I normally avoid trading any kind of convertible shares offered by companies. These are, in fact, securities issued by companies in trouble that I am normally not interested in.
In this article, I will write about a rare and interesting idea. Experienced investors may think that it is quite exotic, but I think it can be extremely profitable. I propose to short sell the warrants (TACOW) offered by Del Taco Restaurants Inc. (NASDAQ:TACO) ("Taco"). You should contact your broker as soon as possible in order to check if you can do this. I can do it, and the interest is not high.
In this article, I will not assess the financial performance of Taco, but you can have a look at this outstanding article about the company.
Tender Offer and the warrant
There are 12,162,817 outstanding warrants right now. The company will buy up to 6,750,000 warrants. So, after the tender offer, there will be some warrants outstanding:
As of July 8, 2016, we had 37,976,206 outstanding Shares and 12,162,817 outstanding Warrants. The Shares issuable upon exercise of the 6,750,000 Warrants eligible to be tendered pursuant to the Offer represent approximately 17.8% of our outstanding Shares as of July 8, 2016.
The company states that there would be some warrants trading, approximately half of the amount right now in the market.
"If the Offer is successful, the liquidity of the market for the Warrants may be substantially reduced.
If the Offer is successful, the holders of Warrants who tender their Warrants will receive Shares that are listed on Nasdaq. Levy Family Partners, LLC, the Ari Levy 2003 Investment Trust, PW Acquisitions, LP and The R.J. Investment Trust, which hold approximately 34.2% of the outstanding Warrants, have agreed to tender an aggregate of not less than 1,500,000 of their Warrants. To the extent that the Offer is successful, the liquidity of the market for any remaining Warrants, which are listed on Nasdaq, may be substantially reduced. These Warrant holders may tender a greater number of Warrants, up to the total number of Warrants they hold (subject to proration and the other terms of the Offer)."
This is the tender proposed by the company:
"The Offer is to permit holders of Warrants to tender up to 6,750,000 Warrants at an exchange ratio of 0.2780 Shares for each Warrant tendered (approximately one Share for every 3.6 Warrants tendered), subject to proration, as described herein. Accordingly, if more than 6,750,000 Warrants are properly tendered and not withdrawn prior to the Expiration Date, and we do not extend the Offer and increase the number of Warrants that may be tendered, we will exchange Warrants from tendering Warrant holders, in accordance with the terms and conditions specified in the Offer, on a pro rata basis (disregarding fractions), in accordance with the number of Warrants duly tendered by or on behalf of each Warrant holder (and not so withdrawn). This Offer will not have any special proration provision for odd-lot tenders, which means that all odd-lot tenders (including Warrant holders who own fewer than 100 Warrants) are subject to proration. The proration period will expire on the Expiration Date."
It is worth noting that this is another dilutive mechanism of Taco. The company has increased the number of shares in two years from 19 million shares to 38 million. Making the shareholders to exercise their warrants will create more shares in the market. This is not good for the shareholders.
The warrant's strike price is $11.5, but the current stock price is $9.47. So, the warrant is out of the money. Before the announcement of the tender offer, the warrant stock price was $1.83, at the moment it is $2.52.
The tender will end on August 5, 2016:
"The "Offer Period" is the period commencing on July 11, 2016 and ending at 11:59 p.m., Eastern Time, on August 5, 2016, or such later date to which the Company may extend the Offer (the "Expiration Date")."
After the company ends its offer period, the price of the warrants should fall to approximately its initial price. If we can short sell the warrants, we may make about 27% return in a month.
Conclusion and risk
If the stock price of Taco rises during this month, we may lose some money. However, the strike price is far away from the current stock price, and it is quite unlikely. In any case, the potential return that we can obtain is much higher than the potential loss.
This is an outstanding and very rare opportunity. I hardly find warrants that I can short sell, but I can do it in this case. The fact that the company is buying some, but not all the outstanding warrants has created this special situation.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.