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Author: junkman02 Big red star, 1000 posts Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 35357  
Subject: Intel’s Jr Sub Cv 35’s Date: 4/20/2009 3:54 PM
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AMD’s 7.75s of ’12 [not to be confused with AMD] were offering a fat YTM of 27.93%. So I wanted to benchmark their numbers against those of their chief competitor, Intel. Part of doing that process led me to asking if any of Intel’s bonds were being traded. That led me to discover their 2.95’s of ’35.

Intel’s 2.950’s ’35 are a convert whose ratio is 31.7162 shares/$1k face. It is rare to see converts offered in the secondary market. So I was immediately interested, not so much in the bond itself, but in the bond as a way to buy the stock in what might amount to an arbitrage opportunity. But markets tend to be efficient, so I doubted that the opportunity existed. Still, I wanted to run the numbers, just to be sure.

Intel’s stock [ticker: INTC] is currently trading at $15.17. Buying the bond at its current price of 86 would give me the right to convert each $1k of face to 31.7162 shares of stock. In other words, I’d be paying $860 dollars to buy the right to own 31.7172 shares of stock, or $481.13 of stock. Not a good trade. I’d be doing the proverbial equivalent of trading elephants for rabbits. But what if I delayed doing the conversion until the stock price were higher? While I was waiting, I’d be receiving a current-yield of 3.43%. (That’s obtained by dividing the 2.95% coupon by the $860 purchase price.) Getting paid 3.4% while waiting to make some money isn’t a bad gig. But how high would the stock price have to get before doing the conversion would become profitable?

That number, too, is easy to obtain. Divide the purchase price ($860) by the conversion ratio (31.7162 and a stock price above $27.12 would mean profits. So the next step was to pull a multi-year chart of INTC. But, lo and behold, what does a 5-year stock chart show? That $28 is overhead resistance. In other words, and for whatever reasons, as soon as INTC’s stock price got near a price that would be attractive to holders of the convertible bonds, the stock price went no higher. That has happened no less than three times in the past five years. Clearly, the phenomenon can't be explained by coincidence. Too, too, funny. The arbs are already all over that one and little old me just ran some numbers showing why buying INTC’s bond (so I could buy their stock) wouldn’t be a good idea. Instead, just trade the common directly (were I so inclined).

AMD’s bonds are another story. But that’s a story that has to be explored from the fundamental side of things, i.e., the company’s financial statements. My guess was that the project might be worth doing and that the bonds should be bought if it could be estimated that purchase price were fairly close to a Chapter 11 workout price. By my eye, just looking at their balance sheet and throwing out things like “goodwill” and “intangibles” and discounting the remaining assets by half, it looked like $0.46 on the dollar would be the best a Chapter 11 workout would offer. But AMD’s 6’s of ’15 (also a convert) were currently being offered at 44.

Immediately, I was intrigued. The yield-curve was inverted; spreads were wide; and bonds prices were way off their Jan ’09 bottom of 26. So I’d be very late to the trade, and I'd be buying into a predicted Chapter 11 situation. (Inverted yield-curves are a VERY reliable predictor.) But I was still interested in the way that always happens with value investors when they‘ve found something that can’t be immediately eliminated but seems to offer a path toward profits, however tenuous.

The bid for the bond was 38. The ask was 44. That’s a spread of six points and very wide. If the case for buying were really compelling, I’d hold my nose and pay up. But there was an alternative path: attempt to split the spread with a limit order. Unfortunately, E*Trade doesn’t allow limit orders. But I could solicit an offer. But since my size would be only a single bond, I’d doubted that the solicited offer would be an improvement on the offer already shown. But I went through the process anyway just to see what would happen. After a ten-minute wait, all they did was the equivalent of re-quote me. So I canceled out and tried to go through the front door. In other words, I resigned myself to paying up. After a wait, I got a fill on my order.

So I now own one of AMD’s 6’s of ’15 with a broker’s reported YTM of 23.533% and a YTM (by my methods) of 33.59%. (The huge difference is that we each use different formulas. But I trust my numbers, not theirs). My current yield will be 13.33% (On that we both agree.) But with a 6.033 holding period (in years), the CY won’t amortize the bond before maturity. So I’m simply making a bet that my entry price and my estimate of a Chapter 11 workout price are close enough that my downside loss is close to zero and my upside gain is 55 points. Meanwhile, I’ll be clipping coupons.

Most likely that bet is wrong by half. (The only ones who make money in the bankruptcy process are the lawyers. Their fees devastate the assets that might otherwise be distributed to creditors.) A more probable workout is $0.22 cents on the dollar paid in equity, not cash. So the reward/risk ratio is probably close to 2.5 (instead of the more often advised 3.0). In yet further words, I just got myself into a typical Chapter 11 situation in which stockholders will get nothing and the bondholders will become the new stockholders. But I’ll just have to wait to see what happens. I don’t like being late to a trade, but the loss is tolerable if I’m wrong.

A further note. AMD’s 6’s are also a convert at a ratio of 35.6125/$1k face. The break-even stock price for my entry on the bond price would be $12.64, a level they’ve traded well above in the past. But the present stock chart is a ski slope, and prices are down, down, down. I doubt there’ll be an opportunity to convert. The most likely scenario is a Chapter 11 filing before year’s end and a workout sometime the following year.

So, I buy CDs, and I buy junk. One has little risk and offers little reward. The other offers the opposite. But the same sense of value motivates my purchase of each, and I never make big bets about anything. So I always survive, and sometimes I prosper. Now I'm done for this market day and ready for a walk.

Charlie
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