Prospect Japan Fund (PJF.LON) – Merger Arbitrage – 44% upside

Current Price – $1.26

Expected Buyout – $1.81

Upside – 44%

Expiration Date – expected in H1 2017

Prospect Japan Fund trades below its NAV and received a non-binding all-stock buyout offer from the related party. This offer values the fund at $2.15/share – equivalent to 70% upside. The merger is very likely to go through. The biggest risk is market price of the acquirers shares which affects not only the eventual payout (no possibilities to hedge) but also the NAV of PJF.

 

In Short

This is a fairly straightforward situation:

- Company trades at $1.26/share;

- Disclosed NAV  is $1.29/share – 2% upside;

- ‘True’ NAV is $1.82+/share – 44% upside;

- Company received a non-binding buyout offer which values it at $2.15/share – 70% upside.

I am of the opinion that the buyout will happen but at a reduced price – somewhere around the ‘True’ NAV.

 

Background

Prospect Japan Fund is an investment company listed in London. Shares are denominated in USD and it is possible to trade through IB, however the stock is illiquid.

PJF portfolio is comprised of 7 small cap (sub $200m) Tokyo listed equities, warrants in one company and cash. It owns sizable portions in each of the equities (e.g. 15% of Daito Bank and 12% Fukushima Bank), therefore full portfolio liquidation would take time – still I consider the portfolio to be relatively liquid. The value of portfolio excluding the unlisted warrants is c. $116m and is approximately equal to the current market cap of PJF.

The juicy bit here is warrants in Prospect Co (listed in Tokyo under ticker 3528). Prospect owns PJF’s investment manager (Prospect Asset Manager) and is also the potential acquirer of the company.

PJF has stock acquisition rights (SARs) to purchase 135m of Prospect shares at ¥54 strike price till Dec 2020. Untill recently Propect traded below or close to exercise price and because of that SARs were valued on PJF balance sheet at cost of $2.7m (2015 annual report and 2016 interim fillings). In the latest NAV calculation these SARs continue to be included at costs. However, with the increase in Prospect share price (currently ¥97) the value of SARs has drifted substantially from $2.6m at cost to $51m currently. And that is only counting the intrinsic value of SARs - with almost 4 years before expiration, the time value is likely to be material as well. Adding the difference between cost and intrinsic value of SARs to the reported NAV results in $168m ‘True’ NAV or $1.82/share.

 

Acquisition proposal by Prospect

On 10th of Jan 2017 Propect issued proposal to acquire all PJF shares in exchange for 2.5 shares of Prospect. Preliminary discussions are ongoing and the initial deadline has already been extended once.

At the time when proposal was issued it valued PJF at $133m, which was roughly equivalent to its true NAV at the time (counting in full intrinsic value of SARs and adding another $4.5m for the time value). With the increase in Prospect share price (from ¥67 on 10th of Jan to ¥92 currently) the exchange offer of 2.5 Prospect shares for each share of PJF significantly overvalues PJF. I do not see any justifiable reason on why would Prospect be willing to pay more than the actual NAV on the portfolio of listed securities and SARs. Therefore, I expect Prospect acquisition offer to be adjusted accordingly in order to reflect the purchase price approximately equivalent to my calculated ‘True’ NAV plus few million for the time value of SARs.

 

Is Prospect share price sustainable?

Most of the upside in this transaction hinges on SARs valuation and in turn on the share price of Prospect. Prospect share price has shot up from ¥40 to ¥100 in a period of 2 months. This was mostly driven by decision to increase dividend from ¥1 to ¥3. This resulted in substantial increase in yield and in turn pushed the share price upwards – Japanese equities tend to follow yields closer than earnings. I cannot say much on how sustainable this dividend is (all IR info in Japanese), but my guess is that management would not triple the dividend if there were any concerns about ability to pay it for at least few years. If Prospect acquires PJF portfolio, then it will definitely have sufficient financial resources to continue with the pay-outs. As long as dividends remain at ¥3/share it is likely that Prospect share price will continue to trade at least within the ¥90-¥100 range (resulting in 3% yield).

There is some background on Prospect’s business (including short version of financials) in this presentation.

 

How likely is the acquisition?

Prospect wants PJF mainly for its cash value in order to fund further growth projects (see pages 20-22 of the presentation). I view this acquisition as equivalent to raising equity capital, just with less hassle of finding interested investors (especially foreign ones). At the same time overhang from SARs would be removed resulting in cleaner balance sheet.

Most (88%) of current PJF shareholders are active fund managers, who should only be interested in getting fair value for their PJF shares (which currently is north of $1.81). Depending on the final exchange ratio current PJF shareholders would end up owning c. 50% of the merged company and current large shareholders of PJF (3 companies own 60%) would end up with large stakes in Prospect and be exposed to its business performance instead of a basket of Japanese small cap equities.

However, Prospect is far more liquid than PJF and therefore exiting larger stakes in the open market looks quite feasible – 3% yield really seems to do the trick in attracting investor attention as the daily trading volume increased >10x since the dividend announcement. Thus I do not see much concern from the perspective of current PJF holders and believe they should approve the transaction.

Worth noting that since the acquisition proposal, some funds have sold down and some have added to their PJF positions. One can find all the announcements here.

 

Another potential catalyst

If the deal does not materialize. the company is still likely to announce materially higher NAV that reflects fair SARs valuation (if Prospect share price remains at current levels) in the annual report, which is due to be released some time at the end of April.

 

86 COMMENTS

  1. work 22

    I had looked at this as well, but couldn’t figure out if it was a “PFIC” – Passive Foreign Investment Company- or not. Did you get any color on that? Anybody else reading have a comment? There are different (and punitive) tax issues if it is for US citizens. Just can’t tell for sure as an American.

    (see some alarming links if you are more interested:)
    https://en.wikipedia.org/wiki/Passive_foreign_investment_company#Additional_reading

    https://thunfinancial.com/why-americans-should-never-ever-own-shares-in-a-non-us-incorporated-mutual-fund/

    1. dt

      I am clearly not an expert of PFIC rules, but my reading around it suggest that if the merger with Prospect happens then PJF will clearly no longer quality as PFIC as majority of its assets would be non-passive (i.e. 25% look through rule). As for its status at the moment, I am unable to add any further color, but seeing large US asset managers being involved in here gives some confidence.

  2. FM

    I’m wondering why there indicated “ORD US$0.001″ behind the stock name? Not familiar with U.K stocks. Any idea? Ordinary share of what?

    1. dt

      It simply means that these are ordinary shares at $0.001 par value each. No different from US companies.

  3. FM

    And also, what the price will be if the buyout failed? Back to $0.94 on 9th Jan? That will be a 35% loss vs 44% gain.

    1. dt

      I do not think it will revert to previous levels. As I wrote in the last paragraph – in the annual report for 2016 the company will need to report fair value of SARs instead of including them at cost as was done before. The valuation difference is too huge to ignore. So the reported NAV will appear far above the current share price.

      Previously PJF traded at 25%-30% discount to reported NAV. So if the merger does not happen, we might see similar discount again. 30% of ‘True’ NAV of $1.82 results in $1.27 share price. So downside seems to be well protected here.

      Obviously, the calculation above assumes that the share prices of underlying equities (and most importantly of Prospect) remain unchanged.

  4. Ben

    Quite compelling – thanks for posting.

    As you say it’s hard to see why Prospect would want to pay more than fair value (reported NAV + intrinsic value of the SARs). So I went back and ran the valuation for January 10th, when the offer was first announced.

    Prospect Co was trading at JPY 67 then, and USD/JPY was 115.9. Based on these, I get:

    Implied takeover value = 2.5 Prospect shares = $1.445 per share
    Fair value of NAV = $1.121 reported NAV + $0.164 intrinsic value of SARs = $1.425

    So if my figures are right, even back in January they were willing to pay a slight premium to “fair value”, which is interesting – although of course the premium is much bigger now.

    (I’m not very confident in these calculations – please point out if you spot mistakes!)

    1. Ben

      Oops – that should be “$1.261 reported NAV” instead of “$1.121 reported NAV”

      1. dt

        Ben, I have arrived at similar calculations in the write-up – just I calculated on aggregate value rather than per share basis. I attribute the slight premium towards the time value of SARs, suggest that now Prospect should be willing to pay slightly above $1.82/share if the same rationale holds.

        1. Ben

          Ah yes, I see that now! In my defence, at least I had fun working out the numbers … and I’m glad we ended up with roughly the same answer.

  5. Vladimir Klimanov

    It seems that there is another extansion till 4th of April. Another thing – upcoming dividend payout for Prospect itself (i guess at should be around Mid-March), which may decrease the share price though insignificant (ex-dividend price). BTW, do you know how did they get SARs? I found that first mentioning of SARs was in Feb-15.

    1. dt

      I think extension was expected and I actually view it as a positive sign that discussions are still ongoing. Prospects dividend payout is quite immaterial for PJF investment thesis.

      Re SARs, this is from 2015 Annual report:

      “The Company acquired 1,440 stock acquisition rights (“SARs”) in Prospect Co. for a total cost of ¥288 million (US$2,391,431) in December 2015. Each SAR gives the Company the right to acquire 100,000 ordinary shares in Prospect Co. at a price of ¥54 per share. The SARs are exercisable until 20 December, 2020. “

      1. Vladimir Klimanov

        Thank you. It seems that those SARs were acquired at very low price. Share price at that time was around 50-54JPY, so if we simply run it through BS model we get at least twice more for warrants.

  6. over2u

    Just another interesting observation: if you compare Book value of common equity (which is FMV of investments) to Market cap (both sides of equiation adjusted on cash) you will get a historical discount to NAV around 20% to 30% (which is huge) for the period from 2013 till now. So 30% discount to TRUE NAV results in current market cap, but I guess the main driver here is elimination of discount because of corp actions (M&A). But even if M&A doesn’t happen, we have downside protected as current Market cap is in line with NAV and historical discount. Please let me know if you agree. Thx

    1. dt

      Agree with your observation – expected acquisition is the catalyst that is likely to significantly narrow the gap between market price and NAV.

    2. Michael

      I disagree. The present value of fees, kickbacks, management salaries, and other corporate overhead of this closed-end investment company needs to be calculated, to arrive at a fair value discount. 30% discount does not mean the the investor derives a benefit from this discount, nor that it fairly compensates the investor for the present value of current and future fees, kickbacks, management salaries, and other corporate overhead that commonly come with controlling majority shareholders at the expense of minority shareholders, nor that there is downside protection.

      1. dt

        If announcement of PJF acquisition does not come to light shortly, then obviously the expenses of running the company need to be taken into account. Management fees and other fund expenses are c. $3m annually, so without appreciation in the underlying assets the fund NAV would decline by 3% annually.

        Not entirely sure what you mean by kickbacks and mistreatment of minority shareholders. Do you have any supporting evidence for that? PJF stock is quite concentrated in the hands of a few institutional investors, who like the public retail shareholders are interested only in share price appreciation.

        1. Michael

          Then please go ahead and just calculate the fair present value of the fees. The problem is, it appears that the fund did not pay out any distribution for more than a decade. Therefore we cannot calculate the fair value. Based on a no-arbitrage hypothesis and the assumption that active management generates market returns (a reasonable assumption in this case as the funds seems to hold a fixed number of positions with little turnover), I usually calculate the fair value of closed-end investments by equating the annual fees charged to shareholders to the annual additional profit of shareholders (on top of underlying investment returns) from sales and distribution of assets at NAV. Obviously, this is not possible when there are no distributions. Theoretically the fair value of the fund is zero, unless we assume that the distribution policy changes some time in the future, or activist shareholders force liquidation. Coincidentally, U.S. closed-end funds with fees in the 2.x% range and reasonable annual distributions, typically trade with 20%+ discounts. This shows that the market has “figured it out”, and my calculations appear not all that absurd. 3% annual fees is an outrageous number. Together with no distributions, I would attribute at least a 50% fair discount to this “investment vehicle” (if it can even be called that way). Closed-end investment vehicles are basically captive capital for the management company (capital can never be pulled out by shareholders, just exchanged with other shareholders), and as such they are really rather cows being milked. If we assume a generous fair value of PJF of 50% of NAV, with current NAV per your article ca. $1.82, and current share price of ca. $1.35 per 05/31/2017, and current proposed buyout proceeds of $1.85 if the transaction goes through, we would currently have almost equal potential downside to potential upside, depending on whether or not the transaction goes through. To evaluate the investment, the interesting parameter is the likelihood of it going through.

          1. dt

            Michael, thanks for elaborating on your points. I disagree that 50% discount to NAV is currently the downside. Most CEFs trade at discounts not far from 10% to NAV, if the discount is larger usually the activists get involved to narrow it (e.g. Bulldog Investors). Also the fund that does not pay out any distributions is definitely not worth 0 – by this logic Berkshire would also worth 0, but I think we all agree that this is not the case.

            1. Michael

              Mathematically it is zero, because with no distributions you will never profit from the discount if the discount is constant between the time you buy and the time you sell, and when you sell you just pass along the misery to someone else – unless you assume that the dividend policy will change in the future. The question is when that happens, and how many time you were charged 3% of your assets before that happens. You are right that CEFs with potential activist investors have lower discounts. Those that are firmly in the hands of majority shareholders, family or related entities that otherwise benefit from the CEF setup (like management fees or other methods or draining) with close to zero chance of liquidation in our lifetimes, have very large discounts. I believe the difference to Berkshire is that Berkshire has very low annual management fees/compensation compared to assets. Furthermore, investors attempting to value Berkshire must make an assumption that Berkshire will pay dividends in the future. This following from a simple logical mathematical argument that no company can keep growing in size faster than GDP in the long run. Growth is naturally limited by the size of the economy, and therefore Berkshire will eventually have to distribute its cash rather than reinvesting it.

  7. fernando oliveira

    Arent you concerned that once the buyout goes through the investors get the new shares, they will all be selling at the same time therefore capping the potential upside due herd selling?

    1. dt

      That indeed might be the case. But my expectation is that once there is more clarity regarding buy-out and exchange details PFJ shares would be pushed upwards, and thus the gap between the current share price and expected buyout price would narrow potentially providing an exit opportunity.

    1. dt

      Indeed shares dropped 17% over the last few days. I tried to find reasons for this, but the only thing that came up was this:
      http://www.leaprate.com/financial-services/fines/japan-sesc-to-fine-prospect-asset-management-inc-for-insider-trading/
      Apparently, Prospect Asset Management (which manages PJF as well and is also subsidiary of Propect Co) is being accused of insider trading and faces a fine of 3m Yen.

      This seems to be quite immaterial relative to Prospect Co market cap (12bn yen), but it might have wider impact with regards to market sentiment towards the stock.

      Also if google translate is any good, the company seems to be disputing insider trading allegations. From http://www.prospectjapan.co.jp/ir/pdf/kenkai170322.pdf

      “2 Our View. The fact pointed out in the recommendation is that PAMI has negotiated a contract with Tristage Corporation,
      Knowing important fact that the agency deciding the line decided to acquire its own shares. It is based on the assumption. However, the PAMI operation personnel, at the time of the monitoring committee problem. There is no fact that TriStage Corp. has received a notice that it decided to purchase treasury stock. Therefore, the contents that the supervisory committee is quite different from the facts, the judgment of recommendation is wrong.
      I am convinced that it was something. As a result of the FSA ‘s judgment on PAMI in the future, it is clear that the Company’ s views are correct. We think that it will be decided that a surcharge will not be imposed. that’s all”

      Worth noting, that this was announced on the 22nd of Mar, but the largest stock drops occurred over the last two days, so recent price performance might be unrelated, or market is truly slow and overreacts to immaterial news.

  8. dt

    Last week PJF published annual financials. Not much new in there. As expected the valuation of Propect Co SARs has been increased (from $2.7m to $10m), although by my calculations the increase was supposed to be 2x larger using the same inputs, so not sure exactly how did the PJE accountants arrived at that.

    With the recent decline in Prospect Co share price, the ‘True’ NAV stands at $1.45 per share – significant decline from the time of the write-up.

    No further updates with regards to proposed buyout. Next deadline is 4th of April and my guess is that it will be extended again, unless something really bad is happening with Prospect (see comment above) in which case the deal might simply be cancelled.

    Also Wells Asset Management keeps on selling down their PJF stake and account for significant part of the average daily volume, so there is downward pressure on PJF share price.

    1. FM

      Any idea on why “Wells Asset Management keeps on selling down their PJF stake” ?

      1. dt

        My guess is as good as yours. They might see better opportunities elsewhere or they might simply be using liquidity to exit what what they consider good-enough-price.
        Other major shareholders so far are keeping their position.

    2. over2u

      As I understood book NAV dropped from $1.36 to $1.23, and new NAV already include revalued SAR (though agree that they valued too cheaply, maybe there are additional features that influenced the value as SAR acquisition cost was also below BS model value by 2 times). Therefore, it seems very limited upside left. What you advice to liquidate the position given the changes?

      1. dt

        Not sure I follow you. The latest reported NAV is $1.29/share and that does not include the full valuation of SARs. Fully valuing the SARs NAV stands at $1.45, so almost 30% upside to current prices if the buyout occurs at ‘True NAV’.
        Until there is some clarity regarding expected buyout, I am not selling out. However, this is not an advice and everyone should do their own due diligence before buying/selling.

        1. over2u

          Sorry, my mistake. Your calculation is correct. Meantime, there is another extension till 02.05.2017. Seems that smth is cooking.

  9. over2u

    Extension by only one day till 31 May 5pm. I guess it is a good sign.

    1. dt

      One day extension sounds very strange. I guess we will know tomorrow what that really means.

  10. dt

    Buyout offer has been announced:
    http://www.londonstockexchange.com/exchange/news/market-news/market-news-detail/other/13243792.html

    The same 2.5 Prospect Co shares for each share of PJF. This translates into $1.85 per PJF share based on the latest Prospect Co close. Transaction is still subject to shareholder approval on both sides (from PJF side letters of intent for 63% of the shares already received).

    Spread is now very wide ($1.25-$1.35), but taking the mid-price the offer still represents 40% upside, liquidity is very low, so price might still move during the day.

    Obviously all depends on the share price of Prospect Co (no borrow to hedge), which has rallied 17% today on high volume. My guess is that the spike in Prospect Co is happening due to settlement regarding previously announced insider trading allegations (http://www.reuters.com/article/brief-prospect-unit-accepts-surcharge-or-idUSL3N1IX293), which at the end of March caused shares to drop from 90Yen to 60Yen. This pending settlement might also be the reason why the takeover discussion has taken so long. This settlement has now removed the overhang that has potentially scared Japanese investors and now they are flocking back to the security which yields 3.6% at the latest price (management already announced that the same 3Yen/share dividend is also expected to be paid in 2018). If this is indeed what is happening then Prospect shares are likely to revert back to 90Yen levels, where it was trading before the allegations surfaced. This is only speculation and there might be other reasons for jump in Prospect Co share price. Also Prospect Co share price likely does not yet reflect the reached merger agreement and expected dilution from PFJ shareholders – this might put pressure on Prospect Co share price.

  11. Fa

    What is your ETA for the deal settlement aka the delivery of the Prospect Co shares?

    1. dt

      As per merger agreement it should be sometime in H2 2017. Shareholder meetings of both companies need to happen first.

  12. Joe Hill

    Thanks for the idea, dt. Given your history with the name, is there anything that gives you great pause that this thing won’t get done at $1.85? Seems like the “dealbreakers” have been resolved but haven’t been following as closely as I should (Ticked I missed the chance to buy at $1.07)

  13. Michael

    By your estimation, what is the likelihood of approval from both sides? With the currently proposed rate of 2.5 Prospect Co shares for each share of PJF?

    1. dt

      Joe, Michael, I think this deal has a high chance of getting done as per current agreement:
      - After few months of deliberations I would assume that management/BoD of both companies discussed this with their shareholders and have their verbal approvals for the transaction. We know this is definitely the case for PJF as letters of intent have been received for 63% of the shares. There is currently no info on the intentions of the Prospect Co shareholders, but assume they would be pro-merger or at least indifferent, as they would be facing dilution either way (from SAR exercise or from new equity for PJF shareholders).
      - There might also be some legal aspects (e.g. court approval required) which could put a stop to the deal, but I am not able to offer anything besides speculation on these matters.

      The biggest risk I see here is volatility of Prospect Co share price as there are no possibilities to hedge it – up 18% yesterday upon announcement of settlement and down 8% today probably on the news of the merger (i.e. dilution). Thus the spread could easily close not by PJF appreciation, but rather by Prospect Co moving downwards. My expectation is that Prospect company shares would eventually settle at $80-$90. The lowest case estimate is probably 60Yen/share, as Prospect Co has not traded below this since the dividend was announced (5% yield at this share price). At 60Yen/share, PJF is worth $1.35, roughly break-even to current prices.

      1. Michael

        I am not too familiar with the mathematics involved in mergers, but I am not quite understanding your calculations. Is your $1.35 value of PJF with a 60 Yen traded Prospect price based on PJF’s NAV including SARs, or on the value of the 2.5 shares of Prospect assuming the takeover goes though? I think in the latter case, the value would be (60 [Yen] * 2.5) / 110.4 [exchange rate] = $1.35. But wait! We have to subtract the effect of dilution from the transaction on Prospect shareholders after the merger, right? We should assume that the effect of dilution is only partially reflected in the current Prospect share price, as the likelihood of the transaction is not yet 100%, just like the after-merger value of PJF is not yet all reflected in the current PJF price, right? While it appears difficult to separate the market valuation of Prospects’s operating business from the portion of the effect of the proposed merger already priced in the current share price, neglecting the effect of dilution entirely would certainly lead to a too high estimate, right?

        1. dt

          Michael, agree with your points. My downside case estimate ($1.35/share) assumed that when the merger settles the company would trade at 60Yen, which is below the current market prices. At 60Yen/share Prospect would have dividend yield of 5%, which is very high in Japan. If the market believes current 3Yen/share dividend is sustainable then I would not expect Prospect to trade at these low levels for long.

          The question is then obviously how sustainable this dividend yield will be. English financial posted below,
          hardly provide any insight. However, I take some confidence that all of institutional holders of PJF are for merger (not clear how many of them intend to hold on to Prospect Co shares after the merger). Hope this clarifies my thinking on the situation.

          http://prospectjapanfund.com/pjf/pjfoffer/Prospect%20Co.%20Translated%20Financials%20-%20Preliminary%20Results%20for%20the%20year%20ended%2031%20March%202017.pdf

  14. FM

    Hi dt, how do you think the chance of getting approved by both shareholders?

  15. Michael

    What are the market making, trading, and quotation rules for this symbol on LSE? It appears that my limit orders are never shown in quotations; and to top it off, volume is generated at lower prices than my (buy) limits while my limit orders were online!

      1. Michael

        Thanks. According to the link, the order book, or bid and ask orders other than the market maker’s, are only visible during certain 10-minute periods, and hidden otherwise. Frankly, I find that logic a bit hard to understand, and I feel it makes it just a bit harder to get limit orders filled at fair prices.

    1. Joe Hill

      Michael, I noticed the same thing. Very frustrating.

      Also, you guys see the biggest volume trade today was the 166,194 shares traded for $0.999. Very odd

  16. Michael

    According the the LSE web site, “Prospect Gets Support From 76% Of Prospect Japan Shares In Takeover”. What percentage do they need for final approval?

  17. over2u

    “The Independent TPJF Directors are pleased to announce that the requisite resolution was duly passed by Prospect Shareholders at the Prospect ASM held in Tokyo earlier today.”

    So, just wandering why do we still have such huge gap for PJF share price? What other risks left?

    1. dt

      I think the main reason for the wide spread is that it is not possible to hedge Prospect shares. Market likely expects that after the merger occurs and some of the current PJF holders will start selling their newly received, the share price of the merged company will drop, effectively closing the current spread, just from the other side. Just speculation on my side, there might be other reasons that I am not aware of.

      1. over2u

        It is definitely possible, but will move div yield up to 5.5% – which seems very high.
        Also Prospect (3528) started translating its financials to english where additional information on company financials may be found: 1) company confirms its dividend policy going forward, 2) condominium business looks healthy with 141 new contracts sale (vs. sale of 115 for this year). So based on quick look it doesn’t seem that 3528 business in any way deteriorating substantially to justify c. 20% share price hit.
        The other thing is deteriorating PJF portfolio of low liquid stocks – probably the dillution may be higher than initially expected – current exchange ratio offers c.20% premium to true NAV (adj. on option value).

      2. Michael

        I am not understanding this argument. The impact of anticipated selling pressure would apply to both current PJF and Prospect shareholders likewise. Efficient market hypothesis would dictate that informed Prospect shareholders sell their shares pre-merger, and buy PJF instead, if there were no other merger related risks, regardless of whether Prospect can be shorted or not. The expected investment return is the expected return of the business, plus expected (risk-adjusted) return from the merger arbitrage. Furthermore, any cost or impact of takeover of the acquiring company should be priced in no later than at the time of the merger announcement, i.e. when the information becomes public. I am not an equity valuation or merger arbitrage professional. Please correct me if I’m wrong.

        1. dt

          I think the key here is low liquidity. Otherwise you would be correct that existing Prospect shareholders would be better of selling their stakes and buying cheaper PJF instead.
          Also there is still some risk that the deal does not go through.

          1. over2u

            Agree – current spread is 3% wide and I guess given that situation is very low liquid it didn’t gather enough attention of arbs. Hope not missing other risks here

      1. Freedomist

        What do we need to do for this? Any action to take on IB? Or just wait until the shares change into Japanese shares? What do we get after the merger of the shares? Thanks.

        1. dt

          My understanding is that nothing will need to be done and your PJF shares will simply get converted to the New Prospect shares.

  18. Fa

    So nothing to do…. All “PJF shares” will become “3528 shares” on July 28th ?
    Right?

    1. dt

      That is my understanding as well.
      There is a court hearing on the 27th, but not sure what kind of impact it can have (it seems like just a formality)
      There might also be a delay between the time PJF shares are cancelled and New Prospect shares are admitted for trading.

  19. dt

    Trading in PJF shares has been suspended – new Prospect Co shares should hit the accounts over the next couple of weeks (with 10th of August being the latest).

    1. over2u

      Thank you, dt. Great idea. One interesting thing that even at the last day the spread between PJF and Prospect Co was huge, even on the back of increasing 3528 share price. Is it just market irrationality coupled with poor liquidity?

      1. dt

        We will have to judge whether this was actually a good idea when new Prospect Co shares will be distributed and available for trading. If market price of Prospect Co drops in the meantime, this might still turn out to be a money loosing trade.

        No possibilities to hedge this risk clearly add to the size of the spread as well.

  20. over2u

    Info from IB re PJF shares conversion into Prospect Co: “The conversion is expected to take place on or shortly after August 10, 2017.”
    Meanwhile, Prospect Co shares showing some weakness though still trade at high-60s level.

  21. Michael

    I bought at an average price of ca. $1.27 around 02/24/2017, and received 2.5 Prospect shares for each original PJF share. I’m not sure if the last closing price is 65 or 67 Yen, but assuming 65, my profit as of today is ca. 13.8%. I’m not sure if I should wait to sell my shares, to avoid selling during post-merger sell pressure (if any).
    Was the arbitrage play a good investment? I think the Japanese small cap market is an appropriate benchmark. SCJ gained 8.8% in the same time frame. DFJ gained 7.5%. Therefore the excess return of the statistical arbitrage was ca. 5%.To further evaluate the result, an analysis of how merger arbitrage plays generally behave in up and down markets, and a risk based return analysis, would be required.

    1. dt

      Will be interesting to see how the trading goes on Monday.
      Prospect Co yield of 4.6% is clearly far too high for Japan (assuming this yield is sustainable). I do not think the larger shareholders will be dumping newly received Prospect Co shares right away, but there still should be significant selling pressure from arbitrageurs closing out the positions.

  22. Michael

    Prospect is now down at 61 Yen. Unfortunately, dividend yield alone is not a good predictor of future returns or a meaningful valuation measure for an individual company, let alone for a micro cap in the real estate business. Let’s hope it doesn’t further tank.

    1. dt

      I am not able to comment on Lazard’s intentions or behavior with respect to Propect shares, but I think you are misunderstanding the situation. Lazard became major shareholder of Prospect due to conversion of PJF shares – before the merger they owned 23m of PJF shares. Not sure of th exact date this position was established, but previous annual report indicates that Lazard already owned similar position back in Apr 2016.

      Why do you say you are stuck with Prospect shares? You can easily liquidate them at least on IB and right after the distribution this would have resulted in 11% gain and break-even at current prices. So definitely would not call it a stuck position.

      1. Fa

        Lazard asset management is not more known to take long term positions than short term arbitrage trades….

      2. Michael

        “Stuck” as in “underperformed the index” (if I sell now), which I would hate, given my administrative work vs. buying an index fund and doing nothing. “Stuck” also as I want to avoid the possibility of inadvertently being part of a “negative” statistical arbitrage by selling during a time of sell pressure after the merger, that may come with merger arbitrage plays.

  23. Fa

    Prospect Japan is now trading 56 / 57 JPY which is more or less the equivalent of PJF price before the tender started.. (1.27 /1.28). So the only way to extract value was to dump the shares received right away…
    Do you have an explanation for the huge trading range of Prospect Japan this year : From 40 to 90 and now back at 56 ?
    Maybe buying 56 JPY is a good long term play…..

    1. dt

      For me Prospect Co is in the ‘too hard pile’, so I am not able to comment whether this is a good long term holding at current prices. The only thing to note is that dividend yield of 5% is clearly an outlier in Japan and if this dividend can be maintained and paid out in 2018 then I would expect Prospect shares to stabilize significantly above current levels in longer term.

      While the market moves are usually hard to explain, I think 3 factors were the main drivers behind wild share price swings over the last year.
      1) Dividend announcement back in Dec 2016 pushed shares towards 90JPY
      2) Announcement that merger with PJF will actually happen and that Prospect Co shareholders will get diluted pushed shares lower.
      3) Eventual dilution and merger arbitrageurs exiting the position have pushed the shares even lower.

  24. Fa

    Thanks a lot ! I do understand that commenting on Prospect Japan long term is a very different than an arbitrage trade.
    Have you sold your Prospect Japan shares yet ?

  25. Ben

    There may be further price pressure ahead. On Sep 8th, more Prospect shares will be hitting the market, as they get sold on behalf of any shareholders who aren’t able to hold Japanese stocks directly.

    1. dt

      I would expect that majority of shareholders who are not able to hold Japanese stocks have already liquidated their positions before the merger. More than 85% of the of PJF shares were held by fund managers, who are definitely able to keep Japanese stocks with their prime brokers. So any selling pressure would likely be minimal.

  26. Ben

    Thinking more about the price drop, which began around 3 days before the new shares were released…

    Even though there was no stock available for borrow, I wonder if it would have been possible to sell the shares a few days before the merger completed, as long as the merger shares were then released within the settlement period (3 days for Japanese shares, I believe).

    1. dt

      If no borrow is available on IB, it might still be that other brokers have borrow availability (especially Japan based ones, or overall larger prime broekrs used by hedge funds).
      Also a negative move 3 days earlier might simply be caused by previous Prospect Co shareholders anticipating upcoming selling pressure due to newly distributed shares and selling down their position in advance.
      So really many potential explanations for the observed share price movement.

  27. Michael Bumstead

    IB is telling me Prospect Co only trades in increments of 1000. Since my purchase wasn’t in a multiple of 400 shares, I have XX,750 Prospect Co shares. Any suggestions on the 750? I’m selling the rest, since that isn’t a business I want, but am curious if anyone has any ideas on getting rid of the remainder. I’ll be disappointed to look at a 750 share reminder of a break even (for me at least) arbitrage position forever…

  28. Fa

    You just have to call IB dealing desk and ask them to sell your Japanese oddlot (quantity < 1000 shares) at the next closing auction. (I believe Oddlots are only exchanged at the close)

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