Friday, May 27, 2011

SunPower (SPWRA) - Trading a Tender Offer and Negative Rates

SPWRA is trading $20.86, up small with IV30™ up 14.3%. The LIVEVOL® Pro Summary is below.


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I normally write this at the end of each blog, but we get it upfront here:
This is trade analysis, not a recommendation.

Legal Stuff:

Ok, here we go -- how to trade a tender offer (or rights offering).

Let's start with the news. The fun began on 4-28-2011 with this news:
French oil company Total SA said on Thursday that it will offer $23.25 for up to 60 percent of the shares of solar panel maker SunPower Corp.
The move will put Europe's third-largest oil company into the growing solar business.

The offer values SunPower at $2.3 billion, and SunPower shares jumped on the news, rising $6.39, or nearly 40 percent, to $22.51 in aftermarket trading after the deal was announced. Total shares fell 15 cents to $63.65.
The companies said Total would also offer SunPower up to $1 billion in lending.
Source: AP

Let's start simple. The price as of this writing is $20.86, of which 60% of that is comprised of $23.25 tender"able" shares, and 40% is comprised of "some number" where the stock market is pricing SPWRA after the tender. i.e. where the other 40% of shares will go. The simple math is:

$20.86 = (0.6)$23.25 + (0.4)($Market Expection Post Tender)
Yielding -----> Market Expectation Post Tender = $17.275

How the tender works:
If you own SPWRA stock (actual stock, not calls!), you can tender your shares and hope to get as many as possible turned into $23.25 in cash. The guess is that 60% of the shares will be turned into that amount. The tender date is Jun 14th, 2011 (for now).

Ok, that seems easy enough, let's look to the Options Tab since we'll be referring to it quite often.

Possible Trades to Analyze
If you assume the stock price is fair value, then owning stock for $20.86 is a push. Let's look at other trades to analyze.

1. If the stock is going to open at $17.27 (ish) on Jun 15th, just buy some puts! The Jun 21, 20, 19, and 18 puts are all under priced, clearly! But, no...

Tenders get pushed back all the time. In fact, I believe this one was already delayed a few weeks. That means those puts turn into something we like to call nothing.

2. Buy puts in July
Well, here's where it gets tricky. The 21 strike in July implies a forward stock price of:
$21 - $4.10 (about fair value in puts) + 0.45 (about fair value in calls) = $17.35.

What do ya know, right around the price that the stock price is implying. In English, the stock is VERY hard to borrow and that negative rate makes puts more expensive than calls. How much more expensive?

Well, if the rate was normal, then the Jul 21 puts would cost:
($21 - $20.86) (i.e. parity) + 0.46 (i.e. the value of the calls) = $0.60. But, in fact, those puts are worth ~ $4.10. So, REALLY expensive. Now purchasing puts isn't obviously cheap, it might even be expensive.

3. Buy synthetic puts in July
Ah ha -- no we're thinkin'. We can get those puts for $0.60 by purchasing the calls and selling stock one-to-one. Through put call parity those calls become puts. Awesome, except...

Shorting this stock costs a lot of money and it's literally hard to borrow (literally hard to find shares). The risk with HTB is several fold and includes but is not limited to location risk, buy-ins, rate changes and stock pops on short squeezes.

In this case, the risk is even greater. On tender, a chunk of the shares you're short might be tendered -- meaning as the short stock holder, you will be forced to pay $23.25 to buy the stock back. Ouch...

As an added risk -- if this thing is hard to borrow now, what happens when 60% of the float goes away when Total buys them through the tender? Uh, yeah -- even harder to borrow.

4. The sleeper trade
Let's look at the facts. A large company is willing to pay $23.25 a share for a majority of the company. By selling puts and buying calls on the same line in July, we have seen that you can own synthetic stock for ~ $17.35 a share.

And what if the tender moves past Jul expo. (which is possible)? This position owns real stock (not synthetic) for $17.35 -- that can be used to tender @ $23.25 or simply sold at the prevailing market price (which right now is $20.86).

The risk? Huge, actually. What if the tender offer fails or goes away? What if the stock plummets after the tender well below the "expected" price? After all, the float will be small and a bunch of long shareholders that are simply holding stock now to play this tender are going to dump the stock. A few weeks before this tender, SPWRA was a $15 issue. The 52 wk low is $9.61. Gulp...

5. Bet on the stock rising
Did you consider a short squeeze or even a second bid? A higher bid if the tender fails? A competing bid?

Check out the skew (below):

The Jul and Sep 20 lines are bid -- interesting...

Alright, there are dozens more creative ways trades to analyze this through spreads, etc., but hopefully this illustration made the rules more clear. And of course, rule #1 -- everything changes every second.

One last thing to consider -- SPWRA has A and B shares -- both are up for 60% tender.

This is trade analysis, not a recommendation.

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  1. (Like Weds) I was looking at this before you wrote on it, BUT I couldn't get anything to execute, ergo spreads are fairly wide and liquidity is limited.

  2. The markets are wide on this one for sure -- there's a lot of uncertainty with the MM downstairs. I just saw one of the LMMs an hour ago.

  3. In hindsight, buying Jun 19-21 puts turned out a pretty good trade. Looking back, we could have expected IV to increase and even if we assigned the probability of tender not going through at 50%, the prices for the puts still would be cheap.

    Question. If one was able to locate shares to short on Jun 14th, would they issue a buy in that same night to indicate to you that you have been called in to buy the shares back at 23.25?

    Is that how it works when you are short in a tender? if not how?

  4. The forced purchase of short stock in a HTB is pretty random -- or so it feels. I believe your scenario is possible, but the real risk not knowing what's going to happen. Often times traders on the floor see a HTB stock exploding and just assume it's because of a buy back (assuming they're short) so they re-double with long puts on a guess. It's literally that random and risky.