Gabelli Equity Trust: Rights Offering Analysis

Jun. 22, 2021 2:06 PM ETGabelli Equity Trust (GAB)67 Comments

Summary

  • GAB is in the middle of a 10-for-1 transferable rights offering.
  • The offering is likely to be dilutive due to the substantial discount that the new shares are offered at.
  • What should investors, who held through the ex-rights date and now own GAB rights, do?
  • 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 »
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Author's note: This analysis was part of our CEF Weekly Roundup release to Income Lab members on June 8, 2021, and data are from that date unless otherwise stated. Please check latest data before investing.

This article analyzes The Gabelli Equity Trust's (NYSE:GAB) rights offering. From the press release:

Gabelli Equity Trust Announces Rights Offering for Shares of Common Stock Record Date and Summary of Terms

May 19, 2021 07:45 PM Eastern Daylight Time

The Board of Directors of The Gabelli Equity Trust Inc. (NYSE:GAB) (the “Fund”) has approved a transferable rights offering which would allow the Fund’s record date common shareholders to acquire additional shares of common stock (the “Offering”).

  • Each shareholder will receive one transferable right (the “Right”) for each share of common stock held on the record date (June 2, 2021).
  • Ten Rights plus $5.50 (the “Subscription Price”) will be required to purchase one additional share of common stock (the “Primary Subscription”). The purchase price will be payable in cash.
  • Record date shareholders who fully exercise their Primary Subscription Rights will be eligible for an over-subscription privilege entitling these shareholders to subscribe, subject to certain limitations and a pro-rata allotment, for any additional shares of common stock not purchased pursuant to the Primary Subscription. Rights acquired in the secondary market may not participate in the over-subscription privilege.
  • The Rights are expected to trade “when issued” on the New York Stock Exchange beginning on May 28, 2021, and the Fund’s shares of common stock are expected to trade “Ex-Rights” on the New York Stock Exchange beginning on June 1, 2021. The Rights are expected to begin trading for normal settlement on the New York Stock Exchange (NYSE:GAB RT) on or about June 7, 2021.
  • The Offering expires at 5:00 PM Eastern Time on July 14, 2021, unless extended.

When premiums are running high, it is actually a logical thing for managers to conduct a rights offering in order to monetize that premium and generate accretion for shareholders - although as we've seen time and time again, the short-term effects on the share price are usually detrimental. This is why we recommend selling CEFs that conduct rights offerings and then buy back shares later: one benefits both from the temporary price declines as well as the long-term performance boost that comes from accretion!

Ex-rights day drop relatively muted

In the case of GAB, the ex-rights date drop was relatively minor (19 cents, or -2.5% on June 1, 2021) compared to other funds.

Chart

Data by YCharts

This could be because of two reasons. Firstly, the fund wasn't trading at an egregious premium heading to the ex-rights date (it closed at a +10% premium the day before). Secondly, this is a transferable 10-for-1 offering meaning that each right is worth significantly less compared to a typical 3-for-1 offering.

Possible arbitrage opportunity available

The subscription price is fixed at $5.50, and at today's closing share price of $7.26 each right should be worth 17.5 cents. Meanwhile, the rights (GAB RT) closed at 9.45 cents, so we have another case of where rights are worth less than their intrinsic value.

(Source)

This suggests an arbitrage opportunity where one could buy 10 rights for $0.945 and $5.50 (total $6.445) to subscribe for one new share of GAB which is worth $7.26, some +12.6% higher, on the open market. This is ostensibly a nice deal; however, the risk is that the price of GAB declines from now until the expiry date of July 14, 2021. So it might be worth waiting until the final one or two weeks to see if the arbitrage opportunity is still in play.

It should also be noted that the offering is likely to be dilutive given the fact that the fund's NAV currently stands at $6.92. However, since it is a 10-for-1 offering, the impact on NAV dilution is likely to be minor, around -1.9% at current NAV.

Update: What should GAB investors do?

GAB closed on June 21, 2021 with a price of $6.68, while the rights closed at 11.1 cents, which is actually right about what their intrinsic value should: 11.8 cents. The reason that the intrinsic value of the rights has fallen since our initial analysis is because GAB sold off sharply over the last couple of days.

Chart
Data by YCharts

This was partly due to the market sell-off but also partially due to the declining premium of the fund. While one cannot predict the former, the latter has been a typical behavior that we have observed for funds during their rights offerings periods (which is why we recommend our members to sell a fund when one is announced).

A corollary to this is that the arbitrage opportunity that we identified above is now significantly diminished.

What should GAB investors who own rights do now? The simple answer is that they should either subscribe for discounted GAB shares with the rights that they own, or else sell the rights on the open market. Since the rights are trading at around their intrinsic value, both options are about equivalent economically. Remember that either way, one should act before July 14, 2021 which is the expiry date of the offer (and brokers may have their own, earlier, internal deadlines). Letting the rights expire worthless would be the least ideal outcome.

For more information about the merits of GAB as a standalone investment, see Nick Ackerman's article here: GAB: High Yielding Equity Fund. (Disclosure: Nick is a member of the CEF/ETF Income Laboratory team and he had a neutral rating on the stock in his April 2021 review).

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