Teekay shares or Teekay PEPS? An Investor’s Perspective

By Lambros Papaeconomou, of Mallory, Jones, Lynch, Flynn & Associates,

TK PEPS Main Characteristics

Borrower: Teekay Shipping Corporation

Security Type: PEPS

Total Amount Borrowed: $125,000,000

Unit Price: $25.00

Dividend: 7.25%

Date Interest Commences Accruing: February 16, 2003

1st Dividend Payable on: May 16, 2003

Maturity: May 16, 2006

Moody’s Rating: Ba3

S&P Rating: BB

Chart 1

Suppose on February 12, 2003 you were considering investing $25 for 3 years in Teekay Shipping (NYSE:TK). You could purchase either 0.6941 TK shares (stock symbol: TK) at $36.02 (the day’s closing price), or one TK Premium Equity Participating Security (TK PEPS) – (stock symbol: TK_PA), Teekay Shipping’s offering of convertible securities that was priced and sold that day. Would you invest in TK shares or TK PEPS? Under what circumstances would your investment in TK shares be more profitable than TK PEPS and vice versa? How were TK PEPS priced vis-à-vis TK shares? Did arbitrage opportunities exist? In this article we will attempt to answer above questions by analyzing, in depth, Teekay’s recent offering of convertible securities.

TK PEPS earn an annual dividend of 7.25% (or $1.8125 per unit) and are automatically converted into TK shares after 3 years as per the conversion formula described in Chart 2. TK shares earn an annual dividend of $0.86 per share which, at the purchase price of $36.02 per share, is equivalent to an annual dividend yield of 2.39 For a $25 capital investment, investors in TK shares would own 0.6941 shares that will pay them an annual dividend of $0.5969, whereas investors in TK PEPS would own one unit that will earn an annual dividend of $ 1.8125. Therefore investors in TK PEPS will earn an extra $1.2156 per annum. However, as described above and also shown in graph 1, the number and value of TK shares they will receive after 3 years could be the same or lower than those owned by investors in TK shares, and would depend on the stock price of TK shares after 3 years (referred to as “future stock price”).

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