|This was on the wire today:|
By Michael Rapoport A Dow Jones Newswires Column
NEW YORK (Dow Jones)When you refinance, you typically do it because you think you'll be better off whether you're a homeowner refinancing a mortgage to take advantage of lower interest rates or a company refinancing its debt to make it easier to pay back.
But, the company's assertions notwithstanding, it's hard to see how beleaguered MicroStrategy Inc. (MSTR) is much better off from its recent refinancing of $125 million in convertible preferred stock.
The company, still trying to recover from its accounting disaster of last year, has touted the refinancing as removing a lot of uncertainty from its future by turning away from a path that could have resulted in virtually unlimited dilution to the value of its existing shares. But while refinancing buys some time for MicroStrategy, it carries its own problems, including a big cash outlay that depletes the company's coffers and significant dilution a few years down the road regardless.
And after all that maneuvering, the refinancing doesn't even remove the danger of UNLIMITED dilution it was ostensibly meant to address. If MicroStrategy can't get its stock price back up from its current singledigit level over the next few years, current shareholders could face major dilution to the value of their holdings.
Before getting into the refinancing, here's how the original financing would have played out.
MicroStrategy originally issued the $125 million in convertible preferred stock last June. At that point, it was convertible into MicroStrategy common shares at a price of $33.39 a share, based on MicroStrategy's share price at the time. But there was a time bomb in the terms: The conversion price could be reset once a year, to wherever MicroStrategy's price was around the anniversary of the financing.
That meant that if MicroStrategy's stock price plunged, preferredstock holders would get more common shares when they converted their $125 million into a commonstock stake. The lower the price went, the more shares they'd get, creating greater and greater dilution. That's why these types of convertibles are known as "deathspiral" securities.
MicroStrategy stock is currently trading at just over $5 a share, and the anniversary date of the financing is approaching. So unless the stock price were to suddenly shoot upward, the conversion price would have gotten revised sharply downward soon and it was possible some of those preferred holders would start converting.
Ultimately, if the stock stayed at its current price, MicroStrategy might have had to issue 24 million shares to convert the stock, plus up to another 6 millionplus shares over a maximum term of four years for dividends on the preferred stock. That's total dilution of about 37%. And if the stock's price had continued to fall, the price could have been reset again, and dilution could have gotten even worse.
Enter the refinancing, in early April. The new terms call for the company to buy back some of the preferred shares for $25 million in cash, and to exchange most of the rest for three new series of preferred shares maturing in 2004, all with much lower conversion prices from $5 to $17.50 a share.
Problem solved, right? At those conversion prices, MicroStrategy would still suffer some dilution about 11 million common shares would be issued to convert the preferred stock, causing dilution of about 13.5% over the next few years but at least it removes the flexible conversion prices that raised the risk of unlimited dilution.
"Given recent market developments, our capital structure was creating too much uncertainty for investors," said Michael Saylor, MicroStrategy's chief executive, in a statement at the time the refinancing was announced. (A MicroStrategy spokesman declined further comment.)
But read the fine print. The $5 conversion price on one of the new series of preferred stock is fixed, but there's still some worrisome flexibility on the other two series.
When the preferred shares mature in 2004, MicroStrategy has a choice: It can either pay about $61 million in cash to redeem the preferred shares, or it can convert them to common stock. The cash option is probably what MicroStrategy would prefer, but it may not have a choice the company is currently a little hardpressed for cash, although it's impossible to say what things will look like in three years.
So, if the cash isn't available, MicroStrategy may have to convert the preferred stock. But here's the rub: If MicroStrategy's stock price is lower at the time of maturity than the two preferred series' conversion prices $12.50 and $17.50 a share then the conversion price gets revised downward to the market price, wherever it is.
And that would mean greater dilution. If the stock's price stays where it is today, in fact, MicroStrategy would have to issue about 7.4 million shares more than it would have to under the current conversion prices.
And that's not all. Those two series of preferred stock carry huge dividend rates of 12.5% a year, payable in cash or common stock. Again, it's possible MicroStrategy might have to use stock instead of cash to pay those dividends. That would mean an extra $23 million worth of stock issued by 2004 4.4 million more shares if the price stays where it is now.
Finally, there's another $5.3 million worth of the original preferred stock that isn't being converted to new stock. Either MicroStrategy will pay cash to redeem it, or it'll have ITS conversion price lowered to the market price in July. At current prices, that's another 1 million shares.
Add it up: 11 million common shares to be issued in 2004 under the best circumstances, plus another 7.4 million if the stock's price stays where it is now, plus another 4.4 million for dividends over the next three years, plus another 1 million for the remnants of the old stock. In all, MicroStrategy may have to issue up to 23.8 million shares, which would be dilution of about 29%.
When you put that together with the $25 million in cash the company is paying, the refinancing doesn't seem like a great bargain. And remember, this is assuming the stock stays where it is now. If it's lower in 2004, dilution is even more severe; if it's higher in 2004, dilution is less severe.
Or look at it another way. Forget about dilution. Forget about what MicroStrategy's stock will do. Under the original terms, MicroStrategy would have had to pay out about $163 million in cash and/or stock to preferredstock holders, counting all dividends and assuming MicroStrategy extended the maturity date to 2004, the maximum it was allowed to under the agreement. Under the restructuring, MicroStrategy will have to pay out about $148 million by that time. A savings of only $15 million over three years? Doesn't seem like a lot for all the effort.
Of course, by 2004 this matter may be moot, one way or the other. MicroStrategy says it expects its core business to hit the breakeven point by the end of 2001, and maybe the company will generate enough cash by 2004 to redeem the preferred stock. But as of March 31, the company had a cash position of only $91.4 million and that may not last long for a company whose operations burned through $87.8 million in cash during 2000. Especially when the company has just committed to that $25 million cash payment for the preferred sock, and plans to spend more on restructuring.
Any significant dilutionrelated issues for MicroStrategy are well in the future, of course, and may never come to pass. But don't think the refinancing has magically solved all of MicroStrategy's potential problems with dilution. It hasn't.
By Michael Rapoport, Dow Jones Newswires; 2019385976; firstname.lastname@example.org
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