Wednesday, April 25, 2012

Interesting Rights Offering Opportunity

It’s been awhile since I posted a trade idea so I thought I would offer up an interesting opportunity I recently came across.  While lacking the upside potential of last year’s tender offer for Norilsk Nickel shares (where one could make essentially a risk-free $10,000), this trade idea offers the potential for a quick ~6% return, with minimal downside exposure. 

On April 18th, Ivanhoe Mines (NYSE: IVN) announced that it will pursue a rights offering to raise C$1.8 billion by offering existing shareholders the right to buy new shares for C$8.34 ($US8.48).  Assuming all the rights are exercised (which will most certainly be the case since Rio Tinto has agreed to backstop the rights offering), approximately 215.8 million new shares will be issued (C$1.8bn /C$8.34).  Currently, the Company has 741.1 million shares outstanding, suggesting that existing shareholders will be offered the right to purchase a little more than .29 shares for each share they own (215.8/741.1).

As of the close of business on April 25th, Ivanhoe’s stock was trading at $11.47 on the NYSE.  As such, shareholders are being offered the opportunity to buy shares at a 26% discount to its current price ($8.48/$11.47-1).  Assuming the current price incorporates the dilution from the rights offering, one can make more than 35% on the shares acquired through the rights offering. 

Lets take a simple example to see how I arrive at the 6% net return. 
Step 1: Buy 1,000 shares at $11.47 = $11,470 upfront investment
Step 2: Subscribe to the rights offering, which will entitle you to buy 290 shares at US$8.48 = Additional investment of $2,459
Step 3: Immediately sell all 1,290 at the prevailing market price once you have received your shares in the rights offering.  Again, assuming the share price doesn’t change between now and the issue date, you should receive $14,796 in gross proceeds (1,290 shares * $11.47)

As such, you will net $867 from your total investment of $13,929, which equates to a 6.2% return ($11,470 to buy your initial shares + $2,459 to subscribe to the rights offering).

The only risk (and obviously it is a significant risk!) is that the share price drops below the rights offer price.  While possible, and certainly the shares have been under significant selling pressure over the last few months, I think the risk of a 26% decline in Ivanhoe’s share price (which would essentially result in a breakeven trade) is well worth the prospect of a 6+% gain, particularly since this will likely play out in the next 3-4 weeks.

As usual, please let me know your thoughts. 

1 comment:

  1. I don't see how you would break even when the stock declines 26%. So the marketrisk might be bigger than you think, especially when more people trying to do this type of trade, which would result in substantial selling pressure once the shares have been granted.

    If you buy 1000 shares at 11.47, imo to breakeven the stock should move to 10.8. Anything below that you lose money (1290* 10.8 = 13932)

    It might be a possibility to cover the downside with options, however, this will eat most of your profit i would say.

    am i missing something here?