Date: Tuesday, May 20, 2008
Author: Mara Lemos Stein, Dow Jones Newswire
Arbitragers take note: It isn't too late to make some gains in the takeover of U.K. news and financial-data provider Reuters Group PLC by Canada's Thomson Corp.
The deal closed last month, and the new company, Thomson Reuters Corp., has two parent companies that are listed at the Toronto Stock Exchange and the London Stock Exchange. Shares at the LSE are trading at a significant discount to those listed at the TSE, offering an opportunity for arbitrage as hedge-fund managers expect the gap to close in coming months.
The price differential is both a reflection of diverging investor sentiment toward the company on the opposite sides of the Atlantic and a consequence of takeover cash-and-stock consideration. Thomson paid for Reuters' $16 billion acquisition partly in cash and partly in new shares, which involved an exchange of the Reuters' London-listed stock for new Thomson Reuters PLC shares, thus increasing supply of shares in the London market.
(This story also appeared in Hedge Fund Trades, a daily newsletter published by Dow Jones & Co.)
At current market prices, arbitragers that got into the trade after the deal was announced a year ago aren't making as much money as they had hoped because The London shares are trading at about a 16% discount to those listed in Toronto. As is standard in an arbitrage play that involves payment in stock, the hedge funds were long Reuters' shares, which were listed in London, and short Thomson's shares, which were listed in Canada. As their Reuters' shares became Thomson Reuters, they ended up holding an asset that is exactly the same as the one listed in Toronto, only it's 15% cheaper.
That may be an advantage for those wanting to get in on the trade now, but for those looking to exit, it's a bother. Because many of the arbitragers wanted to get out of the position after the deal closed last month, they actually contributed to the persistence of the price disparity, hedge-fund managers said. To exit the trade, they have to buy back shares on the TSE to cover their shorts, thereby pushing those prices higher, while selling the LSE-listed shares. What's more, they said, the cost of borrowing Thomson Reuters' shares at the TSE has risen since the new listing on April 17.
"People didn't make the entire amount of money they thought they were making in the trade because the London shares are trading at about a 15% discount (to Toronto-listed shares)," said Roy Behren, co-manager of Westchester Capital Management, which manages about $800 million in merger arbitrage mutual funds and hedge funds. "We expect the discount to tighten in the months to come, so we're not exiting here."
Based on the closing prices Friday, Thomson Reuters' shares on the TSE were at C$37.56, while those on the LSE were at GBP16.55, or about C$32.29.
The London shares rose 0.7% Monday to GBP16.68 as the company announced plans to cut 835 positions, in a much-anticipated work-force reduction following the merger. The Toronto shares were closed Monday because of Victoria Day in Canada.
Although the price discrepancy can be partly explained by a technicality - the increased supply of shares in London and short covering - hedge-fund managers said they are perplexed by the size of the discount, especially as the dual- listed company structure guarantees that holders of either have the same economic and voting rights to holders, meaning they get the same cash dividends and capital distribution.
The shares debuted at the TSE and LSE on April 17 so it's still early, but in a global market, any difference is usually wiped out more quickly, not least because of the presence of hedge funds that tend to crowd a trade whenever they spot an arbitrage opportunity.
The price disconnect can also be blamed on the fact that while Thomson, a provider of legal and professional information, is a blue-chip company in Canada with large investors and many analysts following it, Reuters has fallen out of favor in London.
"Clearly, the U.K. investors are much more negative than North American investors," said Jeff Ubben, managing partner at San Francisco-based hedge fund ValueAct Capital Management. "The U.K. investors are very much focused on what happened last cycle; they aren't sure about how much progress management has made and the power of the product." ValueAct, which manages a long-equity portfolio of about $4.5 billion, was a substantial holder of Reuters' shares before the takeover and has about 4.5% of Thomson Reuters PLC (TRIL.LN) stock, the London-traded shares.
For their part, it seems, Canadian investors are reluctant to buy the company's LSE stock, even if it's cheaper, said Paul Glazer, principal at Glazer Capital Management, a $240 million merger arbitrage hedge-fund firm in New York that is trading the arbitrage between London and Toronto shares. Last week, Glazer sent a letter to some large Canadian pension-fund investment firms pointing out the share discrepancy and questioning whether these funds are breaching their fiduciary duty by not buying the cheapest shares in London. Glazer told Hedge Fund Trades that he hadn't gotten any response from his letter at the time of writing.
"Basically, anybody who buys a Canada (listed Thomson Reuters) share at 20% premium to those in the U.K. is breaching its fiduciary responsibility," said Glazer. "If it's not fiduciary, it's just making an error and they could buy more of the same asset for the same amount of money."
Glazer, whose firm is long the London-listed shares and short their Canadian equivalent, isn't concerned that the recipients of his missive may argue that he has a vested interest in seeing Thomson Reuters' share price rise in London to make a profitable arbitrage trade.
"My arguments are all factually correct," he said. "And I state my position in the letter."
Besides the arbitrage play, some say there's value in Thomson Reuters, which is now the world's largest provider of financial information for the brokerage, investment-banking and wealth-management sectors.
"Right now you can pay 14 times 2009 earnings in the U.K. for the stock," said ValueAct's Ubben, and about 16 times earnings, if the trade is in the TSE-listed shares, which he said is cheap compared to competitors.
The new company has three liquidity pools, because the TSE and LSE shares also trade in American Depositary Receipts in New York. "I think Tom (Glocer) may find that it's too much to support, and they should move away from the U.K.," he said, referring to the company's chief executive, who was previously Reuters' CEO.
"We would like to see North America setting the price; we'd like to see a big share repurchase in the U.K. that's funded in the U.S.," Ubben said. A large convertible stock offer, for instance, of about $2 billion, would bring many U.S. investors to the stock and force a change in the market. He said company officials are considering such an offering. The move would also mean more sell- side analysts in the U.S. would start looking at the name, which Ubben thinks would help shift the negative sentiment that prevails in the U.K.
Until that happens, there's still money on the table in the arbitrage trade.
By Mara Lemos Stein, Dow Jones Newsletters; 201-938-2354