$SWY, the CVR, and the psychology behind the event

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I was pretty fascinated with $SWY last week. This deal has now closed and there is nothing to do but if you want to read about what the deal/trade was you can here:

http://alphavulture.com/tag/swy/

Here's the crux: They day is Tuesday. SWY was trading at $35.15. The odds of the deal closing were 99.99999% as they just received FTC clearance and put out a PR saying the deal will close in the next 5 business days. People estimated the deal would close Friday morning making Thursday the last trading day of SWY stock. Upon close, an investor would get $34.88 in cash and two CVRs (contingent value rights). One of these CVRs was to be worth 7 cents payable in about a year. The other is the crux of the investment: A 49% stake in a mexican supermarket chain that is estimated to be worth between 50 cents and $1.50, payable anytime in the next 3 years with 3 years being the max.

Here's the problem post people had with the idea: You need to buy a ridiculous amount of SWY stock to make the CVR a meaningful position. Let's do an example:

I have a $1,000,000 portfolio. I buy 10,000 shares of SWY, costing me $350,150. This would be a 35% position in my portfolio which is obviously huge for anyone unless its $SRPT (hehe).

Upon closing, you would be left with 10,000 shares of 2 CVRs. Your cost would be $35.15-$34.88 = 27 cents. 10,000 shares x 27 cents = $2700.

On a $1 Million portfolio, your entire position would be $2700 or less than 1/3 of 1% of your assets. If you're lucky, that $2700 should grow to $10,000 sometime in the next 3 years and is almost certain to not lose money. But you had to put up 35% of your entire portfolio to create that teeny tiny position!

For people w/ margin, money is cheap. Very very cheap. Interactive Brokers will lend you money at under 2%. If you borrowed 100% of your entire account value for a week to finance this transaction it would cost you:

$1,000,000 X 2% = $20,000 annual interest/52 weeks = $384 in interest making your total cost of the CVR $2700 + $384 = $3100. Still, who wouldn't want any investment that is most likely going to triple in well under 3 years and has little risk associated with it?

My biggest issue was Interactive Brokers. They let me leverage SWY at more than 5-1, which is great. But what would happen once the deal closed and I had to wait 2-3 days for the cash to hit my account? My fear was they would make SWY "non marginable" for those 2-3 days and I would have an instant margin call on the rest of my portfolio which is filled with illiquid non marginable stuff, mostly $ABCD and $SRPT (haha). After spending a day talking to them and emailing them and having some friends do it too, I got comfortable they would not liquidate my portfolio.

I made SWY 40% of my portfolio, on margin. On Thursday night I decided I was going to take it to 75% or even 100% as if IB was going to screw me and liquidate my portfolio, I'd be pretty much completely screwed even if it's just a 40% position so why not go for gold. Unfortunately, it never traded on Friday and I wasn't able to get the trade off.

Why did this opportunity exist? Well, virtually every fund in the world can't make a position bigger than 10 or 15% let alone 40 or 50%, for starters. If you made SWY a 10% position the value of the CVR (at cost) would be so small (less than 1/10 of 1% of assets) that most funds wouldn't even bother. Futher, the CVR is non-tradeable and many funds can't or don't want to own an asset like that because they have no idea how to mark it for their investors at year end. In short, it's a headache to make a very little amount of money.

SWY was a 9B market cap! That's a shitload of stock that needs to be absorbed by people who are either willing to take on a CVR that's a teeny tiny part of their portfolios or for people who are willing to risk 40-100% of their capital for a week. And thus, the opportunity existed.

I told a few people about it and half passed and the other half made it huge (30-200% of their portfolios). There is no real good reason to pass, even if you only made SWY 10% of your portfolio. It's free money w/ a small accounting headache at tax time.

Say you have a $250,000 account and bought 1000 shares of SWY. When all is said and done, you will have $250~ tied up that will be worth about $1000 in 1-3 years. That's $750 you did nothing to get. That's a lot of dinners! But most just wouldn't waste their time...which is clicking "buy 1000 shares of SWY" in their online account and doing nothing after.

I wish we had 10 of these a year but this situation was super unique and will probably not be repeated often if ever. You need:

Very large, liquid company
Non-core assets that the acquirer doesn't want
Unable to sell those non-core assets quickly resulting in a CVR
CVR non-tradeable
CVR worth less than 1% of the entire deal making it too costly/hard to acquire a meaningful position

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