Friday, November 26, 2010

If You Absolutely Insist on Having Some General Motors, Look at the Convertible Preferred (GM; GM.Pr.B)

1961 Chevrolet Corvette Convertible

What's not to love about a GM convertible?
('61 Vette Roadster)

From Barron's Weekday Trader (Fri. Nov. 19):

The Other Way to Play GM 
GM's convertible preferred offers less upside, but more downside protection.
GENERAL MOTORS' $15.8 BILLION initial public offering generated enormous attention yesterday, but there was virtually no coverage of a companion issue of $4.35 billion of mandatory convertible preferred that offers another way to play the auto maker's revival.

General Motors' (ticker: GM) preferred offers investors a 4.75% dividend yield; the common pays no dividend. The preferred has a complex structure that gives investors less potential upside, but better downside protection.

The preferred, priced at $50 a share and listed on the New York Stock Exchange as GM Pr B, was trading this morning around $50.

Here's how the structure works: The GM preferred has a conversion premium of 20%. This means that at the mandatory equity conversion in three years, investors will get $50 a share if the common is trading at a price between $33, the IPO price, and $39.60. Investors get 1.51 shares of GM stock if the common is at $33, sliding down to 1.26 shares if the stock is at $39.60. 

Convertible fans like the structure, even though a security with a mandatory conversion feature doesn't offer the same protection as regular convertibles without one. Warren Buffett is a big fan of traditional converts. His Berkshire Hathaway holds a big issue from Dow Chemical.

"The mandatory convertible is, hands-down, a superior instrument to the common," says Barry Nelson, a senior vice president and portfolio manager at Advent Capital Management in New York, a specialist in convertibles.

He says the GM preferred should offer about 80% of the appreciation in GM common above $39.60. For example, if the common stock doubles, to $66, in three years, investors should receive about $90 for their preferred, including dividends, an 80% gain. GM shares are trading at 33.76 this morning, down 43 cents.
If the stock remains steady or declines, convertible holders will do better than common holders because of the 4.75% dividend on the preferred. 

For those wanting some yield and a play on GM stock, the preferred seems like a good investment.
On Wednesday the common closed at $30.48, the series B preferred at $50.29.
Here's GM's pricing news release with a link to the prospectus.
Yahoo Finance uses the symbol: GM-PB