Monday, December 15, 2008

Arbitrage For The Retail Investor

Sometimes, a public company (say Company A) will own shares in another public company (say Company B). When Company A's ownership stake in Company B is worth more than the market cap of Company A, clearly the market has made a pricing mistake. When this occurs with large companies, investors enter the market and drive the prices to more reasonable levels. When this occurs with small companies, however, there is little return on investment for large funds, offering small investors a chance to profit.

Consider Glendale (GIN), which owns 43% (and control) of Firan Tech (FTG). FTG trades for $6.2 million, and so Glendale effectively owns $2.7 million worth of Firan...but Glendale itself is trading for only $2.6 million! In addition, Glendale owns cash, inventory and A/R of $15 million over and above all of its liabilities!

Even if you believe that Firan is overvalued in the market, you can take a short position in FTG along with a long position in GIN. No matter which direction the market values of these companies move, you neither profit nor lose. As long as GIN increases in value relative to FTG (which it should eventually), you have made an arbitrage profit, on a retail investor scale!


Unknown said...

However, both are running the risk of delisting (less than 1 USD a share) what happens then with the arbitrage?

Saj Karsan said...

Hi Matias,

According to the listing requirements of this exchange, there is no minimum $1 USD requirement.

Anonymous said...

Isn't this the type of thing hedge funds tried to do with Porsche and Volkswagon? ;)

Saj Karsan said...

Hi Chad,

On a naked short you can certainly get killed. But those who owned both Porsche and shorted Volkswagen in equal proportions would have benefited from Porsche's gain, which would neutralize the losses resulting from Volkswagen's price rise. They would most likely have to answer margin calls, however.