The article "What Short-Sellers Are Really Thinking"
is on page C1 of the hard copy of WSJ and it may help some readers understand
the huge short position on LGND. It doesn't address the availability of funds
issue (which I suspect is largely dependent on the asset value of your
account), so I can't say exactly how much money is required to establish so
a position, but it is clear that it happens all of the time, particularly
in the case of mergers and/or options. As the header on the continuation
part of the article "New Short Interest Thinking Views It As 'Market
Neutral'" clearly states, the short interest does not necessarily indicate
that the short holders are anticipating a price decline in the shorted
issue, but it merely represents one of two sides, both of which are held
in the arbitrage position. It also does not lead to short covering, unless
the merger falls apart.
That is exactly what is happening in LGND's case. In March? of 1995, LGND
announced the merger between LGND and GLYC (it was finalized on 5/18/95).
It was an all stock deal, and GLYC shareholders were to get 0.5301 shares
of LGND for each share of GLYC. I don't have a historical chart in
front of me, but I think LGND was at something like $13 and GLYC was $5.
In any event, the conversion offered a premium to GLYC shareholders
The 0.53 shares of LGND were worth something like 6 1/2 while GLYC was
20-35% below that price.
Before the announcement the was no short position in LGND (whenever I checked
the NASDAQ short interest tables, LGND wasn't listed). After the announcement
there was, and it was easy to see why. (Again the subsequent availability
of the shorted funds are not clear, but the ability to grab the premium
was obvious). If an investor shorted LGND and bought GLYC, the premium
would be locked in (as long as the merger was completed). The shorted
LGND would be covered by the bought GLYC stock, but since GLYC could be
bought for less than 6 1/2, the arbitrage position collected the difference.
Once the position was established, subsequent price changes would
have no effect. As a result of the deal, not only did LGND's short
interest increase, but its price decreased and soon (a week or two?)
the premium disappeared (0.5301 shares of LGND was about equal to the
price of GLYC). When the merger was approved, the arbitrage position
received its LGND shares which was used to cover the short position.
It was never necessary to buy LGND on the NASDAQ because the cheaper
GLYC was bought instead. The only risk was a collapse of the merger.
If that happened, then the LGND shares would likely go back up and
the arbitrage position would have no LGND stock to cover and would
have to buy the stock (a more conventional short position). However,
the position wasn't very risky, because both boards had recommended
the deal and LGND's board controlled over 50% of LGND outstanding shares,
and the final vote was something like 99% approval by LGND and 96%
approval by GLYC (not only would GLYC's board vote for the deal, but
so would anyone who set up the arbitrage position by buying GLYC).
At about this time, LGND also announced the creation of ALRIZ. After
the GLYC merger, the short position didn't disappear. I asked LGND
about the remaining short position and after some checking, they told
me that it was largely arbitrage with ALRIZ. As I explained previously,
its a similar set-up. A short position of LGND can be covered by
the LGNDW contained in ALRIZ. The position locks in the discount, an
the risk now centers around the callable ALRI. As long as ALRI is called,
the call price more than covers the exercise price and the position
pockets the discount. Again, LGND is never bought on the NASDAQ.
The LGND shares are acquired when LGNDW is exercised. Moreover, the
price of ALRIZ is fairly well tied into the price of LGND because of
the LGNDW. Thus, the short position idn't forced to cover, because
when LGND goes up (increasing the amount of money owed to the broker),
the price of ALRIZ also rises (increasing the value of the arbitraged
account). Its a market neutral position that captures the discount
(which was more more than it is now - at the bigginning of 1996, ALRIZ
was only 50% more than LGND, while now it is over 100% more). Of course
now its also more obvious that ALRI would be called,, but it was
really rather clear that it would happen, even at the time of the
announcement in 1995). |
