Retail Ventures (NYSE:RVI-OLD) is a holding company that owns 63% of another public company, DSW Inc (NYSE:DSW). While RVI does have certain liabilities (related to its divestitures of other businesses) and its own corporate costs, its ownership in DSW is now the dominant determinant of RVI's value as a company.
DSW trades on the NYSE for almost $600 million, meaning RVI's ownership share is currently being valued by the market at $368 million. But RVI trades for only $169 million, less than half of its stake in DSW!
Buying RVI stock, however, is not guaranteed to return 100% even if these stocks converge over the next few years. This is due to the fact that it's entirely possible the market is overvaluing DSW and that it's price will eventually come down.
But by simultaneously buying RVI stock and shorting DSW, however, the investor is protecting himself from a decline in the value of DSW. As long as the values in these companies eventually converge, which will happen if RVI starts liquidating its shares or sells its stake in DSW, the investor will make money.
This trade, however, is not without short-term risks. Who knows how long it will take for the prices to eventually converge? In the meantime, the prices of these stocks may diverge even further, testing the mettle of the investor. Furthermore, the investor should understand the complex nature of RVI's other liabilities and expenses, to ensure they are manageable and don't represent a good reason for the price difference.
Investors appear well aware of this opportunity already. The short interest in DSW is 27% of its float, while the comparable number is just 1.5% for RVI. Nevertheless, the price divergence has persisted for many months. How much longer will it last?
We saw another arbitrage opportunity a few weeks ago. Here's how it ended.