From WSJ: The German sports-car maker said Friday that its pretax profit in the fiscal year ended July 31 soared 46% to €8.57 billion euros, or about $10.9 billion. Eighty percent of that came not from making cars but from sophisticated financial instruments connected to a protracted takeover bid Porsche Automobil Holding SE has been pursuing for a company many times its size, Volkswagen AG.
The vehicle: “cash-settled options.” The buyer of regular stock options gets the right to buy or sell stock at a certain price by a certain date. But in cash-settled options, as the name implies, the buyer gets the right not to stock but the cash difference between the options’ “strike price” and the market price of the shares when the options are exercised.
Porsche began buying cash-settled options tied to VW stock in 2005, when VW’s share price was below €100. If the price rose, Porsche could exercise the options and receive the difference between the lower strike price and the higher market price. It could then use the money to buy VW shares.
In Germany, an investor needn’t disclose ownership of any size holding of options if they are the type settled in cash instead of shares. That allowed Porsche to build a large stake in VW while keeping the rest of the market unaware of its activity.
Such options have one other important twist: Banks that underwrite them typically hedge their exposure by holding actual shares. That takes these shares out of circulation.
Three things to keep in mind:
1. SHLD’s repurchase program includes the purchase of call and put options:
Share repurchases may be implemented using a variety of methods,
which may include open market purchases, privately negotiated transactions, block trades, accelerated share repurchase transactions, the purchase of call options, the sale of put options or otherwise, or by any combination of such methods.
2. Repurchased shares are still carried on the balance sheet.
As of August 2nd, 2008, SHLD carries $4,798B in repurchased stock on the balance sheet. Is SHLD holding the shares with the intention of reselling the shares at a higher price in the case of a massive short squeeze? With over 20M shares short and majority of outstanding shares held by long term value guys, how will shorts cover their shares?
3. Outstanding shares in the open market
Please read the SHLD short math covered extensively by ValuePlays and this blog.
Only 126M shares exist in the open market. Under the existing repurchase program, SHLD may have repurchased up to $206M of shares (3-4M shares at today’s prices). The total share count may be reduced to fewer than 122M shares. Based on my analysis of SHLD institutional share holdings, insiders and various value funds including Fairholme and Legg Mason control approximately 122M shares. We are getting close to a tipping point in terms of liquidity of SHLD shares.