CBS Exchange Offer - An Uncorrelated 7% Without Proration

Jul. 1.14 | About: CBS Corporation (CBS)

Summary

CBS is divesting of its CBSO subsidiary via an exchange offer.

CBS shareholders who tender their shares will obtain CBSO shares at a 7% discount.

Odd-lot holders are not subject to proration, and can earn substantial risk-adjusted IRRs.

The general thesis behind this article is that investors with 99 or fewer shares of CBS can participate in the CBS/CBSO exchange offer in order to generate ~7% returns with little risk, and with funds locked up for only a few days - earning a substantial IRR. As the thesis is relatively simple, I will make the article as brief as possible, while touching on what I consider to be the most salient points.

History: In April 2014, CBS (NYSE:CBS) partially divested of its outdoor advertising division via IPO (CBSO), selling ~19% and retaining an ~81% ownership stake. CBS has decided to complete the disposition by conducting an exchange offer - granting shareholders the opportunity to exchange their CBS shares for shares of CBSO - at a 7% discount to market price. See the CBS press release here. From the SEC filings: "for each $100 of shares of CBS Class B common stock that are accepted in the exchange offer, holders of CBS Class B common stock will receive approximately $107.53 of Outdoor Americas common stock."

The actual mechanics is slightly more complex than a simple 7% profit: from the latest 425 filing: "The average values of the CBS Class B common stock and the Outdoor Americas common stock for purposes of calculating the exchange ratio will be determined by reference to the simple arithmetic average of the daily volume-weighted average prices ("VWAP") of CBS Class B common stock and Outdoor Americas common stock, respectively, on the NYSE during the three consecutive trading days ending on and including the expiration date of the exchange offer (the "Averaging Period"), which will be July 7, July 8 and July 9, 2014, unless the exchange offer is extended."

Essentially, the 7% premium will be calculated based off of the weighted average of the stock prices of CBS and CBSO during the last three days of the offer (July 7th through 9th). The most up-to-date exchange rate (along with the prospectus and various other materials) will be available on the Exchange offer website here.

An investor can participate by acquiring 99 shares of CBS stock, short-selling a suitable number of CBSO shares, and collecting a low-risk profit of approximately 7%.

Given the rather simple thesis, I will spend the greater portion of the article discussing risk factors.

Risks -

Insufficient Interest in Tendering: It is possible that there could be insufficient investor interest. However, given the intentionally beneficial mechanics behind the exchange (a 7% built-in premium), and the fact that the transaction can be hedged by going long CBS and going short CBSO, I feel that this risk is a minor one. CBS needs to receive sufficient exchange demand to relieve it of 58.2 million of its 97 million shares, in order to go forward with the transaction. With CBSO shares currently trading at $32.69, this requires approximately $1.9B worth of tendered shares for the transaction to proceed. With a current CBS market cap of $34.8MM (from Seeking Alpha), approximately 5.5% of outstanding CBS shares must be tendered in order for the transaction to proceed. Given the 7% premium being offered, this does not seem like a high hurdle.

Proration: Given the fact that an investor can go long CBS and short CBSO to hedge much of the market gyration risk, and that only ~5.5% of outstanding CBS shares need to be offered up, there exists the risk that the deal will be prorated and that investors will receive fewer shares than requested (complicating the hedging process, and causing exposure to market risk). Smaller investors can eliminate this risk easily by acquiring and tendering 99 (or fewer) shares and taking advantage of the odd-lot provision: If an investor tenders fewer than 100 shares and this amount constitutes that investor's entire position in CBS, the investor is not subject to proration.

Market Gyrations: Although I generally consider myself a long-term investor and hold undervalued positions for years, if need be, in this particular situation, market gyrations, themselves can become a risk. Because the exchange ratio is calculated based on the 3-day moving average price of two different stocks, the actual exchange rate can (and likely will) move significantly between now and July 9th. As a result, it is inadvisable to immediately take a hedged long/short position intending to participate in this exchange offer. Rather, this risk can be substantially mitigated by waiting until the last day or 2 of the Averaging Period to take positions. Although your ability to tender shares quickly will depend on your broker, Interactive Brokers offers the capability to acquire shares and tender them on the same day (usually with a couple hours' delay). This should enable investors to take hedged positions subject to only relatively small market gyration risk (although this could cause the final premium to vary from the estimated 7% figure).

Hedging: With only 19% of CBSO shares freely trading (and some fraction of that likely held by accounts that do not lend their shares to short-sellers), it is fairly likely that CBSO shares will be difficult to borrow, causing hedging difficulties. This will require investors to make a decision about whether to participate in the exchange offer unhedged (earning what would likely be a strong relative return, but accepting market risk), hedging or creating synthetic positions via options, or taking other actions.

CBSO Share Cap: There is a maximum cap on the number of CBSO shares that can be issued per CBS share of 2.1917. This cap was put into place to protect CBSO shareholders from the risk of substantial dilution associated with the exchange offer in the event of a substantial decline in CBSO stock. With CBS at $62.14 and CBSO at $32.69, the 2.1917 share cap would represent a value of ~$71.65 (2.1917*32.69) per CBS shared exchanged. This represents a ~13.3% premium to the current CBS share price. However, a strong increase in CBS' share price or a strong decline in CBSO's (or both) could result in the upper limit being hit, which would reduce the profit potential from the transaction. The mitigant is the same as described under "market gyrations;" waiting till the last possible moment to acquire and tender CBS shares. If market price fluctuations cause the exchange offer to be unprofitable or minimally profitable for participants… then there is no reason to participate at all. Save your capital, and go on to the next opportunity.

Conclusion

Overall, I consider this to be a low-risk opportunity for a small investor to quickly earn a respectable return (7%), with a great risk-return profile and substantial IRR profile based on the speed of the exchange transaction. The position can be entered opportunistically based on market characteristics at the time, enabling investors to participate only if the opportunity is favorable.

Disclaimer: This piece does not constitute a recommendation to buy or sell securities; investors should do their own research always. This piece should be considered a starting off point for further research.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Author intends to participate in the tender offer at the last minute, and will likely go Short CBSO at that point.