Ford: Convertible Trust Not Preferred

Co-Written by Patrick Kirts

Last fall Portfolio Asset Management discussed the merits of the 6.50% Cumulative Convertible Trust Preferred Security (F-PS). This trust was also known as Ford Motor Company Capital Trust II. The idea was simple, get paid while you wait for Ford to do nothing but keep on trucking. Well, last week we found that like the homeowners that bought too much house and asked the banks to lower their mortgage rate, Ford (F) just can’t pay for their preferreds.

Ford made headlines this week with its announcement to retire up to 40% of its debt--over $10B--through the combination of a cash and equity conversion offer to its bondholders. Some bondholders rejoiced as Ford is offering 30 cents on the dollar for bonds previously trading for 20 cents on the dollar. The common stock price sank due to the reality, not fear, of dilution. This is good for the company, since they will avoid bankruptcy, but not good for those expecting interest paid on time. We have maintained for months that Ford is in a much better financial situation than its rivals GM and Chrysler. However, while the news may be music to the ears of bondholders, a small, little-commented-upon provision of Ford's announcement leaves owners of the Ford cumulative convertible preferreds singing the blues.

That little provision states that starting April 15, the date of its next dividend payment, Ford will suspend payment on its 6.5% Cumulative Convertible Trust Securities (F-S) for a period of up to five years. Now, Ford will have to pay those missed dividends, but for the moment it preserves cash, as the company reorients itself to new economic realities. The last time Ford made an offer for F-S was back on July 2, 2007 when they offered to convert the shares and add a $14.25 kicker, paid in stock, to retire the shares. I would have been happy for a similar payoff, but in this case nothing was offered but hope for the future.

The logic of owning preferred shares in this environment is simple: As stock prices decline, the bigger dividends on preferred shares offer higher cash flow than the common, and have more liquidity than bonds. As long as the firm limps along, you get paid to wait. Last fall, when the question was who of the big three automakers would live, we had a simple answer: only Ford. So far, we are right, but Ford’s decision to stop the dividend payments to this particular security forces us to deal with reality now.

Owners of Ford preferred shares must make a choice. They can wait for Ford to resume payments--if it ever does, or sell now. The suspension of payment forces one to seriously consider additional potential risks. What separates Ford from GM and Chrysler is not better business fundamentals, it is liquidity. Ford still has the money to deal with mounting losses, without going to the government trough. But as the entire industry continues to decline, until it reinvents itself, one must wonder if this difference will still be there in a year or two as losses continue to mount. Ford may face the same crisis as its rivals before the economy recovers and people start buying cars again in profitable numbers. If this scenario comes about, then it won't matter if one waits to collect the dividends--bankruptcy, or even worse, nationalization, could wipe out any prospect of ever getting paid. In the meantime, the price of the preferreds may continue to slide, or even go to zero. The least risky move right now is to sell Ford preferreds, and there is certainly no reason to buy.

Stock position: None.

Comments

[Wren337:]

I'm surprised you didn't mention the OID conversion on the F-S shares. Now that the dividends are accumulating they are being treated like a zero coupon from a tax perspective. Holders can expect to get a 1099-OID for the dividend they did not receive. It should cost most people about $1/ year out of pocket to hold F-S, unless they are held in a retirement account. It's spelled out in the IPO very clearly.

Mar 10 12:32 PM

[User 373847:]

They can also be converted to common at the rate of 2.82 shares of common for each share of preferred. That is pretty much the price they have fallen to.

Mar 10 07:41 PM

[pondee:]

"This is good for the company, since they will avoid bankruptcy,"

"then it won't matter if one waits to collect the dividends--bankruptcy, or even worse, nationalization, could wipe out any prospect of ever getting paid."

Okay, so Ford will avoid bankruptcy but don't own the preferreds as they may go bankrupt. Good thing you only have two hands.

Mar 11 02:16 PM

[Lee Eugene ...:]

Very NICE!!!!

You picked up on a part of the game most people miss out on. I thought the OID issue was too thick for most readers. Clearly you were the first out the gate to see some issues with it. All I can say is keep using your brain. Most people never read the prospectus.

Lee Munson


On Mar 10 12:32 PM Wren337 wrote:

> I'm surprised you didn't mention the OID conversion on the F-S shares.
> Now that the dividends are accumulating they are being treated like
> a zero coupon from a tax perspective. Holders can expect to get
> a 1099-OID for the dividend they did not receive. It should cost
> most people about $1/ year out of pocket to hold F-S, unless they
> are held in a retirement account. It's spelled out in the IPO very
> clearly.

Mar 12 10:18 PM

[Wren337:]

These things broke my heart. I had dreams up picking them up at 100% payout and holding on for a few years (in a non-retirement account). I was reading through the IPO to look at the deferment terms when I happened on the OID conversion. Holding a significant number of these could really kill you.


On Mar 12 10:18 PM Lee Eugene Munson wrote:

> Very NICE!!!!
>
> You picked up on a part of the game most people miss out on. I thought
> the OID issue was too thick for most readers. Clearly you were the
> first out the gate to see some issues with it. All I can say is keep
> using your brain. Most people never read the prospectus.
>
> Lee Munson

Mar 13 11:35 AM

[Lee Eugene ...:]

Wren337,
They broke my heart too. After offering a 50% premium to some of the other debt, they offer nothing but hope and deferred payments. While it could all work out in the end, it was a disappointment. This is a good case for diversification and position limits. Even for a professional trader, these are important lessons.
Lee

Mar 17 05:57 PM

[egodruid:]

Aren't these convertible at a 2.8246 common per preferred at the holders' option? So at any time they are worth at least that multiple of the common, aren't they? Why wouldn't eberyone convert immediately after the last div payment April 15th?. Mathmatically buying the F-S, getting the April div then converting works out to be about a 10% discount on buying the stock. What am I missing??

Mar 20 04:47 PM

[egodruid:]

OK counterpoint.

If you like Ford, the F-S is a better vehicle than F assuming they continue to trade at the 2.825/1 ratio. The taxes you pay waiting for the dividend seems to be a reasonable price for the probability of the accrued dividends and interest, and worst-case you're "at the table" upon dissolution with a $50 per share subordinated claim.

Where's my logic burp?

Mar 20 05:36 PM

[UpsideHunter:]

egodruid, you're right. The easy answer is to buy these in your IRA or 401K account, avoid the OID issue, hold them long term, and as you say, worst-case you're "at the table" upon dissolution with a $50 per share subordinated claim.

Lee, there are lots of reasons to buy -- like a 40% nominal yield, assuming they don't go BK, and huge potential upside for those with patience. Only if F goes BK, with the subordinated debt totally wiped out, is this a loser. Looks like a good bet to me.

On Mar 20 05:36 PM egodruid wrote:

> If you like Ford, the F-S is a better vehicle than F assuming they
> continue to trade at the 2.825/1 ratio. The taxes you pay waiting
> for the dividend seems to be a reasonable price for the probability
> of the accrued dividends and interest, and worst-case you're "at
> the table" upon dissolution with a $50 per share subordinated claim.
>
>
> Where's my logic burp?

Mar 26 11:44 AM

[Flyer34Stock:]

Can someone explain the 'dissolution with a $50 per share subordinated claim' ? I not familiar. Does this mean if they liquidate that have to pay us out at $50 per share?

Mar 27 09:30 AM

[Flyer34Stock:]

Two follow questions - Are we sure we are still getting a dividend payment on April 15th? (Do we know the Dividend Payable Date?)

Secondly does anyone know how to go about converting these into F? I haven't bee able to get anyone at Ford to call or email me back.

Thanks.

Mar 27 09:44 AM

[Flyer34Stock:]

Sorry - looking for the Ex-Dividend Date, April 15th supposedly is the Payable date

Mar 27 09:46 AM

[egodruid:]

"At the table with a $50 subordinated claim" means these shares have a $50 liquidation preference. That is if F goes bankrupt, the assets of the company are liquidated and all the creditors are "at the table" with their claims to those proceeds. Common equity holders are not there and only receive money if all the creditors in the room are made whole on their claims. This never happens because if there was equity, they weren't bankrupt. While you'd be at the table, you'd have the lowest seat. All trade receivables, and dept senior to yours (most if not all other debt) comes first. If there is anything left it would be divided by the number of FPS shares outstanding. The likelihood of seeing $50 is slim and none, but you may get something, whereas equity holders would not.

Mar 28 11:08 PM

[Flyer34Stock:]

Can anybody confirm if we are to see a dividend payment on April 15th??

Mar 31 11:28 PM

[egodruid:]

We will NOT see a dividend on the 15th. My first read of the announcement was wrong. Dividends are done till further notice.

Apr 03 07:42 PM

[gratianus:]

Aside from the way F and yoked to it F-PS have performed since this "run as fast as you can away" opinion piece was posted, it's worth noting that the premium above the straight conversion rate continues to increase. Today, it was 11.4%, a steadily rising number that turned positive on 3/23. This premium is what speculators are willing to pay for the possible future reinstatement of deferred dividends, an outcome that seems less unlikely each day.

Apr 10 02:02 AM

[oldie383:]

lots of words here and really not the answers. Has anyone thought of the likely case where the economy returns to its true range (pre 1999). Has anyone here thought of WHY Ford has enacted this strategy? I'd like to give you my thoughts but I figure they will fall on unreceptive ears

Apr 20 08:58 AM