Sometimes Closed End Fund Mergers Work In Shareholder's Favor (Buy JHP And JTP)

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Includes: JPS, NZF
by: Alan Schmerler

Summary

My last two articles tried to explain what happens when a higher quality CEF (lower discount), gets acquired by a lower quality CEF (larger discount).

On March 22nd, shareholders of Nuveen approved the merger of three of their preferred funds. JTP and JHP will be merging into JPS.

Since both JTP and JHP both trade at larger discounts to JPS, shareholders of JTP and JHP will benefit and are both buys.

My last two articles covered two Nuveen Municipal CEF mergers scheduled to close on April 11th. There I showed what happens when a higher quality (lower discounted) fund gets taken over by a lower quality (higher discounted) fund. Basically, the holders of the higher quality CEFs get the short end of the stick (Sorry NPT and NIO holders). This is because of the unfair practice of allocating shares in the mergers based on the ratio of the fund's net asset values (NAV), on the closing date. I will write another article on April 11th to examine what actually happened when these deals closed.

This unfair way of completing CEF mergers can actually benefit shareholders, if they hold shares of CEFs trading at larger discounts than the CEF they are merging into. On March 22nd, Nuveen announced that shareholders had approved the merger of the Nuveen Quality Preferred Income Fund (JTP) and the Nuveen Quality Preferred Income Fund 3 (JHP) into the Nuveen Quality Preferred Income Fund 2 (JPS), to be renamed the Nuveen Preferred Securities Income Fund. The merger has been given a closing date of May 9th. Thus, Friday May 6th will be the last day JTP and JHP will trade independently.

Here is pertinent closing data as of March 23rd:

Stock Closing Price Closing NAV Discount Implied JPS price
JPS 9.04 9.23 -2.06 9.04
JHP 8.32 8.70 -4.37 8.827
JTP 8.61 9.01 -4.44

8.820

Click to enlarge

Let me try and explain these numbers. Assuming the ratios of the NAVs today will resemble the ratio of the NAVs at the deal's close (because the funds hold nearly identical securities), holders of JHP will receive 8.70/9.23= .9426 shares of JPS for every share of JHP they own. Since JHP is trading at 8.32, they have 8.32/.9426= 8.827 invested for each share of JPS they will own. They are getting their JPS shares at 8.827, rather than the market price of 9.04 for JPS. This goes for someone going into the market to buy JHP now at 8.32. How is this possible? It is possible because JPS trades at a higher discount to NAV than JHP. JHP holders, after the deal closes, will get shares that will value the securities they hold at a higher valuation.

Of course this assumes the discounts stay where they are until May 6th. They will indeed move, possibly making this deal better, or possibly making this deal worse for JHP holders. Still, the numbers don't lie- Investors are much better off buying JHP now at 8.32 than buying JPS at 9.04.

Here are how the numbers work for JTP. Holders of JTP will get 9.01/9.23= .9762 shares of JPS for every share of JTP they hold. Since JTP is trading at 8.61, they have 8.61/.9762= 8.820 invested for each share of JPS they will own. This too is considerably less than the 9.04 that JPS is trading for.

So, in conclusion, holders of JTP and JHP are being given a gift by this merger. They don't have to do anything- shares of JTP and JHP will automatically be tendered into the deal and on May 11th, your shares will have turned into shares of JPS.

This article is relevant for anyone out there looking to add more CEF preferred exposure to their portfolios. I would recommend buying JHP and JTP right now and you will soon be receiving shares of JPS which you would have created at nice discounts to market value.

You are "creating" JPS at 8.827 by buying JHP at 8.32, when JPS is trading at 9.04.

You are "creating" JPS at 8.82 by buying JTP at 8.61, when JPS is trading at 9.04.

Another question arises from this analysis- why would anyone go into the market and pay 9.04 for JPS when they can instead buy JHP and JTP and "create" the JPS they want at prices much lower than 9.04. Is this due to simply lack of information among investors? This is yet another example of inefficient markets when it comes to CEFs.

Disclosure: I am/we are long JHP AND JPS.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.