Merrill and Level 3 Unwind the Hedge

September 25th, 2008 by · 8 Comments

A few months ago, I spent a whole post detailing the obscure anti-dilution hedge that Level 3 bought from Merrill Lynch back in 2004. D-day for that arrangement was to be this December, with the prize for Level 3 varying between $0 and $175M, and it looked alot more like zero with the stock price at $3.  Well, that’s not how it turned out, apparently the two are unwinding the contract.

Merrill is sitting on 23M shares of LVLT stock as a hedge against the hedge, but because of the terms of the hedge they need to be able to deliver up to 86M shares of stock or $175M and they don’t know which so they have to be ready for either.  Merrill, not being in great shape right now and selling itself to Bank of America, apparently can’t take the risk that the stock will go up in.  And Level 3 would rather get a guaranteed something rather than a likely nothing, but has nothing to lose.  After reading the filing, it seems that what Level 3 gets out of this unwinding is roughly ‘generally based on’ what Merrill gets in the market for the 23M shares they sell.

So you can imagine the conversation:

Merrill: We want to unwind this thing.

Level 3: You want us to cancel a bet that we can’t lose money on and might still win some?

Merrill: And by the way, we need to sell 23M of your stock, so please register it.

Level 3: And let you blast another hole in our stock price?  What do we get out of this?

Merrill: We’ll compensate, what’s your price?  We need to make this go away

Level 3: Give us the 23M shares you’re sitting on.  No wait, actually, we want you to sell it and give us cash – every little bit helps nowadays.

Merrill: Too high.

Level 3: We’re not the ones who need to deal here.  Look at it this way, at $3/share this basically covers the net cost of the whole hedge in the first place.  It’ll be just like we never had a hedge to begin with.

Merrill:  Err look, I think this is dumb, but my boss just wants this off our books, so ok.

[For the humorless: that was a dramatization, I don’t have the conference room bugged]  Anyhow, like Cogent last week, buying its debt back while the financial markets reel, it seems as if Level 3 has managed to get cash for a hedge that in all likelihood would have been worth nothing.  Just because Merrill is reeling and reducing its risk.  I say good for them, and now we can move on to Q3 results in 4 weeks.   The details of course aren’t really clear yet, so anyone with a better interpretation of the SEC filing or further information, please feel free to correct me.

[Followup:  The phrase ‘generally based on’ from the filing needs clarification before we can really say how much Level 3 gets out of this.]

If you haven't already, please take our Reader Survey! Just 3 questions to help us better understand who is reading Telecom Ramblings so we can serve you better!

Categories: Financials · Internet Backbones

Join the Discussion!

8 Comments So Far

  • jeremy drane says:

    morty knows more than i but as i understand it lvlt can tell ML when to sell the 23M shares and if it’s before Dec15th we get to keep the option value of the time left between the date we sell and the Dec 15th.

    in terms of valuing the option value i’d like to think that we could see the stock move up a bit following a good report so perhaps we are just out-of-the-money or just in, say around $4 post earnings.

    if we have 23M shares that’s like owning 230k option contracts (100 shares per contract). i suspect we could get anywhere from .3 to .6 per contract or somewhere around 100k.

    so unless i have the math wrong i just don’t see this as really making us any money at all. rather, this is just a way for us to tell ML WHEN to sell the shares.

    again perhaps i have the math wrong but i don’t think we are going to make hardly any money off this transaction unless we see the stock move up in a big sort of way….and i think $4 might be the top of that range.

    feel free to correct me.


  • Rob Powell says:

    There is nothing at all about time value of the option in the SEC filing, only this:

    Pursuant to that agreement, Merrill Lynch International agreed to pay to Level 3 an amount in cash generally based on the sale price of our shares on the days on which Merrill Lynch International sells the shares to unwind the Bond Hedge and Warrant Transactions.

    To me, the only unclear part is ‘generally’, but the filing doesn’t explain further and I suppose it might be something wild like that but I just don’t know. So I’d ask where you and Morty are hearing this from?

  • morton dick says:

    Rob—– I specified at the bottom of my post at IV, ***this is coming from LVLT Investor Relations*** .
    Not my opinion or reading of the SEC material—– a conversation with IR .

  • toddforthree says:

    i think lvlt needs to be a little clearer on this issue without just punting the issue to IR. i have agreed with rob that the language above from the PR would indicate that lvlt will get the sale price of 23m shares times the price they sell it at. mort says thats not true. so if 3 people who follow this stock very closely cant figure out how much lvlt is going to get they need to issue an explanation. hey lvlt the ball is in your court.

  • Eric S says:

    The way I read it and through conversations, I understand it similar to jeremy. Nominal price unless the stock moves, the sales timing is at Level 3’s directive.

  • J Boone says:

    Rob Thanks for the great post! i have struggled with this from the time it was filed. Why does ML need LVLT to register the shares if they acquired them in the open market?

  • jeremy drane says:

    spoke to IR. to clarify….lvlt can tell ML when to sell the 23M shares and if it’s before Dec15th we get paid some amount based on a confidential formula that has the price of the stock and the date sale as variables. it’s a sliding scale that means the longer we wait, assuming the price stays exactly the same, the less we get. so it is some sort of option value but they are not going to tell us what the formula is so we can only speculate the amount we would recieve. my guess is that it will be a small amount, assuming we stay under 3.98. what i wonder about is whether there is a someone short that is waiting for this stock so they can sell short again. those 7.7M shares blocks in afterhours perhaps went to some fund that is now using those new shares to push the stock down. whatever the case this thing sucks as we were up over 6 and if it wasn’t for the integration blowup we would be 175M richer.


  • carlk says:


    Without being disrespectful, we would hardly be richer as shareowners by 175M assuming the metrics or payouts up the ladder to six are indeed correct.

    Jim Crowe has cost his shareholders the NPV of 62M-net cost of capital for placing the bet-going on for years now, especially during a time where cash was critical to our well being. Merrill Lynch has had our money in their account. 🙁

    Before I become too pessimistic, let me remind us all that, Wall Street has routinely been in awe of these gentlemen’s finance and hedging skills. They recommended for Crowe and Crew to become a hedge fund in telecom versus an operator.

    I will be very unhappy if they do end up losing money on this critical capital when all is said and done!

    All is NOT said and done yet.

    Moreover, The Sky is Not Falling, notwithstanding what these Chicken Little bastids would have mortals believe.


Leave a Comment

You may Log In to post a comment, or fill in the form to post anonymously.

  • Ramblings’ Jobs

    Post a Job - Just $99/30days
  • Event Calendar