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|Subject: F-S||Date: 1/31/2010 3:17 AM|
|Author: joelcorley||Number: 29951 of 35117|
I've heard several people talk about buying F-S. I've thought about buying F-S, even before Cramer told the world what a great deal it was. But I've had misgivings about F-S's value. And I've been in the market for exactly this type of offering for a while now. So when kahunacfa and rog56 mentioned it in that previous thread, I thought I'd post my musings about F-S as a potential investment. What follows is partly a rambling review of the security and part analysis. Any conclusions are my own.
I have to say F-S is a rather unique hybrid fixed income vehicle and an interesting topic in its own right. I've been tempted to purchase shares in the past but have always been too concerned about either the associated risk or the relative pricing of the offering. The latter keeps me from buying even today. But the complexity of the hybrid itself makes it a little difficult to establish a fair price relative to other Ford offerings.
The key characteristic of F-S is that it's a capital trust preferred, meaning it is preferred shares of a capital trust that holds junior debt. In the case of any qualifying capital trusts, dividends of the debt must be suspend-able for at least 20 consecutive months. Unlike most direct (US) corporate preferreds, dividends continue to accrue despite the suspension. But like most direct corporate preferreds, to suspend dividends, Ford must concurrently suspend dividends on all equal or subordinate securities. (Meaning they can't pay dividends on common or direct corporate preferreds until these dividends have been paid.) These are typical characteristics of qualified capital trusts used by bank holding companies to raise equity.
That this is a capital trust issue, which is usually issued by bank holding companies makes me believe it must have been set up with an eye to spinning off Ford Credit as a separate bank holding company. Certainly the F-S prospectus spends a lot of time discussing Ford Credit's activities and market position; but I doubt that's speculation I could verify.
The par value of F-S is $50/share. It is past its call date; but it doesn't mature until 1/15/2032. And though it's past its call date, the actual redemption price doesn't fall to par until 2012. The current redemption price is $50.65. (It was $50.98 for 2009.)
What makes F-S a hybrid preferred is the indivisible inclusion of a common stock warrant with each share of F-S. The warrant is exercisable at the holder's option any time after 1/15/2007 - this is pretty unusual as most equity hybrid preferreds are mandatory convertibles, which usually makes conversion provisions differ from warrant or option contracts. If you exercise the F-S warrant, you must tender your shares. In exchange, Ford will provide you with 2.8249 shares of F. Fractional shares are not actually redeemable. They will result in a return of principal. If you actually redeemed one share at a time, Ford would issue you 2 shares of F and $14.60 in change.
F closed Friday at $10.84, placing the intrinsic value of the warrant at $30.62/share. Or $36.28/share if you're willing to do the paperwork for each share individually and spread the redemptions out over time. (I assume no one is really willing to do that.)
In addition, there is the accrued and unpaid dividend. The annual dividend is $3.25/share; but the deferred dividends also accrue interest, so the present value of the deferred dividends should be $3.33/share as of 1/15/2010, or a few cents more today. That brings the intrinsic value, based on the warrant and accrued unpaid dividends, up to $33.95/share.
From what I gather from the prospectus, Ford actually must pay the accrued dividends if you exercise the warrant, so if you bought F-S Monday and faxed in a notice to exercise and gave instructions to sell the resulting shares of F immediately to your broker, $33.95/share is about what your holdings would fetch.
At first blush the current share price of $42.11 doesn't compare favorably to the $33.95 of intrinsic value. However your fair value calculation still needs to consider a risk-adjusted rate of return on future dividends, assuming you're holding the security.
Also warrants are almost identical to call option contracts, so there is also some non-trivial time-value to the warrant which I've not calculated... But I can look up a LEAP contract for Ford for 2012. An ATM contract at $17.50 (our effective strike price is $17.70) is going for about $1.11/contract. You could remove the extra 20 cents of intrinsic value; but then you'd need to add probably another 50 cents to a dollar of time value to the warrant. I'll call it $1.75; but maybe someone else will run it through the Black–Scholes model for a more precise figure?
Anyway, adding the value of the warrant increases the estimate of F-S's present value to about $35.70/share with nothing really in that number for discounted future income. Friday's share price effectively reflects an excess $6.41/share premium for that projected income. That might actually be reasonable, but you have to bear in mind that the value of the warrant and the value of the income stream are mostly independent variables - you generally can't have both outcomes. This suggests buyers are buying F-S today mainly for the return of the expected income and are adding in some principal value for the time-value component of the warrant. (The inherent time-value of the associated warrant was why Ford was able to sell F-S near par with a coupon of 6.50% in 2002, despite its deteriorating credit. Without the underlying value of the warrant, the debt would have needed a coupon in the 8's or 9's or it would have had to be discounted severely.)
So I'd say the real value of F-S depends on where Ford's common stock goes from here. I'm reluctant to put too much optimism into that though. Oh I think F will survive for probably another decade - I'm banking on it through the purchase of other Ford debt. But I'm not yet sure how strong Ford's performance will be going forward.
Despite the recent run up, I honestly have no idea how much longer you'd have to hold F-S before the share price got above the strike price of $17.70. For that reason, I have no idea when the underlying warrant component will increase the price above par.
Also Ford has other trust preferred issues that are not suspended. (They're holding senior debt, not junior.) F-S's current YTM is 8.04% with a current yield of 7.72%. That compares to PJE, which has a YTM of 9.57% and a current yield of 9.37%.
So let's look at F-S another way. Let's discount F-S's yield by the apparent accrued dividends ($3.33) and the value of the warrants ($1.75) - these are items that we can price separately from the underlying debt. Of course these quantities effectively raise the securities effective redemption value for comparison purposes - not lower its price. The result is a higher YTM of 8.96%. Current yield of course remains unchanged - the reality is that current yield is undefined, so using it for comparison is at best inappropriate.
Other Ford issues yielding more than 8.96% are PJE, XVF, KVU, DKL, XKN, PIJ, TZK, and even FCZ. FCZ is a direct and senior debt obligation of Ford. That probably makes it the highest yielding exchange-traded Ford obligation you can currently buy with its YTM at 9.06%. FCZ's security interest is on par with F-A, which has a YTM of only 8.10%. Admittedly PJE, XVF, KVU, DKL, XKN, PIJ and TZK are third-party trusts - organized by a third party to hold Ford-issued debt obligations. Potential default or malfeasance of such a trust probably worries some; but their underlying securities are senior to F-S, so at their worst I'd consider the two comparable risks if Ford defaults.
Based solely on these comparisons and assuming you've decided to buy Ford's debt anyway, I'm not sure why you'd choose F-S. At a minimum, I'd think you'd need to see F-S's YTM rise by 50 to 75 basis points to make them comparable. And from an income / cash flow perspective, F-S just doesn't make sense compared to the alternatives.
BTW, If you're thinking about looking at the yield curve for these preferreds, don't bother. Most of them mature in 2031 or 2032. (A fact that's troublesome in itself.) A couple are longer dated; but PJE matures in 2031 and F-S matures in 2032.
And for completeness, I should also point out that according to Finra TRACE, some of Ford's senior debt has traded hands recently with YTMs as high as 10.785%. Of course the preferred market does seem to offer slightly better liquidity; but today buying one of those bonds might be preferable to buying a preferred or exchange-trade-debt offering ... assuming you can actually catch any listed by your broker and you have the necessary powder.
All and all, most of Ford's other offerings seem better priced than F-S at the moment.
Who currently holds XKN, KVU & PIJ.
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