boost TBV by doing so, and stop the preferred dividends from accruing. If you convert some or all of it now, and allow them to raise only $300MM, it would no doubt give a boost to the stock price and allow them to raise the capital at a better price and maybe even at a higher ratio to final TBV.
So, I think it is logical for the company to ask Treasury for something like this and I think it is logical for Treasury to respond positively to the request. The result would be very positive for the stock. Investors will see that they are going to end up with TBV well above $1 and will probably bid the stock up closer to $0.60, a double from here and a good chance to double again over the next few years.
No comments:
Post a Comment