Conversion Structure – Taking Advantage of Uncut Dividends
Audience: Real estate investment funds that are interested in fundamental strategies that are more innovative than the typical long/short. Example: AEW Capital Management
Background: HRPT Properties Trust (ticker HRP) is a REIT that primarily owns office buildings in central business districts and suburban areas of major metropolitan markets in the United States. It has a large concentration of properties leased to the U.S. Government and medical related tenants. The ability of HRPT to maintain their quarterly dividend of 21 cents has recently been subject to significant scrutiny. Merrill Lynch’s research analysts’ current forecast is for a 20%+ dividend cut. I quick evaluation of put call parity reveals that the market has already priced in at least a 33% dividend cut, before year end. My view is that there is a significant non-zero probability that the dividend will not be cut at all and that it is very likely that the dividend will not be cut by less than 33% percent.
Structure: The appropriate vehicle with which to express this view is a conversion. The structure is simply long a stock, long a put and short a call of the same strike. This makes the traditional payoff diagram a flat line. This structure will pay the difference between the dividend and the street’s bet on dividend, this difference is 7 cents if the dividend is not cut. The next two dividend payments are expected to be August 25th 2008 and November 22nd 2008 (ex-dividend dates are one month before respective payment dates). Thus one may take advantage of this situation using the January 17th 2009 options struck at 7.50 (stock currently trades at 6.98).& ...