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from ftalphaville blog:
But what do we know? Here’s the view of FT Alphaville’s friendly (professional) convertible arb specialist:
Firstly, this is a mandatory convertible. It’s NOT DEBT (obviously as it qualifies as tier 1 capital). An 11% coupon may sound high but if one considers what this structure actually is then it should become apparent that this is not high.
This deal is best thought of as a forward issue of equity with a minimum maturity of just over 2yrs and a max of just under 4yrs. Citi is effectively guaranteed that it will be issuing the holder(ADIA) common stock at a premium to last night’s closing of between 4% and 21%. Taking this into account and given that the current div yield of the stock is over 7%, this no longer looks such a bad deal.
I have valued the structure:
(i) what we know:
- $7.5bn face
- 11% coupon
- mandatory conversion (”purchase contract settlement dates”) of Mar 15 2010, Sep 15 2010, Mar 15 2011 and Sep 15 2011.
- “Strikes”: stock closed last night @ $30.7 but let’s assume to start with that this deal is priced off $31.83 as this is the “lower strike”. With the stock price < = $31.83, Citi will issue 235,627,500 shs (ie at most $7.5bn of stock). stock price >= $37.24 Citi will issue 201,390,000 shares. The number of shares issued varies between these two “strikes” such that ADIA receives $7.5bn worth of stock ie par. This is otherwise known as a 100/117 mandatory.
(ii) assumptions:
- Citi div’s are flat for the life of the structure @ $2.16.
- credit spread for Citi is 0 (5yrs is actually L+90 but this has a minimal impact on the theoretical value (TV) so we’ll give Citi the benefit of the not inconsiderable doubt).
- “skew” is 10vol’s; ie we will price the put at 51 vol and the call @ 41 vol (this looks to me to be in line with where options are currently quoted).
- that the mandatory, rather than having a variety of different strikes from £31.83 up to $37.24 over the 4 “settlement dates” is in fact just one strike of $37.24 with a March 2010 expiry.
(iii) valuation:
On the basis of these assumptions above, Citi have issued a structure for $7.5bn that is worth $7.18bn (ie 95.75% of par). If I value the Sep 2011 mando’ using the same criteria as above then the TV is 99.60 (ie are issuing something worth almost $7.5bn).
(iv) conclusions:
This is NOT necessarily expensive financing for Citi. I get TV for the longest dated mandatory to be 100. If the strikes are staggered over time the TV climbs. For example the TV of the mar 2010 structure above using 7 skew and a 10% premium rather than 17% (ie $35.00 upper strike rather than $37.24), is effectively par. Also, if Citi cut the dividend by 5% each year during the life of the structure the TV of the Mar 2010 structure goes up by 1pt.
But what do we know? Here’s the view of FT Alphaville’s friendly (professional) convertible arb specialist:
Firstly, this is a mandatory convertible. It’s NOT DEBT (obviously as it qualifies as tier 1 capital). An 11% coupon may sound high but if one considers what this structure actually is then it should become apparent that this is not high.
This deal is best thought of as a forward issue of equity with a minimum maturity of just over 2yrs and a max of just under 4yrs. Citi is effectively guaranteed that it will be issuing the holder(ADIA) common stock at a premium to last night’s closing of between 4% and 21%. Taking this into account and given that the current div yield of the stock is over 7%, this no longer looks such a bad deal.
I have valued the structure:
(i) what we know:
- $7.5bn face
- 11% coupon
- mandatory conversion (”purchase contract settlement dates”) of Mar 15 2010, Sep 15 2010, Mar 15 2011 and Sep 15 2011.
- “Strikes”: stock closed last night @ $30.7 but let’s assume to start with that this deal is priced off $31.83 as this is the “lower strike”. With the stock price < = $31.83, Citi will issue 235,627,500 shs (ie at most $7.5bn of stock). stock price >= $37.24 Citi will issue 201,390,000 shares. The number of shares issued varies between these two “strikes” such that ADIA receives $7.5bn worth of stock ie par. This is otherwise known as a 100/117 mandatory.
(ii) assumptions:
- Citi div’s are flat for the life of the structure @ $2.16.
- credit spread for Citi is 0 (5yrs is actually L+90 but this has a minimal impact on the theoretical value (TV) so we’ll give Citi the benefit of the not inconsiderable doubt).
- “skew” is 10vol’s; ie we will price the put at 51 vol and the call @ 41 vol (this looks to me to be in line with where options are currently quoted).
- that the mandatory, rather than having a variety of different strikes from £31.83 up to $37.24 over the 4 “settlement dates” is in fact just one strike of $37.24 with a March 2010 expiry.
(iii) valuation:
On the basis of these assumptions above, Citi have issued a structure for $7.5bn that is worth $7.18bn (ie 95.75% of par). If I value the Sep 2011 mando’ using the same criteria as above then the TV is 99.60 (ie are issuing something worth almost $7.5bn).
(iv) conclusions:
This is NOT necessarily expensive financing for Citi. I get TV for the longest dated mandatory to be 100. If the strikes are staggered over time the TV climbs. For example the TV of the mar 2010 structure above using 7 skew and a 10% premium rather than 17% (ie $35.00 upper strike rather than $37.24), is effectively par. Also, if Citi cut the dividend by 5% each year during the life of the structure the TV of the Mar 2010 structure goes up by 1pt.
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