Como se combate o populismo? "Com eleições", responde Fukuyama

[Ulisses Pereira]

"The Real Problem for Lucent: Warrants"

By James J. Cramer
RealMoney.com Columnist
1/31/2005 9:57 AM EST


"The mechanics of Lucent's (LU:NYSE - commentary - research) decline probably mystify most of you. I believe you want to think that the quarter had some sort of hidden negative to it that we all are missing. I believe there is a hidden negative, but it isn't the fundamentals. It's the warrants. I will explain here why a casual decision by Lucent and its attorneys, along with the attorneys behind the settlement for securities fraud, to issue warrants had a huge -- and negative -- impact on the stock of Lucent itself.

First, understand that Lucent, as part of a bad-old-days settlement, decided to issue 200 million warrants to shareholders who got burned from a few years back. The warrants were simple: Struck at $2.75, they represent the right to the appreciation above that price out until December 2007.

So far, seems reasonable.

But put yourself in the heads of the people who got these. Do they really understand a warrant? A strike price? Do they even know how to look it up? Talk about a piece of paper nobody wants. Talk about a piece of paper about which every broker is going to say, "You ought to sell that thing, it's just found money."

And that's what happened here.

Of course, there are no natural buyers for these warrants. There's no broker trying to merchandise them. There's no big account that wants them. They are the classic hot potato that no one can get rid of.

So what happens with merchandise that has to be sold when it goes into the maw of all of those market makers?

They have to hedge it. Depending how directional or panicky they are, they can hedge aggressively.

In this case, when they were first issued, the warrants were trading at $1.66 and the common was trading at $3.71. To figure out what kind of deal you are getting, you just need to add $1.66 to $2.75. They "create" Lucent at $4.41 come the end of 2007. Kind of an interesting bet, but not one people are looking to take. The common stock is low enough that you'd rather have the liquidity of the common -- and that common has no terminus.

The market maker pretty much knows there's no market for the darned warrants, so he sells the common stock of Lucent against the warrant. If the stock goes up a lot, he's protected; his warrant will appreciate, too. If the stock goes down a lot, particularly down well below $2.75, he's got a really great trade.

If the market maker wants to, he can take in the warrant, then really bang down the common vociferously, causing a panic among shareholders, particularly the kind of retail speculators Lucent attracts. He can raid the stock down and then if he wants to, when the stock has declined appreciably, he can bring it in and cover the common. Or he can unwind the whole position, buying the common and selling the warrant.

I think this trade went on -- and still is going on -- in abundance. I think people are very na?ve about the power some funds have to shoot against a common stock when they have a warrant or a call on to hedge themselves.

In this particular case, it was quite easy to short the common at the $3.70 area against the warrant and then buy the common back around $3.10. You had risk, in that the warrant declined to $1.10. But the odds of that warrant losing more value than that, given its long-datedness, weren't great.

In other words, what you need to take away from this is that a security that never should have been issued got tossed into the market, which generated severe downside pressure, if not panic, on the company's stock, when all the company really was trying to do was put this horrid episode past it.

I know you might think I am being a conspiracy theorist about this. And if Lucent never rallies again after all the warrants are traded out of retail, I will be wrong. But I can tell you that I have seen this kind of trade for years. The warrants are the ammo, the firepower you need to knock down common; you can blitzkrieg it -- that's what it is called -- and get a stock down so fast your head would spin. You can do it again against the warrants on any real lift.

Yeah, this stuff happens. It happened here.

And it's legal. "

(in www.realmoney.com)