PPG/GGC odd lot exchange offer arbitrage

I was alerted to an interesting odd lot arbitrage opportunity in PPG & GGC thanks to Whopper Investments. PPG Industries is a 22 billion dollar company that is selling/spinning off its commodity chemicals business in a complicated transaction to minimize taxes using a Reverse Morris Trust. The steps of the transaction are described here in the prospectus. Since a picture says more than a thousand words: the transaction explained in diagrams:

So I hear you thinking: this is all very interesting, but where is the opportunity? The opportunity lies within the fact that PPG shareholders can exchange their shares for GGC shares at a discounted price. \$100 dollar worth of PPG shares can be exchanged for \$111 worth of GGC shares. Because GGC is significantly smaller than PPG not all PPG shares can be accepted in the exchange offer: PPG has 153M shares outstanding and approximately 10.7 million PPG shares can be exchanged for GGC shares. Given the title of the post you can guess that there is an exception: if you own less than 100 PPG shares (an odd lot) you can exchange your shares for GGC shares without being prorated. Given the fact that PPG is trading for ~\$143/share this means that you can create a sizable position, and that the expected profit for a long PPG/short GGC trade is a not too shabby ~1500 dollars.

How much you will make on the trade is at the moment not yet known, because the number of GGC shares you will receive for every PPG share is not yet determined. This will be based on the VWAP prices of both stocks on 23, 24 and 25 January. Indicative values are provided daily by PPG. I have created a very simple spreadsheet that can be used to calculate the expected profit of the trade based on the current share price of PPG/GGC, and the latest ‘Indicative Calculated Per-Share Value’.

As is visible the expected value of the trade today is lower than what you would expect based on the 1.11x exchange ratio. This is because the exchange ratio is calculated using the 3 day average VWAP price, and not the current market price. So you are expected to make 11.1% on a ~14K position, but it could be a bit more or less depending on when you initiate your position and how PPG and GGC will trade relative to each other the last days.

A related problem is that you also don’t know yet how many GGC shares you should short to remove most of the market risk from the position. I will simply wait till the last moment to initiate my position. My broker (Interactive Brokers) allows you to tender shares that are bought in the morning of January 25, and at that time the exchange ratio will be mostly fixed. Other brokers often require that you buy several days in advance to be able to participate in a tender offer. In that case hedging is a bit more difficult, but don’t think that’s really problematic. If you are expected to make ~11% you can handle some negative variance without losing money, and you could get some positive variance as well.

Disclosure

Will be long PPG and short GGC soon