value and opportunity

In any finance course, market efficiency is one of the most important parts of the curriculum. The Therory says the following:

There are three major versions of the hypothesis: “weak”, “semi-strong”, and “strong”. The weak-form EMH claims that prices on traded assets (e.g., stocks, bonds, or property) already reflect all past publicly available information. The semi-strong-form EMH claims both that prices reflect all publicly available information and that prices instantly change to reflect new public information. The strong-form EMH additionally claims that prices instantly reflect even hidden or “insider” information.

Usually, the professor will tell students that the strong form doesn’t really hold, but the semi-strong form is more or less given.

So let’s look at the current Unicredit rights issue:

The amount of the capital increase (7.5 bn EUR) was published already last year (December 15th). In order to facilitate the capital increase, Unicredit executed a reverse stock split 10:1 which resulted in a share price of around 6,50 EUR at the start of this week.

Then, on Wednesday Jan 4th, Unicredit came out with the details for the capital increase.

The conditions are as follows: For each old share, existing shareholders have the right to buy 2 new shares at a price of 1.943 EUR per share.

So let’s stop here and look what has happend:

– the information of the total size of the capital increase was out already in December.This hould be the relevant information asit determines the dilution of the existing shareholders
– the only new piece of information was the subscription price of the new shares
– so theoretically, the economic impact of the capital increase (dilution by 7.5bn EUR) should have been in the stock price already since mid Decemeber

How do rights issues work in theory ?

– any old shareholder gets the right to subscribe to the new shares for the stated price
– in theory, the price of the new share shouldn’t matter, because then the right to subscribe is worth more.
– on the first day of the subscription period, the subscription right will be seperated and traded under its own ticker
– the share will then trade on that day “ex” the subscription right
– the shareholdercan then decide if he sells the subscription right or wants to subscribe the new shares

So in the case of Unicredit, this should work the following way (assuming a share price of EUR 6,50) :

Price of subscription right = (6.50-1.943)/ (1/2+1) = 3.038

So next monday, the share should have traded c.p. at around 3.46 and the subscription right at 3.04.

However, that was not what hapend. After Unicredit published the details, the shares tanked massively from 6,50 EUR to now 3.89 EUR.

If we compare for instance the chart with Intesa, the other big Italian bank, we see a dramatic undererformance over the last 5 days:

And this is the part I frankly don’t understand. There was no other specific news for Unicredit apart from the disclosure of the subscription price.

What could be the reason for this dramatic decrease ? I am not sure, but maybe the following points could be part of the explanation:

– Investors don’t want to wait to sell their subscription rights next week and decided to sell out now completely
– hedge funds who want to short the stock did start to sell because the now know the the exact dates when the new shares will be issued and they can cover their shorts
– small investor got confused and think the old shares are worth only 1.94 EUR as well

In any case the developement of share price of the last 3 days would be a good example against any kind of “efficient market” theory if I would ever hold a lecture.

One questions remains: Can we create an actionable investment idea out of this obvious market ineffiviency ?

The problem is that I don’t know have any idea of the real value of an Unicredit share. Among European banks, it is definitely one of the best retail banks around, with a tremendeous distribution power in Italy, Germany and all over Eastern Europe.

One idea comes to my mind right now: If one would could go short Intesa and long Unicrdit,one could basically “hedge out” the Italian risk and maybe profit from the current inefficiency.

However there is no hurry, as the EMAK example showed, one can expect the Unicredit share price to remain under pressure until the very end of the subscription period.