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Mandalay Syndrome


On April 2, Mandalay Resort Group (MBG:NYSE) issued a $50 million convertible bond for "general financial purposes." At the time, revenues were falling according to several analysts, and it can be assumed that the company was prudently (as with many companies regardless of industry) recapitalizing its balance sheet.

On June 12 the company unexpectedly declared a cash dividend for the first time. This in general is very bad for the convertible bond arbitrage set up by hedge funds who now must pay the dividends from their short stock hedge. In general, a dividend -- all things being equal --will also dampen the volatility of a stock. These two factors make the value of the imbedded call option that they own in the convertible bond worth less. (See my piece on Structures for more details.) And in fact, on the day of the announcement, the stock went up about 5%, while the convertible bonds actually went down.

This is important because of its implications to the rest of the market and a possible trend. The new tax laws may create an incentive for companies to pay dividends in a subversive sort of way. Company executives, owning a lot of stock themselves, now can receive dividends and keep 85%. They create a win-win situation for themselves and the common stock shareholders: They receive a big chunk of cash after tax, drive the price of the stock up, and only hurt those pesky convertible bond hedge funds. It is only of small interest (except to cynics like me) that they issue debt (leverage) in order to pay cash out to shareholders.
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No positions in stocks mentioned.

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