value and opportunity

Following part 1 and part 2 about my thoughts on a potential Hyundai Motors capital structure arbitrage deal, I wanted to summarize my thoughts and come to a conclusion.

In between, some new information came up:

a) it is possible to trade single stock futures in Korea thorugh Interactive Brokers
b) the mentioned US ADRs are actually ADRs on Hyundai Motor pref shares, so no “cheap” short potential
c) a contact told me that stock borrowing costs for Hyundai Motors common shares in Korea would be about 3-4%

Based on this new information, the relative value trade (short common shares, long pref shares) looks less attractive.

Traditional long-short

In the traditional short with a long position in the pref shares and a short position in the common, the “carry” would be calculated as follows:

Yield long position (3.77%) minus yield short position (0,80%) minus cost stock borrowing (3-4%).

So we would end up in the best case with 0% carry, in the worst case with -1 % carry for the long short position. Negative carry trades are much less attractive because you actually loose if nothing happens. A good carry trades gives you something in case nothing happens (“positive cary”) plus upside to compensate against the potential unlimited risk from the short position.

Long pref / short future

The problem with the long pref and short future strategy is that one has to fully fund the long position as the short future does not provide funding. So the overall potential return on investment is much lower than a fully funded long short trade. Only if you believe that the pref shares could close the valuation gap dramatically you would get an interesting return out of this strategy. However I do not have any view on this.

So to summarize this: based on current dividend yields and and stock borrowing costs, the long-short trade does not look too attractive as it doesn’t provide a positive carry. The long pref / short future trade might not be worth the effort too implement it as the upside potential is relatively limited and now real catalyst is on the horizon.