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Because of the terms of the notes discussed in this article, Ford’s (NYSE:F) share price is extremely likely to be elevated through the rest of this quarter, and then quite likely to fall next quarter. The natural effect of the notes will be multiplied by the overall market backdrop (fluctuations due to inflation-induced monetary policy changes), and even more correlated by the likely near-term effects of supply line difficulties and short-term problems associated with the Omicron wave in multiple countries.
I am bullish on Ford’s two-year prospects to gain market share with new customers in the U.S. and consolidate its strong position in light commercial trucking in Europe by expanding its EV model offerings and production, in line with management’s announced plans. Therefore, I have a long position in Ford.
However, I view these plans as having a longer duration. In Q2 2022, the negative near-term factors suggested above are quite likely to combine with the end of the note-induced buying and general market factors and depress the share price. I have changed my near-term investing strategy to compensate.
Readers are advised to review the details given in Note 14 on page 21 of Ford’s Q3 financials. Here’s what’s most relevant in the next three months:
In March 2021, we issued $2.3 billion aggregate principal amount of 0% unsecured Convertible Senior Notes due 2026, including $300 million aggregate principal amount of such notes pursuant to the exercise in full of the overallotment option granted to the initial purchasers.
Each $1,000 principal amount of the notes will initially be convertible into 57.1886 shares of our Common Stock, which is equivalent to an initial conversion price of approximately $17.49 per share, subject to adjustment upon the occurrence of specified events.
These notes are convertible early under various circumstances, including the following:
During any fiscal quarter commencing after the fiscal quarter ending on Sept. 30, 2021 (and only during such fiscal quarter), if the last reported sale price of our Common Stock for at least 20 trading days (whether or not consecutive) during a period of 30 consecutive trading days ending on the last trading day of the immediately preceding calendar quarter is greater than or equal to 130% of the conversion price of the notes on each applicable trading day…
So, I’ve come to the following conclusions:
- I read this as these notes becoming convertible once the share price hits $22.74 ($17.49 X 1.3 = 22.737) and remains there for 20 out of the last 30 trading days ending Q1.
- There’s a big payday for whoever holds these notes if the price does go to these levels.
- We’re close to that level, and the sophisticated players in the market are all aware of this correlating mechanism.
- It is very cheap right now to lever with options, so it’s very cheap to push the shares up.
- And last but not least, right now a lot of overseas players are looking to arbitrage USD.
Observations and Discussion
When I looked at the results from the first trading day of the quarter, I decided that the notes were in play. I do not believe the morning cliffs were produced purely by optimism:
Source: Seeking Alpha
Seeking Alpha contributor Mott Capital Management wrote a recent article commenting on the danger in Ford stock, and referred to options movements. The comments on the article were largely negative, but I believe that the author has picked up something real in behind-the-scenes trading, and that the notes are the mechanism underlying a valid observation. It is a common investing error to undervalue contrarian voices and overvalue bias confirmation.
I originally entered my long position figuring a fair value price bracket expectation of $18-$22 at the end of 2022, and further increases after that time. I believed then – and still believe – that there will be a long run of positive results and optimistic news for Ford.
The reasons why I view Ford as strong longer-term investment are outside the scope of this article, but relatively well covered elsewhere on Seeking Alpha (see, for example, its Seeking Alpha Quant Ratings). I also factor in the pricing levels at which Ford’s newer models are entering the market, my belief that Ford will grow its commercial van market share, the reality that hybrids and EVs will attract new customers to the Ford brand in North America, and Ford’s demonstrated willingness to cut its bad businesses and focus on markets in which it has a very strong chance to excel.
The large recent insider buys were made knowing about the notes and anticipating their effect. As such, you can discount their informational value. Ford is now a “buzz” stock, but at the beginning of next quarter the odds that it won’t be start rising, and any negative news will have a disproportionate effect. Market conditions are also very problematic in Q2 due to monetary policy changes.
Consider taking some off the table this quarter, at least with limit orders. I am willing to lose 50% of my stake. Looking at trading today (Jan. 4th, 2022), I assume that a lot of players are doing the same. The shares will go up and down, but over $23.25 there isn’t any incentive for players to boot the stock up. A lot of savvy institutional players will be taking some gains while FOMO retail investors are buying. $23.75 to $25.00 seems to be a reasonable level if you really want to be long, but also dislike being caught in a market maelstrom generated by speculation surrounding financial instruments.
My personal hunch is that I will be able to buy back in under $20 in the second to fourth quarters, and I think I have a greater than 50% chance of being able to buy back in under $21 within a year. Selling options on your shares is another potential strategy.
Looking to be long
My advice would be to wait it out. Now is not the time, with the ledge effect likely to occur early in the second quarter.
Honestly, I wouldn’t go short. I’m sure smarter, younger, more sophisticated investors can make money, and it would be wonderful if individuals could suggest strategies in the comments, but to me the risk/reward ratio right now for shorts in this market is skewed to the “risk” side. Ford is too strong a stock with so much money floating around looking for a home to allow a solid basis for shorting, in my opinion. I think there is a non-negligible possibility that shares could go considerably higher than $25, and end the year higher.
Conclusion and Risks
This is a crazy, fast-moving market. While I was writing this article, my first limit order ($24) executed. Moves that I expect to take a month or two can happen in a day. Do your own due diligence, but also read the financial reports. They will give you a real edge.
The Fed’s announced policy for 2022 is, in real terms, an increase of stimulus because the spread of interest rates vs. inflation keeps widening. The risk later in the year is that the Fed will be forced to raise interest rates higher due to runaway inflation, or that the Fed will make a desperation move with their QE (bond-buying) strategy. If and when they do, the overvaluation inherent in the ratio of total market capitalization to U.S. GDP should exert a long-term drag on market returns. The effect might be a very sudden turn in market sentiment.
Prior to the publication of this article, one such market turn occurred due to the publication of the FOMC minutes. It will not be the last this year.
With respect to my thesis and price brackets given in this article, I am a conservative contrarian, and so I seek to shave risks from the top and bottom. Therefore, my price brackets are conservative because I figure the return multiplied by the probability when I figure these price brackets. For example:
.9 (90%) X $12 = $10.80
.7 (70%) X $13 = $9.10
.3 (40%) X $15 = $4.50
Staying around the 80% probability generally produces the highest level of average returns. I am a firm advocate of poker rules in business and investing. For younger investors with longer time frames the natural calculations change, and tax consequences are individual and should be included in each investor’s calculation. The strategies in this article certainly cannot be ideal or appropriate for every investor, and I advise everyone to seek a portfolio risk review with a certified financial advisor.