Upside – 2.7%
Expiration Date – Q1 2017
This idea was suggested to me by one reader of the site – it’s an arbitrage trade in Canadian preferred shares. Upside is tiny, but the deal itself is interesting – so I decided to write it up. I have a small position mainly to track how this transaction plays out.
TransAlta is offering to exchange all 5 Series of its preferred stock into a single type of preferred stock. Company is doing this to simplify the capital structure and to reduce accounting value of its preferred capital. All series of preferred stock would be getting higher dividend as a result.
“Pursuant to the Arrangement, (i) holders of series A shares will receive 0.503 of a New Preferred Share; (ii) holders of series B shares will receive 0.550 of a New Preferred Share; (iii) holders of series C shares will receive 0.705 of a New Preferred Share; (iv) holders of series E shares will receive 0.790 of a New Preferred Share; and (v) holders of series G shares will receive 0.820 of a New Preferred Share. The New Preferred Shares will pay fixed cumulative dividends of $1.625 per share per annum, yielding 6.5% per annum”
BoD has already approved this transaction, and shareholder vote is set for the 16th of February. If shareholders approve, the exchange is expected to close during Q1 2017.
Where is the trade?
The table below indicates the implied prices of the ‘New Preferred Shares’ for each Series of the current preferred.
All of these securities will be converted into the same single security, however they trade at different implied prices currently. Series A particularly stands out as being priced above the rest. So the trade is to sell the most expensive and to buy the cheapest one, taking into account different conversion factors. Current spread between Series A and Series C is 2.7%. These spreads vary on a daily basis, but for some reason Series A is always more expensive than the others. After the exchange is completed, short and long positions will annul each other.
Will shareholders approve this?
This exchange transaction will need to be approved by 2/3 of preferred holders of each Series. I believe shareholder approval is very likely. All series have traded up after the announcement on the 19th of December.
Also all shareholders will be getting higher (or the same) dividends than they receive currently.
So if the vote is rejected, the prices of preferreds will drop and dividends will remain unchanged – probably not something the preferred holders will be fond of.
The only things the current holders of preferreds will be giving up are par value and liquidation preference (i.e. Series A priority vs Series C and etc). These items would matter only in liquidation scenario, but Transalta seems to be far away from liquidation (at least for the moment being) – it is an electricity utility company that generates sufficient operating cash to for capex, to cover common and preferred dividends as well as to pay down debt.
Taking all of this into account, I believe ‘yes’ vote is likely, but as these are semi-fixed income securities I might be underestimating the importance of liquidation scenario for preferred holders.
The main risk is that the transaction gets rejected by shareholders. If preferreds trade back to the pre-announcement levels upon this, then Series A (short part of the trade) would drop less than the other Series (long part of trade) – by my estimates the loss would be around 10%. So the downside vs upside clearly does not look favorable here.
Also I still do not understand why Series A is constantly trading above the rest. I might be missing some piece of the puzzle.