Symc case study report

Symantec Corporation Convertible Notes with Call Spread

Case Study Report

Attila Németh

2013 1

The Symantec case

• Symantec is the market leader on software market.

• Technology industry is a fast changing market – products life cycle is short, new products and new demands occur, as a matter of fact, continually.

• I did deeper research about the company (I examined the sales, operating profit, net income, leverage (chart 1 is incomplete in my case study, the leverage diagramm is missing) and the stock price for a longer period,

• and tried to find out the motivation behind the transactions.

• I seek for this specific transaction and realized this is a real transaction which was gripped my interest more.

• I read the annul report of Symantec - 2012 (there are a couple of cititions in my case report).

• I found and read the purchase agreement of the convertible (June 19, 2006), and the offer by Simpson Tacher.

10 06 2013 LSBU-IBA International Finance 2

The motivation of Symantec

• Symantec is not only a software company but merges, buys and sells companies to keep the market leader position and expand its market.

• This activity – mostly the aquisitions - are needed financing.

• The company has high volatility on stocks, as usually in the software industry (historical 35,9%, implied –for 2 years-34,3%).

• The average Equity/Debt ratio in software sector is around 50%.

• I supposed Symantec wants to levarage its E/D ratio, because now it it above 70%, and needs low cost cash to continue the aquisitions.


The motivation of Symantec

The options are:

– Bank loan from the market – SYMC has no credit rating at that time- high interest rate .

– Issue bonds or stocks – who would buy them, and for how much? - and risk of dilution.

– Issue convertible - could be cheaper than the bank loan, but there is risk of at what price SYMC would sell the notes and in 6 years the investors ask for the money back instead of convert the bonds if the stock price would be under the convertible strike price, and premium coupon should pay higher interest than SYMC wanted to – the corporate 5 years bonds yield was 7,6%.

– Issue convertible with other instruments – This is what SYMC did.


The transactions1. SYMC issued converible $2,1 Billion (exp. 2011, 2013 average in 6

years), notes payed coupon semiannualy (annual interest is 0,75%, and 1% average 0,9%) - and $1000 could be convert to 52 stocks uptothe expiry - it means on $19,12 / stock (converting before maturity -trigger price was $19,12 X 1,3= $24, 86). The number of the noteswere 110 million.

2. Bought 110 million call options with a $19,12 strike for the sameexpiry than the convertible and paid $592 million to the Bank .

3. Sell 110 million call options with a $27,3 strike for the same expiry, and got paid $326 million by the Bank.

At that time the current stock price was $15,63.

This is the situation when the possible shareholders (noteholders at that time) geta promise for $19,12 stock price and some premium and they see SYMC also trustin the increasing stock price, in addition with the short call reduce the risk of thedilution.


Summary of the transactions


Participants Position Amounts Payoff Comment

SYMC management

issue convertible get $2,1 billion

must give 110 million stocks and pays

premium or pay back $2,1 billion

pay premium 0,9% annual

Long call $19,12 pay $592 million$ 266 million cost

call spread $19,12-$27,3Short call $27,3 get $ 326 million

Bank

Short call $19,12 get $ 592 million

$ 266 million income

This is for the risk of the bank , but the

bank has to hold 110 million SYMC stockswhich creates cost

Long call $27,3 pay $326 million

Noteholders -Investors

buy convertible pay $2,1 billion

Possible to get 110 million SYMC stocks

or get back $2,1 billion and the

premium

get premium 0,9% annual

The expiration date the same in every positions

Scenario #1

The stock price is under $ 19,12:

The noteholders do not convert the bonds to stocks, and get back their investement (fund).

SYMC had paid the cost of the call spread ($266 million) to the Bank, and the coupon premium to the noteholders, and the fund what the investors have paid 6 years before. SYMC does not excercise the long call and obviously the short and try to inform the market on the most positive ways.

The Bank is in the money if the spot price is above $15,63. The proceeds of the Bank is $266 million (minus the cost), and immediately tries to sell the stocks on spot price.


Scenario #2

The stock price is above $27,3:

The noteholders convert the bonds to stock on $19,12 and they would be happy, and probably they sell the stock on spot price immediately.

SYMC excercises its call on $19,12 and sell the stocks to the Bank on $27,3 and issues new stocks and gives these (110 million stocks) to the noteholders (virtually on $19,12 but from the wievpoint of SYMC on $27,3), but it is perfect to the company, because the stock price is very high and the demand for SYMC’s stocks would be increasing, and Symantec easier can obtain money (credit).

The Bank tries to sell the stock immediately at the spot price (which is higher, than $27,3).


Scenario #3

The spot price at the expiry date is significantly higher than $19, 12 but lowerthan $27,3:

The noteholders convert the bonds on $19,12 and likely try to sell it immediately.

SYMC excercises its long call on $19,12 and gives these stoks to the noteholders(on $19,12), and issues new stocks and uses the short call and sells the stocksto the Bank on $27,3. This is what Symantec invented. As my calculationSymantec’s proceeds maximum $4,5 / share ($ 8,2/ share minus the cost of the call spread/stock and the coupon premium/stock and the paid devidentmeanwhile to the shareholders (but I have no information about the divident), and the stock price is fairly high, so there is lower risk of the dilution.

The Bank is waiting for the increase of the stock price and try to sell the stockswhen the spot price is above $27,3, or if they have some reserve from the callspread income ($266 million) sells the stocks a bit higher than the break evenpoint.


Questions

1. Assuming conversion can only occur at the option’s expiry (expiration date), analyse the cost and the payoff of the call spread from the viewpoint ofSymantec.

– „The payoff of the call spread from the viewpoint of SYMC:

Under $ 19,12 is the cost of the call spread and the premium has paid to thenoteholders.

Between $19,12 and $27,3: when the spot price is $21,5, the payoff could be $0/stocks (SYMC earns $2,4/shareX110 million shares=$264 million and the callspread had cost $264 million.) The full cost, with the bonds premium is $383 million, which is around $3,5/share. When the spot price is around $22,5 - this is the break even point – the payoff is $0. The maximum payoff is $ 4,5/stock ($ 4,5X 110 million=$495 million) when the spot price is $27,3. (see on next slide)

Above $27,3 the same as when the stock price is $27,3.


Questions


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Payoff SYMC

payoff/share

payoff with callspread costswithoutinterest/share

payoff with callspred cost andinterest/share

Questions

2. How should the $19.12 strike options purchased by Symantec be priced?

I don’t really understood the question. Usually the Bank used to price the option according to the Black – Shcoles modell. To be honest I had no time to calculate this, but I know every data were available: (volatility, strike price, spot price, yield, time to expiry).


Questions

3. Should Symantec issue convertible notes?

As Symantec obtained cash around 3% annual interest in 2006. Yes, I assume that was a good decision from the board.


Questions

4. Why would Symantec not directly issue notes with a conversion price of $27?

The than-current spot price is $15,63, and if Symantec only issue a convertible on $27 should have offered a high premium (I suppose higher than 7,6% annual) if even anyone would buy the notes, and if the spot price is under $27 at the expiry the noteholders would not convert the bonds. In this case Symantec’s costs are higher, and the chance, SYMC have to pay back the money to the investors more likely. From the market point of view it seems Symantec is in the trouble and urgently needs money.


Summary

• I’m convinced Symantec chose the right decisionwhen isseued convertible notes with call spread toget a low cost cash to continue the aquisitions and retained its market leader position.


Thank you for your attention!


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Symc case study report