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Douglas Albo
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Registered Investment Advisor. Prior experience includes 12-years as a Vice-President, Financial Advisor at Smith Barney and Morgan Stanley.
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Capital Income Management, LLC
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  • Equity CEFs: QQQX And JLA Merger Opportunity 7 comments
    Jun 6, 2014 9:51 AM | about stocks: QQQ, JLA, QQQX

    I don't know where this market goes from here but there is an excellent arbitrage play over the next several months that has a current 7.9% spread. In other words, you could buy one security and if shares were available, short the other and you could lock in roughly a 7.9% return until the consolidation was complete in the fall. Though there would be some risk that the merger would not be approved by shareholders and the NAV ratio could change a bit before the merger is complete, these would be very small risks in my opinion.

    Nuveen announced on May 1st a consolidation of all its equity option-income funds into new funds and new option overwrite strategies. Though most of the combinations are non-events due to similarities in valuation between the funds, the one that gives investors an opportunity is the Nuveen Equity Premium Advantage fund (NYSE:JLA) consolidating into the NASDAQ Premium, Income and Growth fund (NASDAQ:QQQX).

    Both funds are heavily technology weighted and in fact, QQQX essentially mimics the popular and heavily traded PowerShares NASDAQ-100 Trust fund (NASDAQ:QQQ). The difference is that QQQX sells about 50% index options against its equity portfolio while JLA sells about 100%. In other words, both funds are more defensive than QQQ, especially JLA which is one of the most defensive option-income funds you can buy. Selling call options is an income strategy that allows the funds to offer a high yield, currently 7.7% for JLA and 6.9% for QQQX, while still participating in equity ownership.

    When the consolidation is complete in the fall, QQQX will be the surviving fund and will maintain a roughly 55% target sell call option strategy, though it can range between 35% to 75%. The higher the percentage the fund utilizes, the more defensive the strategy and the less appreciation capture the fund offers. So where is the opportunity?

    Merger Based On NAV Ratios

    The merger will be based on the Net Asset Value (NYSE:NAV) ratios of the two funds when the merger is complete in the fall. If the merger closed today, the current ratio would be 75.2% because JLA's NAV as of 6/5/14 is $14.25 and QQQX's NAV is $18.96.

    This ratio can change slightly day to day and if the NASDAQ-100 continues to perform well, then the ratio may go down a bit because QQQX's NAV should outperform JLA's NAV in a continued strong NASDAQ-100 market. But if the NASDAQ-100 is flat or goes down over the next several months, the ratio should go up a bit in favor of JLA. In either case, the 75.2% ratio will probably not change appreciably over the next several months until the merger is complete.

    How To Value JLA

    Though both JLA and QQQX are trading near their multi-year highs, JLA has the most to gain from here. That's because JLA shareholders will become QQQX shareholders in the fall so really, JLA shareholders shouldn't even pay attention to JLA's market price and really should only care about where QQQX's market price and valuation difference between the two funds goes.

    Currently, QQQX trades at $19.42, a 2.4% premium over its NAV of $18.96. That's great for JLA holders since JLA currently trades at a -5.1% discount. So really all you have to do to find out what your JLA shares are worth is to take the 75.2% NAV ratio (which I said, can change day to day) and multiply it by QQQX's current market price, which can also change day to day.

    Doing that gives you JLA's current worth and right now, that equates to $14.60 as of June 5, 2014 (QQQX's market price $19.42 X NAV ratio 75.2%). So with JLA currently trading at $13.53, here is where the opportunity of an 7.9% or more appreciation over the next several months comes into play.

    Why JLA Is A Safe Buy Here

    An investor would probably be quite safe just buying JLA and letting the conversion take place in the fall. Unless there is a down technology market during this time in which QQQX's current premium valuation dropped to a discount equal to JLA's, JLA holders would still hold up far better than QQQX shareholders. Another benefit to JLA holders if the markets, particularly tech, were flat to even down before the merger was complete, is that the NAV ratio would go up in JLA's favor as JLA's NAV would hold up better than QQQX's NAV.

    One final bonus is that you would get one and maybe two more distributions from JLA before the merger was complete and JLA offers the higher yield at 7.7%. The first ex-dividend date is next Wednesday, 6/11/2014 and the second would be approximately 3-months later in September. After that, you would be owning QQQX shares.

    The Arbitrage Play

    If an investor wanted to lock in that 7.9% appreciation based on the current NAV ratio, they could own JLA shares and short a roughly equal value of QQQX shares. Though I don't necessarily recommend this since, 1). it may be hard to find QQQX shares to short and, 2). you can have a forced buy-in on QQQX shares before the merger is complete. One additional liability of the arbitrage play is that you would be responsible to pay for one and maybe two of QQQX's distributions, though you could offset this with your JLA distributions.

    Still, this is the definition of arbitrage and as long as the merger is approved, which should be perfunctory, and the NAV ratio doesn't change appreciably, then this arbitrage should work just fine. And if QQQX's market price continues to outperform JLA's market price, which is has done recently in a strong tech market, then that just makes JLA's market price that much more valuable. Remember, owning JLA now is like owning QQQX at a discount.

    Disclosure: I am long JLA.

    Additional disclosure: Short QQQX, QQQ

    Stocks: QQQ, JLA, QQQX
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Comments (7)
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  • das555
    , contributor
    Comments (210) | Send Message
     
    I see it the same way and have been a steady buyer of JLA.
    Thanks.
    6 Jun, 10:19 AM Reply Like
  • AlbionWood
    , contributor
    Comments (824) | Send Message
     
    I'm in JLA already and the price appreciation is nice, but I bought it for income. If I understand correctly, I will end up with less income post-merger, so will have to decide whether to sell the QQQX and redeploy.
    6 Jun, 06:40 PM Reply Like
  • BD1
    , contributor
    Comments (2) | Send Message
     
    So if I currently own QQQX I could sell it and buy JLA and do about the same thing?
    6 Jun, 07:13 PM Reply Like
  • cpyles42
    , contributor
    Comments (38) | Send Message
     
    I haven't read the merger materials, and I assume you have, but are you sure the merger ratio will be on the NAV price per share? or the aggregate NAV? (similar to its market cap) the latter would make a lot more sense and be more consistent with how a merger actually happens.. While the former is highly dependent on share price but not how many shares are outstanding, e.g., what if the share price was $2?
    8 Jun, 12:16 AM Reply Like
  • Douglas Albo
    , contributor
    Comments (660) | Send Message
     
    Author’s reply » I wish! That would make JLA shares even more valuable at around $16.25 based on a combined NAV and combined # of shares. But no, the consolidation is intended to be non-dillutive and non-taxable so it will be based on the NAV ratio of the two funds. JLA shareholders will actually get LESS shares than they currently own but at QQQX's market price. QQQX shareholders will be unaffected all the way around.

     

    This is similar to how the NIE/NGZ merger went last year. In that case, I was long the surviving fund, NIE, and short NGZ, just the opposite of this one where QQQX will be the surviving fund. I wrote an instablog on that as well...

     

    http://bit.ly/1idhLTi
    8 Jun, 09:20 AM Reply Like
  • das555
    , contributor
    Comments (210) | Send Message
     
    This is a relatively straight forward calculation. Nuveen has stated the merger will be based on the relative NAV values of JLA and QQQX while the financial impact to the JLA holder will be dependent upon the relative Market Values of JLA and QQQX.
    For simplicity sake, assume JLA and QQQX each had the same NAV value $10 - then at the merger, for each share of JLA you would receive one share of QQQX. But if at the merger the Market Value of JLA was say $9 (a discount to NAV value) while the Market Value of QQQX was $11 (a premium to NAV Value) the holder of a share of JLA would exchange his JLA share (worth $9) for a share of QQQX (worth $11). Merger based on NAV Value, financial impact based on Market Value - allowing the nimble investor to potentially exploit the difference. In an efficient market, one would expect as the merger approaches, the JLA share to sell up from $9 to at least it's NAV of $10 and the QQQX share perhaps to sell down to its NAV of $10 thereby eliminating the arbitrage opportunity. The market however is not always efficient and CEFs in particular are often poorly understood - giving rise to the current opportunity pointed out by Mr. Albo. Currently JLA is selling at a 5.05% discount to NAV while QQQX is selling at a 1.21% premium to NAV - the only way this doesn't work out well for the JLA purchaser is if QQQX sells down from it's current premium to a 5.05% or greater discount (which I view as unlikely).
    8 Jun, 10:44 AM Reply Like
  • sbpb
    , contributor
    Comments (2) | Send Message
     
    okay I am not stupid but am confused now that i think i see both selling at discounts to nav albeit small on qqqx. both are now negative navs (8/28/14) -----now what i am having trouble seeing the exhange values

     

    can anyone help
    28 Aug, 01:45 PM Reply Like
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