Some more thought on a potential OI /Portugal Telecom long/short trade
Since my post last week, OI shares have clearly outperformed PTC shares (14.3% vs. 7%). As some readers commented, OI shares would have been the even better alternative so far. OI was actually the best performing Brazlian stock last week.
Maybe one additional remark to the issue if PTC trades at a premium or not:
Some commentors argued that one basically can calculate the value of PTC shares in the following way:
0.6330 * OI common share plus 2.2911 EUR. At yesterdays OI close this would mean 0.633 * (4.66/2.95) + 2.2911 = 3.29. At a current price of 3,60, PTC looks overlvalued bei 31 cents and a short PTC / long OI trade looks like a no brainer.
However this approach ignores the fact that new OI shares will be issued at a discount to the existing ones. As PTC shareholders get the new shares at the discount and old OI shareholder do not get compensation rights, the assumption that a current OI shares equals a new CorpCo share is clearly wrong.
If we assume a 1:1 share increase at OI before the merger, we have to think about this capital increase the following way:
First, one needs to assume the impact of a discounted share issue without compensation. Lets look at an extreme example: If I double the sharecount by issuing 1:1 new shares without compensation (capital increase “Russian style”), the value of the existing shares would be clearly halfed as I have twice the shares and no change in profits, NAV etc.
Putting this into a formula, the “loss” of the existing shareholders in the assuemd 1:1 capital increase is basically the discount divided by 2 (which equals the value of the missing suncription right).
So let’s just set up a virtual long short trade with current prices:
Step 1: Long Short at current prices
At the current price of (4.66/2.95) = 1.58 EUR per OI share, I would need to do the following trade:
Short 1 share PTC at 3.60 / Long (0.633 + 2.2911/1.58) = long 2.08 shares OI
Step 2: Assume a 20% discount on the new OI shares with an issue price of 1.264 EUR per share
This would lead to the following situation after the merger:
I would be long 2.08 OI shares which would trade at (1.58 EUR – (0.2*1.58/2))= 1.42 EUR
Then, I would be short from the PTC exchange the following amount of shares: (2.2911/1.264) +0.633 = 2.24 shares
So suddenly my “no brainer trade” leaves me short 0.16 shares or 0.16*1.42 EUR = -0.23 EUR per intitial PTC share (plus cost of borrowing). So the impact of the discount destroys an “arbitrage” opportunity.
On the other hand, I can use this long/short approach to calculate the implied discount on the new shares. At the above prices, the implied discount is around ~-26% (all other things equal).
So only if I have the opinion that the discount of the new shares is lower than 26%, I make money with the long short trade. Clearly, this looks like a large discount but I would not want to bet against that.
I still stick with my 0.5% PTC position in order to actively watch this playing out. The potential long OI /short PTC trade mentioned by some commentators could be interesting, but is clearly a bet on the discount for the new shares, not an arbitrage deal.