Well, we all know that IQW.PR.C was recently downgraded. But there are still people buying the common, which gives rise to a kind-of interesting arbitrage possibility.
According to the prospectus:
On and after December 1, 2007, Quebecor World Inc. (“Quebecor World” or the “Company”) may on 30 days’ prior notice redeem for cash the Series 5 Preferred Shares, in whole or in part, at the option of the Company, at $25.00 per share plus accrued and unpaid dividends or may, on 40 days’ prior notice, subject to stock exchange approvals, convert all or any of the Series 5 Preferred Shares into fully paid and non-assessable subordinate voting shares of the Company (the “Subordinate Voting Shares”). The number of Subordinate Voting Shares into which each Series 5 Preferred Shares may be so converted will be determined by dividing $25.00 together with all accrued and unpaid dividends at the date of conversion by the greater of $2.00 and 95% of the then Current Market Price (as defined herein) of the Subordinate Voting Shares. See “Details of the Offering”.
On and after March 1, 2008, each Series 5 Preferred Shares will be convertible at the option of the holder on the first day of March, June, September and December of each year on at least 65 days’ prior notice into that number of fully paid and non-assessable Subordinate Voting Shares determined by dividing $25.00 together with all accrued and unpaid dividends to the date of conversion by the greater of $2.00 and 95% of the then Current Market Price of the Subordinate Voting Shares. If a holder of Series 5 Preferred Shares elects to convert any of such shares to Subordinate Voting Shares, the Company may on at least 40 days’ notice prior to the conversion date elect to redeem such shares for cash and/or arrange for the sale of such shares to substitute purchasers. See “Details of the Offering”
The Current Market Price is the weighted average trading price for the 20 trading days which ends on the fourth day prior to the date specified for conversion or, if that fourth day is not a trading day, on the immediately preceding trading day.
The thing that makes this situation so fraught with interest is that IQW.PR.C is currently quoted at $23.35-50 and has actually declined in price recently (it was trading just under $25.00 a month ago). Note that 23.50 is 94% of par value.
We can assume the company will convert to common. They don’t have any money and they don’t want to pay the pref dividends. If I’m wrong on that one and they convert to cash, well, that’s $1.50 profit to today’s buyer, so don’t complain to me. If they don’t do anything, the holder can convert next March, assuming the company still exists at that point.
And then you get common shares based on PAR VALUE of the prefs. So, assuming you don’t mind a little uncertainty, you’re either getting par value in cash, or you’re getting common at 95% of market against par value; and the current price of the prefs is 94% of par value. When I do the math, that’s 10+% right there. And a dividend until conversion. Not entirely risk free but awfully tempting!
Read the prospectus. Check it out for yourselves. This is not a recommendation to DO it, it’s a recommendation to LOOK AT it.
I never miss a chance to study an arbitrage possibility, but I don’t think this strategy could be called arbitrage. Presumably your idea is to buy the prefs, short the common, collect dividends for a while and later convert into common and close out.
Unfortunately, the # of shares obtainable on conversion is unknown in advance (40 or 65 days) when the conversion decision and short need to be made. For example, to buy $23.50 Pref C now and short a corresponding 2.87 shares of common at $9.17 ($25/0.95/9.17 common price) has a wide profit/loss outcome in one or two months when the conversion price is determined. If the conversion price turns out to be lower (e.g. $4.50) then conversion of the pref will yield 5.85 common shares – a very profitable scenario. However, if the conversion price turns out to be higher (e.g. $15) then conversion of the pref will not cover the short — only 1.75 shares.
The same problem arises if one waits until the company might convert (40 days notice prior to Dec 1) or when the pref holder can convert (65 days prior to Mar 1, 2008 or June 1, 2008, etc.). There is way too much time for swings in the common share price prior to the conversion date.
I would not call this arbitrage although it could be considered to have some (minor) advantages over a short sale of the common.
Presumably your idea is to buy the prefs, short the common, collect dividends for a while and later convert into common and close out.
No! Buy the prefs, collect dividends for a while, get or give the conversion notice, wait for the Current Market Price determination period, short the common as evenly as possible throughout the period, convert, then clean out any remaining odds and ends.
Maybe it’s not an arbitrage exactly, but it’s pretty close. For a market neutral position you don’t need to take any action until the market price measurement period, which is the four weeks prior to the actual conversion.
No decision needs to be made until after the conversion decision has been announced. In such a case, your risk is limited to the difference between your actual average sale price and the final weighted price.
If we say that Mr. Chunky Retail Guy is willing to take a flyer on 1,000 shares of IQW.PR.C, then he knows he’s going to get roughly more-or-less about 2,500 shares of IQW … if he shorts 600 every week during the conversion period, then I submit that the 10% gain on conversion be a pretty good cover against the final conversion ratio.
Again, THIS IS NOT A RECOMMENDATION. I suspect, however, that it’s well worth looking at. The major risk I see is that the company goes bankrupt (or close enough that the common price goes below the $2 conversion minimum) while you’re holding the prefs in a naked long.
Taking this approach, then, the opportunity is in November if the company announces that it will convert in late October.
I would imagine that the announcement will cause the pref price to jump to make the arbitrage yield more like 5%, so the opportunity would be smaller than it might seem today. If the company doesn’t convert on Dec 1, the investor option to convert on Mar 1 is more likely to slip under the radar.
On the plus side, there is a $0.43125 pref dividend going ex Nov 17 and Feb 17.
One possible issue is trading costs for multiple shorts.
Another is that the average Hi/Lo for IQW is about 3.6% per day, so a random sample of (e.g.) 4 shorts might be expected to be +/- 2% of the 20-day closing average, or wider if there is a positive or negative drift.
The $2 minimum conversion price risk is not insignificant. Weaker than expected EPS could be the greatest risk. First, the 20-day period for averaging is either November or February and earnings are released around the 8th of these months. November could also be a tax loss selling month. If one sets a starting minimum IQW price of $4, the $2 risk is mitigated by having the opportunity to short at higher prices than $2. Simple simulations with 4 shorts show a $23.50 pref price can withstand a 2/3 fall in the common price over the 20 days before losing money (as long as it doesn’t go bankrupt!). Luckily, the pref value is less than 10% of common equity (now at least).
There is also a risk to over shorting if the common price rises sharply (on a refinancing agreement for example). Again, simulations show it has to approximately double to eliminate the profit.
The best thing about this trade is that it only takes one month.
[…] I was expecting direct conversion: The thing that makes this situation so fraught with interest is that IQW.PR.C is currently quoted at $23.35-50 and has actually declined in price recently (it was trading just under $25.00 a month ago). Note that 23.50 is 94% of par value. […]
[…] The company had to scrap a financing today, perhaps because investors kept throwing up. Now with a pre-tax bid-YTW of 138.67% (annualized) based on a bid of 19.00 and a softMaturity 2008-2-29. Note that the soft maturity will entail some risk to the exerciser, since the common will be received and have to be exchanged. On the other hand, if you want Quebecor common – or hold some already – and you’re happy with that, it could be quite attractive. Unfortunately, it cannot be easily arbitraged, since if you short the common now, it might quintuple (hah!) between now and the time the conversion price gets set. But something must work … hmm … buy the prefs at $19, you’ll get $26 worth of common at the February price … OK! Buy the prefs at $19, short the common, buy a call on the common at 36% over current price … I think that works, and I suspect it has a good chance of profit. But check my work first! […]
[…] IQW.PR.C was mentioned as an arbitrage possibility on September 11 when it closed at 23.35-50, but potential profits have been greatly reduced in the last three-weeks-odd: it closed today at 24.36-98. […]
[…] Now with a pre-tax bid-YTW of 136.24% (annualized!) based on a bid of 20.25 and a softMaturity 2008-2-29 at 25.00. Somebody trying an arbitrage despite the dividend suspension? The common is at a mere $2.45 at the close today … the floor conversion price is $2.00 … but I still say an attractive package can be put together if you guard against soaring common prices with call options! […]