Current Discount: 50%
Target Discount: 0%
Upside: 100% (depending on hedging ratio used)
Expiration Date: TBD
A potentially timely situation where the spread can disappear in a matter of a few days/weeks.
Liberty TripAdvisor Holdings is back on our radar for the 3rd time. LTRPA is a tracking stock for Liberty’s 29.2m shares in TripAdvisor (57% voting power and 22% economic value). Tracking stocks often trade at a small discount to their NAV, which used to be the case with this stock as well till March 2020 (see historical graphs below). The pandemic hit travel stocks, while during its peak LTRPA also restructured its balance sheet binding its debt position to TRIP’s share price. All of this has significantly affected the volatility of its NAV creating multiple opportunities for arbitrage. We have already taken advantage of this a couple of times:
- April’21 – post-COVID travel stock hype pushed TRIP share price upwards and LTRPA discount to its NAV widened to 30%-40%. The idea was closed for months later after the spread narrowed to 7%.
- March’22 – Russian/Ukraine war and related flight bans pressured travel stocks down causing LTRPA to trade at a premium of around 20% to its NAV. 4 weeks later, the premium reversed to a 12% discount, and the idea was closed with significant 30%+ gain in 1 month.
A lot more background on LTRPA and its debt restructuring can be found in the two above-mentioned write-ups.
Currently, the discount has widened again to the historically high level of 49%. The move has been caused by a blowout/much better than expected TRIP Q2 earnings, which pushed its share price 25% upwards over the last few days. TRIP has reported strong demand in leisure travel. Revenue grew +77% YoY and +59% QoQ, while adj. EBITDA was +336% YoY and +303% QoQ. The reported revenue is already in line with the pre-COVID levels, while earnings are also not far away. Monthly users were up +19% YoY and are now just 17% shy of the 2019 levels.
The spread is unlikely to remain at current levels for too long and will mean-revert closer to 0% as it did many times before. The volatility combined with LTRPA leverage might also cause the discount to temporarily swing into premium.
The hard part
Although there is plenty of borrow availability – the hard part for this trade is hedging and its dynamics. We think it makes sense to use the embedded leverage ratio (see here). At current levels, LTRPA NAV sensitivity to TRIP share price stands at 3.8x, meaning that 1% change in TRIP price causes 3.8% change in LTRPA NAV. This ratio will shift with moving TRIP share price. So at the current levels for every $1 LTRPA long, one should short $3.8 of TRIP to have a hedged exposure.
NAV sensitivity table is provided below:
Dynamic hedging might be required to keep the position fully hedged, however, even if you just use the fixed hedge at 3.8 it seems that you should be fine in most cases as long as the discount narrows down eventually. In fact, if TRIP price goes up by the time the discount narrows, a fixed hedge might even increase the potential upside due to LTRPA leverage. However, its works vice versa if TRIP goes down.
Note: the table above was constructed using yesterday’s closing prices. At this point, LTRPA is at $1.1/share (up $19.5%) and TRIP at $26.06 (up +4.5%), so the discount has narrowed by 4% points, but sensitivities should still be similar.
The important nuance here is that LTRPA equity goes to zero/negative once TRIP share price approaches $18/share price. The current discount formed right after TRIP Q2 results, which pushed TRIP stock price away from LTRPA dead equity zone. We think that after these results, TRIP price is unlikely to revert to pre-announcement levels where LTRPA equity was in the dead zone. At least for the next 3 months until TRIP’s Q3 results are out. However, even if that happens and TRIP share price falls to $18/share again, there’s a good chance that the trade (with fixed 3.8 hedge) would still result in profit or at least limited downside. The thing is that historically (check graph above), even when LTRPA equity went to zero/negative LTRPA share price still stayed rather stable at (around $0.75/share). That’s because market prices in the optionality of TRIP share price to rebound in time. So in such case, the discount would simply get reversed to a premium resulting in sizeable gains for this trade. Dynamic hedging would increase the profit of this scenario even further.
The obvious risk is that if TRIP price overshoots and discount remains unchanged, such traded with 4x larger short position will backfire and the trade might result in significant (even if eventually temporary) losses.