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Nick Sleep

Lucent Preferred 8%
2002-2004
Industry: Technology
Category: Special Situation/Despised

Context
Lucent is a famous bubble stock of the 2001 technology bubble
Post-crash, the stock had fallen 98% from it's peak 3 years earlier

Why the Company is Mispriced
Capital markets had given up on Lucent, they were just burning too much cash
This is despite the company having cash on hand to redeem all preferred shares and debt

Alternative View
Purchased at $350 per share, par is $1000 per share
Common shares were so cheap that if the preferred shares redeemed their shares on the redemption date at prevailing, they would own 50% of the equity
Preferred shareholders would also receive half of their investment back through cumulative dividends before the puts became due
In effect, 1/2 of Lucent's equity could be purchased for $500m, which is equivalent to a few months of R&D spend
This made the redemption the top of the management's list of fixed liabilities

Management could (1) hope that the business would turn profitable, (2) dilute the common equity further to fund the redemption of the preferred
Nomad urged the company to (3) buyback common shares, buyback all the preferred, and pay down the debt with cash on hand. This would eliminate the preferred and the debt, and leave upside for the equity.
However, this would leave management without a cash cushion. Unfortunately management chose to (2) dilute the common and pay down the preferred.

Result
As a result of the cash raise, the preferred rose to a premium to par, resulting in a 3x return for Nomad
This is a 75% CAGR, assuming it took place over 2 years