Right now the bid is $3.23 on these pups. Okay, $5.05 - 2.50 = $2.55 to the rights, only 68 cents to a two year $6 call. I understand the stock is at $5 and we don't have visibility yet on distributions, but doesn't that seem cheap for a long term call option?
I guess it all comes down to distributions, that will set the price to yield for the stock, and therefore the warrant feature. But even if you wanted to sell, it seems today is not the day, the stock is up a little, the rights down. I read that as reflecting the rights popping up in a lot of accounts and being sold. Unless the market tanks, or something more is known about distributions, and it's bad, it seems to be chances are the rights will run back up.
And if not, if the distribution is expected to be so low that the stock is really worth $5 or less . . . then why did all those unit holders vote for this??
Finally you made the right decision. Just a little better manners and you could have learned without public disgrace. Did you factor this in? My tool valued the warrants 50% over the market does anyone have input or thoughts? Might there be issues with measure volatility in the regression? I do not agree for x reasons.
We individual investors have enough challenges to face and this monkey business is a waste of time. No one is perfect and there are reasons Buffett / Munger sit at the top of the hill as the Yodas of investing. That success has little or nothing to do with efficient market math but primarily good old common sense and intellectual integrity. In fact Buffett / Munger talk about how they missed something or got it wrong more than their first place results. For them it is about being even better rather than ego.
You are correct. Most individual investors do not understand efficient market concepts - like you. They unlike you have the good common sense to leave them alone or keep it simple with a little covered call writing. By sticking to what they understand like Buffett, they can do just fine with common sense.
Thanks to management small individual investors have illiquid warrants that cannot be valued using simple tools. That is a good explanation for the pile up in ask / bid numbers.
The shame is there is no way to objectively value these things. Management - why warrants when you have so many small individual income investors looking for stable income?
Noris - You said "How can the market value the warrants when it has no idea of how much free cash flow management will retain". I think I've answered your question with a worked example.
You are confused about some basic concepts which is why you're tying yourself up in knots with long nonsensical posts.
I'll leave it to the other readers to judge the value of your opinions.
Bring up a definition of BETA and volatility. Beta by definition is a relative measure of VOLITILITY to clever by half dude. A BETA of two literally means twice as volatile or risky as the average stock. It is possible theoretically to find the Holy Grail of MPT of a negative Beta or correlation and create a perfectly immunized portfolio with guaranteed returns.
Volatility by definition in a diversified portfolio is measured by Beta simply because there is nothing proven better. In fact the simplified BlackS uses Beta as the expected volatility factor. You might not care about volatility correlation but nearly all the money on Wall Street does and they not you move the market.
As I said in an early post; which you failed to understand, you cannot use time series because it is driven by specific management decisions and events rather than efficient liquid trading. Will we have a repeat of the ‘recapitalization’? NO. Will we have a repeat of the initial voting on the value destroying recapitalization? No. Does EROC have a large enough capitalization and trading volume to assure efficient trading before we ever think about the warrants? NO. Are we going to repeat selling quality assets at trough bargain prices again?
While you are playing number monkey you had better decide whether or not there is the possibility of early exercise to capture a distribution. This in theory will be a well paying MLP from current prices. OH that was not in the simple tools?
Possible the market is off 50%+ in valuation but it is about a six standard deviation event. Look up the ramifications of Six Sigma. The market is very efficient but EROC is very screwed up. Still hard to believe the controlling special interest would not be actively scoping up small lots for an instant 50% gain. They have proven to be good at nothing except exploiting small investors after all.
Just off the top of my head your results are exactly what I expected. You played with things you do not understand and came up with a valuation 50%+ greater than the market and proclaim a grand discovery of what is statistically considered an impossible event. Way to go number monkey!
Just because like a trained monkey you can punch numbers into a tool does mean you understand what you are playing with. You are just the sucker Mr. Market's brother the used car salesman is looking for. All I can hope is you quickly have a monkey touch the monument moment before doing any more public regression into public display of personal ignorance.
Look ma I go this trading tool punch in numbers and all I have to do is find every warrant and option undervalued by 50%. We gonna be rich ma! Rich for sure! Please just stop now.
"I would rather you stop"
I'm sure you would rather I stop as you're embarassing yourself.
There is no part of the option valuation calculation that uses a risk premium. There is a risk free rate variable which is the long term treasury. The BETA of a stock has no effect on the price of an option on that stock.
You said "To value with this methodology you must have a way to rationally and reasonably assign a risk premium"
To value a warrant you need
* Time to expiry
* Risk free rate
* Strike price
* Current price of underlying
No risk premium, no Beta!
So that everyone can see how to value the warrants
http://www.hoadley.net/options/optiongraphs.aspx? <-- online option calculator
* Time to expiry - 670
* Volatility - 50% (there are a few sites that show historic volatility over various time periods. You need to estimate future volatility based on this. This is not BETA)
* Risk free rate - 3%
* Strike price - 6
* Current price of underlying - 5.32
OPTION VALUE - 1.29
No you do not understand Blacks.
You cannot quantify the risk factor. Management has not behaved rationally to maximize shareholder value. Volatility or BETA in the number series is driven by EROC specific management action rather than positive or negative correlation to information entering the market.
To value with this methodology you must have a way to rationally and reasonably assign a risk premium. As market correlation or BETA is unworkable you explain to me oh clever well schooled one how this is to be done?
Again this is a game you are not equipped to play and I would rather you stop.
Longterm, I agree with what you just said. Management acting "eratically" does add to volatility and hence warrant price. I think that is primarily true in the earlier stages of the warrant and could lead to management acting to boost the warrant price early, dumping their personal warrants at the higher prices, and then letting the warrants and unit price gradually decline to the mid $6's. I wouldn't put anything past this bunch. Still, if I was betting, they will probably work harder to boost the warrant price than the underlying unit price, primarily through their distribution policy. At the end of the day, I'm betting on the units being the better investment over the next two years.
"...will result in a volatile price swing. That alone does not make the warrants more valuable."
It is counter-intuitive but higher volatility does raise the value of a warrant (not the value at expiry but the current value). One of the interesting implications of this is in the application of real options. Companies that have exclusive rights to out of the money projects (think an oil field that isn't currently economic) in a volatile country have a more valuable asset than the same oil field in a stable country. This is exactly the opposite result to discounted cash flow where risk reduces the value. (Of course an out of the money project has a negative DCF.)
Anyway the same applies with EROC. As management behaves erratically then you'd expect to see wilder jumps in EROC's share price but if the share price is the same as it is today, after a few wild jumps, then the warrants would be more valuable (except to the extent that they have lost value due to time decay).
I realize this wasn't your main point but it's worth understanding (& it's interesting).
"I am more than a little familiar with efficient market theory and it would be wise for you to stop this behavior now. I do make mistakes from time to time but not this time."
So you believe that Black Scholes is wrong and you are right.
You were wrong about the share holder vote. You're wrong about valuing derivatives. You've confused value at expiry with the current value.
I can't imagine the big holders who voted for this thing being very happy with a $6+ unit price, when EROC pre-vote was over $7, and gutting the value of the warrants in the process. I don't think they voted for this thing to break even.
Maximizing distributions within tolerable limits is in everyone's interest. I think you'll see management issuing guidance towards a 80 cents + 2011 distribution that will push the units to the $8-10 range over time, in line with the Kerrisdale projections.
Oats, I think the discussion has been quite clear and the arguments are well presented. I also share Norris's opinion of the management team. That illustrious bunch unfortunately adds a nasty variable in any analysis.
I strongly agree that the distribution policy is important to the valuation of the warrants, even more than the basic unit price. This is due to the leverage the warrants have as well as their lower shelf life. I think that the Black-Scholes model for valuing the warrants, while it is highly driven by the unit volatility, somewhat misses the impact that the distribution could have on the volatility. Every distribuion announcement, if it changes significantly from the previous quarter or from the initial expectation, will result in a volatile price swing. That alone does not make the warrants more valuable.
I don't know where management personally comes down on the warrants, and they might not yet have that figured out either. They undoubtedly have them now. Down the road, management could choose to sell the warrants on a pre-timed schedule or possibly after quarterly investor reports. I doubt that they are dumb enough to sell large numbers in random insider transactions.
What would be best for the company's interest, would be for the unit price to be about $6.25 -$6.50 during the last 3 months of the exercise period (2nd quarter 2012), everything else being equal. That would result in maximum exercise and minimum disruption to underlying unit value. This type of exercise is the cheapest way to raise new equity capital right at a time when it will likely be very needed for growth. Management could target that $6+ price through its distribution policy in the next 21 months, which one of the points in this discussion. If management is starting down the path of selling its own warrants, look for this to be one of their objectives. If they hold their warrants, they will want to keep distributions on the low end of the range the first year or so and then have large quarterly increases to boost the unit price.
The biggest uncertainty in any of this, of course, is DCF. DCF is largely not under the control of management, thank goodness, unless they choose to screw up on the scale of 2008. Can they be that stupid twice? Even I give them more credit that that.