Most value investors don't short stocks, and with good reason. The science behind buying undervalued stocks is not as easily applied to selling overvalued stocks. An overpriced company can rise for years, constantly requiring margin injections. (An undervalued, languishing stock requires no such cash infusion.) A company with poor fundamentals can also be bought out for more than it's worth, resulting in a loss to short-sellers. But very rarely, a situation can come along that eliminates many of the risks of shorting, while at the same time offering strong potential for upside for the investor. One such opportunity may involve going short Xing Resources (XING) and going long Qiao Mobile (QXM).
Xing has made an offer to acquire each share of QXM in exchange for 1.9 shares of Xing and 80 cents in cash. Today, that adds up to $3.75. But each share of QXM currently trades for just $3.35, resulting in an arbitrage opportunity of 11%. But the risk of this transaction falling apart has to be considered low, as Xing already owns more than 60% of QXM's shares, and therefore controls the company.
In this arbitrage play, however, owning the target (QXM) is not enough to guarantee success. Because the offer is share-based, if Xing shares were to fall, the gain for QXM investors could easily disappear or go negative. But by shorting 1.9 shares of Xing for every share of QXM that the investor is long, an arbitrage profit will be made as long as the transaction goes through. (Even if the transaction does not go through, the investor is still somewhat hedged as Xing's 60% ownership of QXM makes the fortunes of the two companies.)
Before making their investment decision with respect to QXM and Xing, however, investors may wish to wait until QXM's independent board committee responds to the offer.
Long-time readers may recall a similar situation to this one occurring last April, when TATT offered to buy up the shares of Limco that it did not already own.
Disclosure: Author has a long position in shares of QXM