While today’s trading action would be cause for concern to any investor, it always helps to understand the full perspective of what happens with converts, and why. Even some well known financial publications and analysts had confusion over the activity surrounding the equity offering today.
What investors should know is that holders of converts typically short the stock, thereby minimizing risk, and locking in the interest they are receiving as a profit. This strategy is not unique to Sirius, and in fact happens all of the time. Still, even understanding this likely does little to appease the frustration of investors who were hoping to see positive momentum on these equities.
Thus, if you are a frustrated investor, I do not blame you. But, lets take the next step and see what usually transpires. With the convert holders shorting, there are large numbers of shares hitting the market within a short period of time (from a few hours to a few days typically). This selling activity drives the price down, but in many ways, the sale is “artificial”. Think about it this way. The companies doing the selling are holders of converts. Because they have converts, they must have some interest in the company succeeding. Their sale is less about their sentiment on the company, and more about locking in a profitable position which allows them to continue to do business. Their play is the arbitrage of the trade.
This is all well and good, but in real terms there are only buys and sells. Sells take the price down, and buys bring the price up. From the perspective of the market, a sale by a holder of a convert is identical to a sale by someone who wants to simply get out of their position, or a sale by a short that believes that a company will fail.
With that background, there is a bit of a silver lining. When the holders of the converts finish selling, the “pain” is virtually over, and the stock will stabilize, or perhaps even rebound. With that in mind, let’s look at what happened with the last two converts issued by Sirius.
On May 20, 2003 Sirius offered converts. Notice the pricing activity just prior, just after, and then a few days down the road. The selling activity of the convert holders drag down the price. However, once that selling stops, the stock price stabilizes, and then recovers to an even higher price point.
The next convert offered by Sirius came in conjunction with a secondary offering, but nonetheless, the converts would naturally short the equity. This convert happened on October 13, 2004. Notice that the trading days following the convert, the stock drifted down, but then recovered and stabilized. This convert happened just prior to the Howard Stern announcement. The stock obviously responded well to the Stern news shortly after the dates illustrated, but I wanted to show what transpired absent that news.
Many times converts are issued to raise capital, or restructure debt so that the company is in a better position. In this case, the converts are required to consummate the merger with XM. While there is some pain associated with them, the theory is that the results will deliver benefits. Sirius is taking steps to have a merger that promises synergies that will translate to the bottom line.
While this analysis is simple, the concept is sound. When the selling stops, the equity can balance, and take their next steps forward.
Position: Long Sirius, XM.