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.]
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