Johnson & Johnson (JNJ) – Split Off – $2500 Upside

Current Price – $172.39

Offer Price – $185.32

Upside – 7.53% or $1280 for Odd Lot holders (or $2500 if exchange ratio is at the upper limit)

Expiration date – August 18, 2023

SEC Filling and Presentation

 

This is a rather standard split-off setup, where odd-lot accounts can pocket $1000+ in a few weeks. 18 similar split-offs have already been posted on SSI – the most recent ones are MMM/NEOG and DD/IFF. I recommend checking our in-depth Analysis of Split-off Trading Strategies to have a better understanding of share price behavior, risks, and possible trading strategies in this kind of transaction. So far all the split-offs proceeded on announced (or improved) terms and none were canceled. However, arbitrage on some of them did not generate the expected returns due to hedging costs/availability or unfavorable share price movements for unhedged positions.

Johnson & Johson is divesting its 80.1% (out of the 89.6% stake) in Kenvue, its recently IPOed consumer healthcare division. Shareholders of JNJ have the option to participate in the tender and exchange their JNJ shares for KVUE shares at a 7.53% premium. The tender expires on the 18th of August – different brokers might have different deadlines for tender participation.

Every $100 of JNJ stock accepted in the tender will be converted into $107.53 of KVUE stock subject to the upper limit of 8.0549 KVUE shares per each JNJ share. The exchange ratio will be determined on the 16th of August and calculated using the VWAP prices of both companies during the 14-16th of August. At current prices, the upper limit is not in effect and tender offer participants would receive 7.53% premium in the exchange. Odd lot holders (<100 shares) will be accepted on a priority basis and won’t get prorated and this is where the $1000+ return could be generated.

The key difference of this split-off from the others, that I have covered over the last decade, is that JNJ is divesting almost the whole stake in KVUE only 3 months after the consumer health division was IPOed. Actually, as a standalone company, Kenvue only had a chance to report one-quarter of earnings (one month of which was still part of JNJ). Not sure if this might have any impact on the dynamics of the split-off and/or share price behavior. KVUE is trading at a slight premium to the $22/share IPO price.

Current KVUE float is c. 10% of shares outstanding and the demand for hedging will be very high given that the float is set to increase 9x with this split-off transaction. As can be expected the borrow of KVUE shares is getting tight. IB has some borrow availability and it is possible to initiate a hedged position (see pic below). However, borrow fees spiked to 14% over the last few days and are likely to continue increasing further. I think there is a substantial risk of materially higher borrow fees (100%+ annually) and forced buy-ins for the short-leg of the trade (which has happened on a couple of split-offs before. Applicable for hedged positions only).

KVUE borrow

Unhedged play of this setup (i.e. only long JNJ) is also a possibility, and, in fact, this strategy historically has resulted in higher returns for 13 out of 18 of the previous split-offs. However, the unhedged trade on the last split-off (MMM/NEOG) resulted in losses, as NEOG shares sold off heavily after the expiration of the tender.

Both companies have already reported Q2 earnings. Dividends for the quarter will only be paid out after the expiration of the tender. I am unable to comment on the appropriateness of JNJ and KVUE market valuations. Both JNJ and KVUE and mega-caps with $480bn and $50bn capitalizations respectively,

I have added JNJ long (99 shares at $172.39) and KVUE short (797 shares at $25.12) positions to the SSI Tracking Portfolio.

 

Important points/risks to consider (similar to other split-offs):

  • Upper limit. The transaction is subject to the upper limit of 8.0549 KVUE shares per share of JNJ. The upper limit is currently not in effect. Due to the presence of the upper limit, the spread might get eliminated if e.g. JNJ gets more expensive and/or KVUE gets cheaper.
  • Oversubscription. The maximum amount of JNJ shares that will be accepted in the tender is only 7%, around the average for previous cases (around 5%). Nearly all of the previous split-offs have been heavily oversubscribed (10x-20x). It is likely JNJ/KVUE transaction will also be oversubscribed, hence, this trade is applicable to odd-lot positions only.
  • Odd-lots are exempt from proration. Holders of 99 shares or less will be exempt from proration.
  • Tight borrow. There is a strong chance that hedging availability will decrease and borrow fees will go up in the upcoming weeks. As a result of this transaction, KVUE float will increase nine-fold. Fee increases and limited borrow availability adds risks of forced buy-in for the short leg of the hedged trade – this has happened for a couple of previous split-offs.
  • Hedge vs no-hedge. SSI analysis shows that on average unhedged split-off arbitrage results in higher returns – 13 out of 18 transactions had higher profits with unhedged positions. However, the talk here is only about a 7% spread and there is a substantial risk that unhedged trades will result in a loss due to volatility in JNJ share price till tender expiration or KVUE sell-off after tender expiration (it takes c. one week to receive exchanged shares).
  • Final exchange ratio and timing of the position opening. The final exchange ratio will be determined based on the VWAPs of a few days before the final ratio announcement (August 18), so one might wait till then to enter the position. IB deadline for tendering is usually noon on the expiration date, other brokers might have other deadlines. The final exchange ratio usually ends up at or close to the upper limit, I would expect a similar outcome here.
  • Risk of Odd-lot provision cancellation. This provision has never been canceled in a split-off transaction so far. The maximum amount of odd-lot shares participating in a split-off was close to 2m vs around 190m of JNJ shares that can potentially be accepted in this offer. However, at least theoretically, the risk of odd-lot cancellation remains.

72 Comments

72 thoughts on “Johnson & Johnson (JNJ) – Split Off – $2500 Upside”

  1. Since the consideration is in stock, I take it there are no tax issues (like deemed dividend) on receipt of KVUE shares?

    Also, anything wrong with hedging with puts?

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    • I think there would be a timing mismatch with puts. Options expire Aug. 18, probably ca. a week before shares hit the account (assuming one week after the exchange ratio is announced).

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    • Taxation matters might depend on your jurisdiction. Normally, you pay capital gains tax on any returns that this setup might generate.

      Hedging with puts is possible, but is very expensive. You would also need September puts as per Paul’s comment above.

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  2. Why is it that you are: “unable to comment on the appropriateness of JNJ and KVUE market valuations”? Thank you.

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    • I meant to say that these companies are large conglomerates and I assume the market prices them efficiently. Any insights from my side on potential valuation discrepancies (especially for a short period of one month) would be useless.

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  3. Probably a stupid question, can you buy odd-lots in multiple accounts and still receive it? Or since both accounts have the same name, it would be not be considered an odd-lot?

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    • I think it is linked to your tax file number so it will be aggregated and deemed greater than 99 shares.

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      • I think this aggregation has not happened in the past, but has been a constant worry/threat to this strategy using multiple accounts. I believe in general in these situations multiple accounts have not been aggregated together, but they certainly could be.

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    • Did this kind of transactions several time in the past years. Never had any issues. Even used several accounts on my name with IB and other banks (single on my name, joint with my wife, joint with my brother, single on my wife etc.)

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      • Hi Mura – I also have IB and only 2 accounts there (a Traditional IRA and Roth IRA) both of which are single on my name. Have you ever bought 99 shares apiece in this sort of situation, and did the odd-lot work? Thanks.

      • Take it for what its worth. For the $DND transaction, I helped out a family member and was able to buy and sell 99 shares on 2 different accounts (TFSA and RRSP for the Canadian folks). USED HSBC. Both were under the same account.

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  4. Any thoughts on the Talc litigation here? I hope this isn’t like 3M where some badly timed litigation news hurt (the unhedged) return pretty badly.

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    • I’m not a lawyer, but I don’t see that as a problem here. From what I understand, the Talc litigation liability has been spun off into a separate entity, so it is not recourse to J&J and especially Kenvue. If Talc liability spin-off is found illegal, that would be put on J&J’s shoulders and not Kenvue’s. Even in that case, it should have no impact on the current transaction.

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      • This legal issue is exactly the opposite where the spinoff did not fly and so JNJ getting hammered. Def feels like MMM here. They also chose the exact same exchange ratio as MMM, seems odd.

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      • It may be a problem for JNJ, and that is still to be determined. However, I still think it will not affect Kenvue or this transaction in any way. Yesterday, the company released a Q&A in which they definitively stated that the split-off of Kenvue will not be affected by the bankruptcy court’s decision (see the answer to question 6).

        https://www.bamsec.com/filing/162828023026169?cik=200406

      • I think the deal still goes through but like MMM, it could create an overhang on the stock that hurts the exchange ratio and returns especially if you bought when first announced.

    • My personal uneducated opinion only, but I do not think Talc litigation is going to have a material impact on the outcome of this setup. However, the final exchange ratio now is more likely to end up below the upper limit.
      – JNJ tries to push a global $8.9bn settlement which some of the plaintiffs appear to be opposing. So the market likely already accounts for at least $8.9bn+ in damages. So it’s not like a big damages figure will suddenly appear unexpectedly.
      – Even if that would double, the incremental part (additional $10bn) would only account for 2% of JNJ’s market cap. JNJ shares have already declined 4% after an unfavorable ruling last Friday (this ruling disallowed JNJ’s attempt to settle these litigation claims in bankruptcy court).
      – From the disclosures in 10Q there does not seem to be any litigation announcements imminent over the next 3 weeks.

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  5. Before the exchange ratio is fixed, I think the trade is unhedged (wrt JNJ price risk) even when paired with KVUE short. In fact, I think the “hedge” can backfire if KVUE goes up and JNJ goes down between now and 14-16th of August . Am I wrong?
    To minimize JNJ price risk, should enter the trade (hedged or unhedged) as late as possible?

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    • If there would be a chance to guarantee that the 7.5% spread and borrow will still be available after the valuation dates, then the risk-free arb would be to enter the position after the valuation dates when the exchange rate is set in stone. However, for a few cases spread closed/narrowed till the valuations and borrowing were not available. So it’s a guess how it is going to work out this time.

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      • There are a number of ways to lock in the borrow and “activate” it later:
        (1) Short 100 share KVUE in one and long 100 shares in another of your accounts (and then close the long position after the valuation date).
        (2) If CFD is available, you can also long 100 shares of KVUE CFD contract and short 100 shares of the the underlying in the same account (and close the CFD after the valuation date).
        (3) Pre-borrow. Interactive Brokers allows you to pre-borrow stocks without immediately shorting them, but I believe they allow you to hold the borrowed stocks for maximum 3 days only (if no shorting occurs by then, the borrowed stocks will be returned to IB)

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    • I am sorry but why would you be selling call options? call options are a negative delta trade. I sold put options below $22.5 (a price that would likely yield a ratio in excess of the 8.06) as downside beyond that is useless for this transaction. I used the proceeds to buy $24 calls, which is the correct hedging tool.

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      • Now that I think about it, the more optimal hedge here would have been selling in the money calls at 22.5 and buying the 25. Would have avoided the short borrow as well.

  6. Noticed that the gap between the shorted and long market values. Realized that if we actually hit the upper limit, the upside is closer to $2.5k. And it looks like its quite likely. Am I correct in saying this?

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    • I do not believe that is the case. Run the math again. If the valuation date were today, using today’s numbers (which clearly it is not, these will definitely change), if you buy 99 shares, it would cost you $16,830. If you exchange them, you will receive $16,830 X 1.0753 = $18,097 in KVUE shares. At the current $23.65 KVUE price, that would be 765 KVUE shares. If you shorted those KVUE shares at the current price for the hedged trade, you would receive about that $18,097 in proceeds. Your profit would then be $18,097 – $16,830 = $1,262. Again, THIS WILL NOT HAPPEN at these prices, that is just a hypothetical at today’s prices.

      The big risk if you do the trade now is the relative price of JNJ/KVUE going down. Meaning either JNJ goes down significantly more than KVUE, or KVUE went up for some reason significantly more than JNJ. The big risk is a relative decrease of the JNJ/KVUE price ratio between the date of entering into the long/short hedged trade and the valuation dates. The secondary risk, though not as significant because it would likely just eat into the upside rather than causing a loss, is if the ratio goes the other way and hits the upper limit cap.

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      • Thanks for comment. But there are a couple of moving parts here that aren’t being considered. One, I explicitly posed the scenario that we hit the upper limit from here. So the 765 units calculation you referenced isn’t really applicable. Two, the ratio at the time of trade execution was closer to 7. So even in the event that there we remain flat, the payoff will be roughly 9% as the relative ratio has widened over the last week (despite the drop in JNJ). In theory, there is good reason to believe that the ratio will approach the 8.06 mark as short interest continues to mount on $KVUE. Remember, this is the primary driver of that company’s share price at the moment while $JNJ is (largely) doing its own thing. This litigation has shown exactly that. KVUE declined more than JNJ in the last week, with no catalyst besides the share exchange.

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  7. So could you provide a scenario, with the math, in which the upper limit is hit and the upside is closer to $2.5k? Indeed, the 765 units are not applicable, as I said, it was an example of the math to show the profit at the current level. Running a similar calculation at different levels, is how you figure out the financial effect on the moving parts of a trade like this. If you do similar calculations at different levels, I don’t think it leads to a profit of $2.5k for the hedged trade, especially if the upper limit is hit. With the unhedged trade, you could end up with a greater profit, but in the scenario where KVUE goes up, not down as you are suggesting.

    Maybe I was confused about what you were suggesting, but with the hedged trade I don’t see how the upper limit being hit leads to a $2.5 k profit.

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  8. I’m very glad you asked this question, because I just learned that I misapprehended something about this trade. In the scenario that one enters the hedged version of this trade now, at $170 for JNJ and $23.65 for KVUE, and then between the date one enters the trade and the valuation date the ratio of JNJ to KVUE goes up (so either JNJ goes up relative KVUE or KVUE goes down relative to JNJ) if it goes from where it currently is to the upper limit or near that, then I think that would represent a profit of over $2k. For instance, if one enters the trade at $170/$23.65 and then the valuation for the exchange is struck at $170/$22.50 then that would be right at about the upper limit and the profit would go from around $1,250 that it would be at $170/$23.65 to about $2,150 at $170/$22.50 (which if I understand this correctly now, would be right about at the upper limit).

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  9. My cost basis was as follows (purchased on the 29th of July):
    – $Kvue short: $24.46/share – ($19.5k)
    – $JNJ long: $172.01/share – $17.0k

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    • This is close to the recorded SSI trade.

      But as of today (to be precise, EOD Friday 8/4, at $169 and $23.53), 99 shares of JNJ will fetch 765 shares of KVUE. You’ll have to cover 32 shares of KVUE from your $2.5K gain to zero out, which will cost $752. I mean, $1750 is nothing to sneeze at, but it’s not $2500.

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      • That 765 is now 788 as of yesterday’s close. As mentioned earlier, I suspect that we will hit and cross the 8.06 ratio in the coming week. Let’s remember that this trade is the proverbial $20 on the sidewalk. The market is not obliged to grant $JNJ holders a quick 7% return.

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  10. While we are at it, does anyone else see the value in selling a lower strike put (upside in excess of the 8.06) and buying a higher strike call on $KVUE to hedge a deterioration in the ratio? One can do the exact opposite on $JNJ to completely hedge the position. I suspect that the entire cost of hedging won’t exceed $300 and will, theoretically, give you 100% of the upside.

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  11. has anyone received notification from IBKR w the ability to elect to convert?

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  12. Today the news dropped that KVUE will become a S&P 500 stock, this could provide some support for the KVUE shareprice (for those unhedged like me).

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  13. Hi,

    What about a KVUE short risk if the price above 25$, then you get less shares and short lost can exceed deal gains?

    Thank you!

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    • That is a risk. If your short position is higher than the number of shares you will eventually receive in the exchange offer and subsequent to tender expiration KVUE shoots upwards, then you would have losses on the residual KVUE short position.

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  14. Couple more clues on the headwind of $KVUE shorts:
    – Rolling 20 day correlation between $JNJ and $KVUE has collapsed after the announcement, and has turned marginally negative. This is very rare to see with two companies in the same sector.
    – Inclusion into the SP500 did not materialize in any upside for $KVUE. Would expect to see more weakness in the coming week. At this point, I would expect to see the ratio (ex-the exchange offer) to get much closer to 8.06.

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  15. Anyone know when the last date to tender is? Just bought some today at IB.

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    • The expiration date is the end of August 18. Guaranteed delivery is included.

      From the tender document:

      “THE EXCHANGE OFFER AND WITHDRAWAL RIGHTS WILL EXPIRE AT 12:00 MIDNIGHT, NEW YORK CITY TIME, AT THE END OF THE DAY ON AUGUST 18, 2023”

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  16. Has anyone using Vanguard successfully made an election? I contacted customer support regarding the shares not displaying on the dashboard, and they advised me to try again later today.

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    • I have the same question for Schwab. Has anyone using Schwab successfully made an election?

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      • How much does Schwab charge for voluntary corporate actions?

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  17. Does anyone know when these shares are going to be put to us. This short borrow cost is mothercracker.

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  18. Perhaps a dumb question, but if we anticipate that the KVUE share price will rise over the next week and the borrowing costs remain high, wouldn’t it make more sense to cover the hedge today by purchasing KVUE shares rather than waiting until we receive the shares from the exchange? Naturally, this would imply a default long exposure to KVUE shares from the moment we close the short position.

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  19. I’ve had the shares on IB for a couple of days, but they’re not tradeable yet. Is it likely that when trading goes live there will be a sell off? The idea would be to take advantage of this situation with put options.

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  20. JNJ is now down 5% since the expiration and falling.

    My guess is that large JNJ holders who tried to participate in this offer overestimated the proration ratio and have to short more JNJ shares.

    Does anyone else believe that this is soon going to be a buying opportunity for JNJ; once the temporary selling pressure subsides?

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  21. anyone else got a prorated amount from IBKR? I am fuming. They assured me that all 3 of my accounts are going to be full allocated the odd lots.

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    • I understand (from other shareholders) that JNJ determined you got odd lot treatment only if you owned up to 99 shares total across all accounts/brokerages under your TIN.

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      • Wow – that is a big development. Did anyone else on this board have their shares aggregated across multiple brokerages (meaning 99 at one brokerage say IB and 99 at another say Schwab) such that they did not receive the odd lot non-proration?

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    • Are those three accounts all with IB or at different brokers? If all at IB, then they won’t be treated as odd lots if total number of shares is more than 99.

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  22. I had 99 shares and submitted 94 for exchange strange but only 22 shares were exchanged leqaving me with 77 shares. Already filled IBRK a ticker for clearing this out.

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    • you should have submitted all your shares to be eligible avoid prorate if I’m not mistaken

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    • At least with Interactive Brokers, if you have multiple accounts open under one name, the positions aggregate. I’m not sure about other brokers.

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      • Historically, tendering with multiple accounts through multiple brokers used to work well. However, it appears that this time, JNJ decided to aggregate tendered shares even through multiple broker accounts. Would be interested to know if there’s a way to know how the company will treat odd lots beforehand in order to avoid this situation in the future.

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  23. I bought 99 shares in each of my three accounts at a single broker. Submitted as an odd lot tender and it worked out well. No issues.

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