Cytori Therapeutics and Its Publicly-Traded Outstanding Warrants: A Lesson on Leverage

Jun.16.11 | About: Cytori Therapeutics (CYTX)

Shareholders in Cytori Therapeutics (NASDAQ:CYTX) have had a rough ride lately. Although the news stream of company progress has been positive for this stem cell company, a disappointing earnings report on May 5th and overall market weakness has taken this stock down hard. Patience is not a virtue for a weak stock market that wants more and wants it now. CYTX has declined from an intraday high of $8.44 on April 5th to its current price of about $4.80.

While I am still bullish on the long term prospects of Cytori, this is not another article extolling the virtues of its technology that has already shown its ability to treat many illnesses. This article is about math and leverage.

Cytori Therapeutics is one of a few companies that have publically traded warrants outstanding. These warrants trade under the ticker symbol, CYTXW. Issued in March 2009, the warrants expire on 9/13/2014 and give the holder the right to purchase 1 share of CYTX at $2.59 per share. For investors who like the prospects of Cytori Therapeutics and plan on holding the position long term, the warrants will provide a substantially better return if the common stock shows strong long term gains.

The first concept that should be understood when evaluating the warrants is "time premium." With CYTX at $4.80 and CYTXW at $2.80, the time premium of the warrant amounts to $.59 per share for about 3 1/2 years of leverage. This is calculated by taking $4.80 (stock price), less $2.80 (warrant price), less $2.59 (exercise price). There are methods that Wall Street traders use to measure the fair value of a warrant that rely on a concept called "implied volatility." However, a more useful way to evaluate the investment merits of CYTX versus CYTXW for the long term investor is to see how a $10,000 invested in each alternative compares when held to the expiration date of the warrant.

The following chart compares the performance of $10,000 investments at these current prices:

  1. 2,083.33 shares of CYTX @ $4.80 vs.
  2. 3,571.43 shares of CYTXW @ $2.80

Click to enlarge
(Click to enlarge)

Although it is difficult to see on the chart, the upside breakeven point on the warrants is about $6.22. Assuming a time premium of $0 at expiration, the initial $10,000 investment in the warrants at this level is worth $12,964, while a $10,000 investment in the stock is worth $12,958 at $6.22. As the chart indicates, above the $6.22 level, the warrants outperform, and the gap in performance between the warrants and the common stock continues to widen due to the leverage that the warrants provide (more shares controlled). At an investor dream price of $50 per share, the warrants are worth $169,321 versus $104,167 for the common stock.

On the downside, the warrants are worthless if CYTX is trading at $2.59 at expiration (or below) while the common stock still has a value of $5,395.

If you are an active trader, the lack of liquidity in the warrants makes them a poor vehicle for trading. However, for those who KNOW the company well and still feel confident about its long term prospects, the warrants provide the bigger bang for the buck if the company is able to fulfill its potential.

These are the personal views of Wall Street Titan. All investors should always do their own due diligence.

Disclosure: I am long CYTX and CYTXW.