MOLX/MOLXA

This chart is a followup to my previous post on MOLX/MOLXA.

MOLX is trading at a 21% premium to MOLXA. Both shares represent equivalent equity in Molex with differnt voting rights. The 21% premium is significantly higher that the 5 year average spread of 12%. It is likely the the spread will drop 3-5% in the next 3 months. Depending on your leverage could represent a low risk 20-60% annualized return on investment. Also for those looking to invest long in Molex, might consider purchasing the non-voting shares as they have a much greater upside potential.

Molex is traded on the NASDAQ Global Select Market (MOLX and MOLXA) in the United States and on the London Stock Exchange. The Company’s voting common stock (MOLX) is included in the S&P 500 Index.

I am currently short MOLX and long MOLXA.

BHP Billiton’s BHP shares are currently trading at a 20-22% premium to its BBL shares. BHP is a DLC (dual listed company). Both shares represent the same equity share and are entitled to the same dividends and are listed in Australia and the UK but are both resold on the NYSE as BHP and BBL. This spread is at previous historic extremes. The spread has been trending greater over the last 5 years from equal value, but has maintained an average premium of about 13% over the last two years. Given the high liquidity in both shares, and similar Bid/Ask spreads, the current premium in not justified and should return to a 13-15% premium in the next two months.

I am currently short BHP and long the equivalent value of BBL

Chipotle’s A shares are currently trading at a 20-24% premium to its B shares. This spread is near its previous historic extremes. The A shares have a high probability of returning to a 7-10% premium within the next two months if not sooner.

I am currently long CMG-B and long the equivalent underlying dollar value of CMG $100 May Puts.

Blockbuster’s A shares are currently trading at 2.25-2.75x the value of the B shares. Blockbusters pre-September ratio tracked at roughly 1.1x. Since mid September the ratio has varied wildly from 1.25-2.75. The spread had closed significantly in the last two months. On Tuesday there was a bankruptcy rumor that sent the A shares from over $1.00 down to $.20 in a half hour before the trading was suspended. Both A and B shares experienced high volume during the sell off and the next day during the purchasing of shares. The scare and high volatility had unhinged the correlation between the A and B shares. The A shares are currently trading at about $.45 and the B shares $.17. It is likely that the spread will close significantly towards 1.5x in the next month, once volatility subsides. Because of high selling pressure, the available shorts for the A shares are limited. If you are willing to risk a forced buy-in if shares to borrow run out, this is a high probability pairs arbitrage play. (According to the IB Website, there are currently 700,000 shares available for shorts, 3/6/09). To take advantage of this spread, short A shares and buy long an equivalent dollar value of B shares.

I am short bbi and long bbi.b, and continuing to add to my position.

Atlas America (ATLS) is a natural gas drilling and pipeline holding company.  Per share of ATLS, I believe the parent owns 0.7754 shares of natural gas driller Atlas Energy Resources (ATN), 0.4520 shares of pipeline GP Atlas Pipeline Holdings (AHD), 0.0282 shares of pipeline LP Atlas Pipeline (APL), $2.54 of cash, and $0.40 of a small VC firm at book value.  At today’s prices, I believe you can buy the parent and short the ATN portion for even money, i.e. own the rest for free.

The A shares are currently trading at a 6% (down from a peak 10%) premium to its historic relative value to the B shares. The premium usually bounces between 0-2%.  This is a highly unusual spread for this pair that tends to track very closely. Other smaller spreads in recent past have closed within a day or two. The unusual market conditions and the recent heavy sell off and long-term low of the B shares, may cause it to revert to the mean a bit more slowly, since a rally in the B-shares my be required to close the gap. This is not a large spread in relationship to other opportunities currently in the market, but has a very high probability of reverting to its historic relationship in the short-term. A shares represent 30 times the face value of B shares.  A relative arbitrage play of selling 1 A share short and 30 B shares long would return approximately $4500. Obviously, enough capital and margin is necessary to make the initial trade.

I am currently short on the A shares and long on the B shares.

The Pimco High Income fund is at a 68% premium to NAV.  PHK got to such a crazy premium because Bill Gross talked it up in the Barron’s roundtable (helped by the high dividend).   Per Gross’s rountable comments the fund made major changes at the end of the year and is now 60% IG.  Gross’s comments might be the best indication of what is in the fund as the most recent filings are 6/30/08.  My interpretation of his comments  is that there are a lot of financial hybrids in this fund, which may explain why the NAV has done nothing recently even with a nice rally in IG credit . This fund is very levered (assets 2x equity at 6/30).

I took a small short in this a couple weeks ago and see it as a partial offset of my long credit and equity exposure.  Share availability might be an issue now, as I tried to add to the short and could not.  Gross is smart and generally wouldn’t want to bet against him, but a 68% premium is ridiculous.

http://www.etfconnect.com/select/fundpages/gen.asp?MFID=108698

Short LEN and go long LEN.B

I am arguing that the LEN.B shares are economically superior to the LEN’s mainly due to difference in voting rights. The LEN.B shares carry 10 votes for every 1 of the LEN’s. So the LEN’s should be trading at a discount to the LEN.B’s
Historically (last 5 years) LEN/LEN.B has averaged a 9% spread, but it should really be negative. As you can glean from the graph the spread has blown out recently.

I suspect one of the reasons for the spread being so wide is because the LEN’s can be tough to borrow from time to time, so it might be more difficult to arbitrage away the spread.

It is more likely due to liquidity though. Lennar Corp stock is significantly shorted (22% of float) and the LEN.B’s trade thinly compared to the LEN’s. So if you want to short Lennar you go for the LEN’s and with the recent short covering due to the breakdown in the ARB market the spreads blew out. I don’t think this trade is very different from the MWA and GEF trades.

Here are some interesting securities being auctioned privately:

PYMX warrants with $1 strike price; ask is $0.37 for 100,000 warrants; underlying stock is at $1.20.

END 8.5% preferred convertible at $2.50; ask is $0.53; underlying stock is at $0.65.

CVVT common; ask is $1.83 for 100,000 shares; the last quote is $5.00.

ETLO common; ask is $0.05 for 2,383,333 shares; the last quote is $0.65

The Rydex double short energy ETF (REC) recently paid out an $87 capital gains distribution.  It closed the night before at $99, leaving $12 per share in the fund.  Good explanations for this enormous dividend appeared on Seeking Alpha and here: http://www.indexuniverse.com/blog/5052-capital-gains.html?year=2008&month=12&Itemid=3.  Basically, the fund holds $2 of short futures exposure for every $1 of cash, rehedging that exposure daily to maintain that ratio.  Due to the creation and redemption cycle, the fund earned short-term capital gains while there were 100,000 shares outstanding.  Now that only 50,000 shares are outstanding, the capital gains are attributable to only those shares.

I looked at some of the ProShares double short funds to see if similar distributions could occur.  Specifically, I looked at the number of shares outstanding each day and the close-to-close NAV changes each day from the fund inception to today.  (I looked from fund inception, rather than from the beginning of the year, because they might have tax-loss carry-overs from last year.)  By my estimates, SMN — the double short materials stocks, QID — the double short Nasdaq 100, and SKF — the double short financials — might have capital gains distributions larger than the size of the fund.

To take advantage, one could sell options on these ETFs.  Ordinarily, when a stock pays a dividend in excess of 10% of the stock price, the Options Clearing Corp (OCC) lowers the strike of the options by the dividend amount.  For example, if QID pays a $50 dividend, the OCC should lower $60 strikes to $10 strikes.  Puts that once had max-gains of $60 now offer at most $10.  The option premium should collapse.  Buy-writes and straddle sales offer a similar scenario.  The higher the option premium, the more this option value could contract.  Low strike contracts might be canceled altogether.

I see the following downside risks:

1. My estimates of the dividend pay-outs could be wrong and the dividend is smaller than I think.  Even if my estimates are off by 25%, the option premiums should contract considerably.  I estimated the REC distribution, as a sanity check, and calculated $68, rather than $87.
2. The ProShares funds find a way to pay the capital gains tax without a distribution to fund holders.  I do not know of any such loop-holes.
3. The fund pays the dividend and immediately conducts a reverse split, so that the stock price is unchanged and the OCC does not adjust the strike.  I do not know of any precedent for this procedure, but I cannot count out the possibility.
4. The distribution should occur by the end of the year, but perhaps the funds convince the SEC or IRS to wait for some kind of ruling.

To close-out the trade, whether the outcome is favorable or unfavorable, one could simply cover the options positions.  Although the bid-ask spread on these options is large, often up to $1, I believe that the potential gains are worth this risk.

Company is in the process of liquidation.  Has paid out >$1.00/sh over the last year.  Working on getting liquidity on the ARS (i.e.- talking to broker, underwriter, etc).  Insiders are heavily buying the stock.  Note:  ABK has the right to convert these to preferred securities at the Opco Level (2nd only to policy holders).  Stock has moved up on possibility of TARP access by monolines, thereby reducing the penalty if converted into ABK preferred.  Even after the recent move up, trading at a significant discount to intrinsic value.

The MWA and MWA.B pair trade.  Gap has been as tight at $.08 and as wide as $.30 recently.  B shares worth economically more, but trade at a discount, and are being converted to A shares, approved at the next shareholder meeting.  Pick up a quarter/share on a riskless basis.

http://www.marketwatch.com/news/story/mueller-water-products-proposes-submission/story.aspx?guid=%7B001EA5DD%2D0348%2D4C1A%2D9339%2DF348E2B217BB%7D

Salton (SFPI) is trying to go private by the end of the year. Harbinger Capital owns a combined 94.4% through two different entities and will be executing a short form merger on Dec 7 that doesn’t require shareholder approval. This is possible since they own more than 90% of the stock. Originally they intended to cash out minority shareholders at $0.33 but following upwardly revised growth forecasts following a related acquisition, they have increased the cash out price to $0.75. As with many of these types of opportunities, the incentive is the savings (estimated $1.5-2 million per year) that will accrue from avoiding Sarbox compliance. At the original price the savings “coupon” would amount to nearly 15%. Obviously the savings are less impressive at $0.75, but the odds are good and the deal still makes sense. The big risk right now is that Harbinger, like many hedge funds, is facing a wave of redemptions, but given their overall size ($26 billion I think), the relatively small size of this transaction (less than $50 million) mitigates the impact of the fund’s reduced liquidity.

At $0.60 the current arbitrage spread is 25%.

Foster Wheeler’s 10-K reads:

“Each Class A warrant entitles its owner to purchase 3.3682 common shares at an exercise price of $4.689 per common share thereunder, subject to the terms of the warrant agreement between the warrant agent and us. The Class A warrants are exercisable on or before September 24, 2009.”

The correct procedure is to short sell 3.3682 FWLT shares for every warrant purchased, and then to exercise the warrants. This is tantamount to buying at $54.70 and selling at $56.39.