TLB - BPW Arb now with Warrants

Discussion in 'Trading' started by livevol_ophir, Feb 2, 2010.

  1. livevol_ophir

    livevol_ophir ET Sponsor

    As if the TLB - BPW conversion isn't complicated enough, here's a little more to chew on.

    Two warrants exist: BPW.WS (1.18 x 1.20), BPW.U (11.00 x 11.80)

    BPW.WS is a 7.5 strike warrant that you can buy for 1.20. It is like European exercise - it can only be exercised if the deal goes through. You would buy one BPW share for 7.5 which is the net of paying 8.70. As long as TLB stays above $8.49.

    Why 8.49? The target price for TLB conversion is 11.25. The number of shares of TLB that each BPW share turns into is in a range 0.90 - 1.325. So, assuming the worst case scenario (lowest TLB stock) you get 1.325 shares of TLB for each BPW ---> 11.25/1.325 = 8.49.

    So at fist glance this is an easy arb. Buy the warrant for 1.20 --> deal goes through--> exercise your BPW for a total of 8.70 and sell it out @ 11.25 as long as TLB doesn't collapse from ~13 to below 8.49.

    But that would imply that there is ~30% chance that the deal doesn't go through - otherwise the arb wouldn't be there anymore. But all signs point to this being more like a 90% event (or more). So what's happening?

    Recall the difference between a warrant and an option. Specifcally, warrants issued by the company itself are dilutive. When the warrant issued by the company is exercised, the company issues new shares of stock, so the number of outstanding shares increases.

    So the rub here is that there will be a huge subscription to this wrrant and BPW stock in general, which will increase the number of shares of TLB and push it down far enough that buying for 8.70 + risk premium is not necessarily a good purchase. i.e. the market is saying that TLB will be ~9.00 after the deal (I am just guessing 0.30 risk premium). Oddly enough, the more this warrant gets purchased, the less it's worth.

    For completeness: BPW.U is the warrant + one share of BPW stock.

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