ACP: Rights Offering Analysis

Summary

  • ACP jumps on the rights offering bandwagon to monetize its premium.
  • Selling/shorting over the ex-rights date wins again.
  • How to play it for those still in the fund.
  • Looking for a helping hand in the market? Members of CEF/ETF Income Laboratory get exclusive ideas and guidance to navigate any climate. Learn More »
Redundancy concept. Know your rights sign.
Photo by designer491/iStock via Getty Images

Author's note: This analysis was part of our CEF Weekly Roundup release to Income Lab members on May 21, 2021 and data are from that date unless otherwise stated. Please check latest data before investing.

ACP jumps on the rights offering bandwagon

Aberdeen Income Credit Strategies Fund (NYSE:ACP) also decided to jump on the rights offering bandwagon after its premium rose to above +8%, which is the highest on record since inception of the fund in 2011. When investors are pushing up CEF share prices, who can blame them? The last time that ACP conducted an offering was in October 2019 (which we covered here).

(Source: CEFConnect)

ACP's offering is a transferable 3-for-1 offering. The ex-rights date was May 19, 2021, and the offer is due to expire on June 16, 2021. The subscription price will be the higher of 92.5% of the market price (averaged over the final 5 days) or 87% of NAV. Here's the full press release:

Aberdeen Income Credit Strategies Fund Announces Rights Offering And Monthly Distribution

PHILADELPHIA, May 10, 2021 /PRNewswire/ -- The Board of Trustees (the "Board") of Aberdeen Income Credit Strategies Fund (NYSE: ACP) (the "Fund"), a closed-end fund, has approved the terms of the issuance of transferable rights ("Rights") to the holders of the Fund's common shares (the "Common Shareholders") of beneficial interest ("Common Shares") as of the record date, entitling the holders of those Rights to subscribe for Common Shares (the "Offer"). The Board, based on the recommendations and presentations of Aberdeen Asset Managers Limited, the Fund's investment adviser (the "Adviser"), and others, has determined that it is in the best interests of the Fund and the Common Shareholders to conduct the Offer and seek to increase the assets of the Fund available for investment. The Offer seeks to provide an opportunity to existing Common Shareholders to purchase Common Shares at a discount to market price (subject to a sales load).

The Fund will distribute to Common Shareholders of record as of the record date ("Record Date Shareholders"), which is currently anticipated to be May 20, 2021 (the "Record Date"), one right ("Right") for each Common Share held on the Record Date. Record Date Shareholders will be entitled to purchase one new Common Share for every three Rights held (1 for 3); however, any Common Shareholder who owns fewer than three Common Shares as of the Record Date will be entitled to subscribe for one Common Share. Fractional Common Shares will not be issued.

The proposed subscription period is currently anticipated to commence on the Record Date and expire on June 16, 2021, unless extended by the Fund (the "Expiration Date"). The Rights are transferable and are expected to be admitted for trading on the New York Stock Exchange (the "NYSE") under the symbol "ACP RT" during the course of the Offer. Rights may be exercised at any time during the subscription period.

The subscription price per Common Share (the "Subscription Price") will be determined on the Expiration Date, and will be based upon a formula equal to 92.5% of the average of the last reported sales price of a Common Share of the Fund on the NYSE on the Expiration Date and each of the four (4) immediately preceding trading days (the "Formula Price"). If, however, the Formula Price is less than 87% of the Fund's net asset value per Common Share at the close of trading on the NYSE on the Expiration Date, the Subscription Price will be 87% of the Fund's net asset value per Common Share at the close of trading on the NYSE on that day. The estimated Subscription Price has not yet been determined by the Fund.

The offering will be accretive to NAV/share if the fund expires at around a +8% premium, and dilutive below. At current share prices the offering is therefore likely to be slightly dilutive to the fund (ACP's premium/discount was -0.43% as of May 27, 2021).

Selling/shorting over the ex-rights date wins again

When the offering was announced, we advised our members to sell ACP over the rights offering period and certainly before the ex-rights date. I personally shorted the fund in small size in the days leading up to the ex-rights date. This is because our previous research has shown that funds generally drop by more than what the intrinsic value of the rights are worth on the ex-rights date.

This turned out to be the case for ACP:

Chart
Data by YCharts

For transferable rights offerings, shorting over the ex-rights date is usually a profitable strategy. Why was I comfortable holding my short position through the ex-rights date for ACP and not the Cornerstone funds? The answer is that ACP's rights are transferable, so I can simply buy back those rights on the open market and would not be exposed to the liability of ponying up subscription shares to the actual rightsholder.

For some reason, the ex-rights date drop is much more severe than what the intrinsic value of the rights should have warranted.

For instance, the day before the ex-rights date, ACP closed at a market price of $12.40 and a NAV of $11.59. Applying the subscription formula would result in a subscription price of $11.47, giving the rights an intrinsic value of ($12.40-$11.47)/3 = 31 cents each. However, the share price of ACP dropped by nearly $1!

Hence, if one sold ACP before the ex-rights date, they could rebuy their ACP shares the next day together with one right for each share they own, and still come out ahead versus the investor who held through the ex-rights date.

How to play the offering

For those who held ACP over the ex-rights date and don't intend to subscribe for new shares, I'd suggest selling your rights sooner rather than later because our past experience has shown that the value of the rights tends to drift lower as the rights offering period progresses.

The rights, which are trading with the ticker "ACP RT," closed at $0.18 cents on May 27, 2021. This is significantly lower than their intrinsic value of $0.29 as calculated using ACP's closing price of the same day.

(Source)

Hence, there's an arbitrage possibility available where one buys three rights to subscribe for one new share of ACP. At ACP's $11.47 closing price on May 27, 2021, if the offering were to have expired the next day, this would afford an estimated profit of $0.32 per share. This is calculated by applying the 92.5% of the market price condition (in reality it is the average of the final five days but for simplicity we'll take the last closing price), giving a subscription price of $10.61. Three rights cost $0.54, and thus together with the subscription price means that one could subscribe for a new ACP share for $11.15, a -2.8% discount to the current market price.

However, note that if the discount of the fund widens to beyond -13% towards expiry, one should not subscribe as it would be cheaper to buy the shares on the open market. At that point, the rights also would become worthless.

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