B, from yesterdays Wsj.
<<Staff Reporter of THE WALL STREET JOURNAL
There is Bogart and Bacall, Laurel and Hardy, Heckle and Jeckle -- famous pairs, all. Then there's Williams Communications and Williams Cos.: To some money managers, this relatively anonymous duo offers a tantalizing return, with less risk than the overall market.
The companies recently have popped up as a so-called paired trade, a two-sided investment strategy aimed at profiting off valuation gaps between two related securities. In this case, investors are buying shares of Williams Cos., a Tulsa, Okla., energy pipeline concern, and shorting, or selling, its telecommunications offshoot. The bet: that Williams Cos.' management will unlock the hidden value in its energy assets by potentially spinning off its Williams Communications shares.
The returns can be solid, if not spectacular, money managers say. "People have lost interest in opportunities that generate annualized returns of 12% or 15%," says Rick Meckler, chief investment officer at Liberty View Capital Management, a Jersey City, N.J., hedge fund that has been involved in the Williams pair over the past several months, and which currently has similar trades in General Motors and its Hughes Electronics unit, Flowers Industries and Keebler Foods, and BCE and Nortel Networks, among others.
This form of arbitrage can be dicey, of course. Bets like these -- on a much larger and more leveraged scale -- helped undermine Long-Term Capital Management in 1998. However, the risk "is more muted than the market itself," says Mr. Meckler, because investors typically are shorting the most pricey shares, which tend to be the first to fall in a market correction.
And "you could die waiting" for the market to recognize the value in some paired trades, says Christopher Dean, partner at Vector Capital Management, a Norwalk, Conn., hedge fund.
In its simplest form, paired trading involves staking out two positions -- one long, one short -- in companies or securities that typically share some sort of relationship. That tie could be two companies in the same industry, a convertible bond and its underlying common stock, options with different expiration dates, or, in the Williams case, a parent and its subsidiary. Investors bet that a known or expected catalyst will prompt divergent values to converge, creating profit on the long and short side of the ledger.
The Williams duo serves as a prime example of how such trades can be structured, why hedge fund jockeys and Wall Street analysts are bullish on them, and what some of the catalysts are for unlocking the potential value.
Williams Cos. closed Monday at $29.0625 on the New York Stock Exchange and has 442 million shares outstanding. Earlier this year, it spun off part of its fiber-optic network, Williams Communications, which currently fetches $26.4375. The parent retained about 395 million shares in the subsidiary, meaning every share of Williams Cos. represents 0.894 share of the offspring.
Thus, for each 1,000 shares, say, of Williams Cos. that hedge funds such as Liberty View are buying, they're also shorting 894 shares of Williams Communications. In a short sale, an investor borrows stock and immediately sells it, hoping to replace the borrowed shares at a later date and a lower price.
In this trade, an investor essentially creates a pure energy stock, since any movement in the communication shares on the short side should be offset through a coincident impact to the parent's stake. The synthetically created security, called a "stub" is "where you get the value," says Mr. Meckler. Currently that Williams stub is valued at about $5.365. (The math: $29, the price of the parent, minus $23.635, the implied value of the parent's subsidiary holdings, or $26.4375 x 0.894.)
Analysts such as David Fleischer, at Goldman Sachs, value Williams Cos.' energy assets at about $19 a share, based on industry comparables. Through the paired trade, Mr. Fleischer says, "you're buying those assets for less than half of what they're worth."
What will spur the market to recognize this value? Well, "this management team has a history of unlocking shareholder value," says Mr. Fleischer.
That could mean the parent spins out the remaining telecom shares. Some expect such a move in the spring, or soon thereafter, mainly because the company has told analysts it is committed to erasing the value discrepancy that exists. (Williams Cos. is barred from selling certain assets until then because of an acquisition in the spring of 1998 and Securites and Exchange Commission rules regarding pooling-of-interest accounting.)
Some hedge funds are involved in a similar trade in Denver's UnitedGlobalCom, trading at $56.44, and its European subsidiary, United Pan-Europe Communications, $111.50. Each fully diluted UnitedGlobal share controls about 0.7 share of United Pan-Europe, giving the parent's stake an implied value of $78.05. Add in communications assets in Australia and Latin America, and adjusted for debt, the parent's value "is about $84 a share," about $28 more than its quote, says John Woodberry, managing director at Minuteman Capital Management, a New York hedge fund involved in this trade.
This month, for example, Mr. Woodberry added to his UnitedGlobal stake when the shares tumbled to about $50, falling more than $8 in three days. At the same time he shorted Pan-Europe at about $97, a $3 spread on a 2-to-1 basis. He unwound the trade two days later-when the spread moved to nearly $10-after the parent rose a few dollars while the subsidiary edged lower. He put the trade on again Friday with the parent at $56.50 and the subsidiary at $111, a spread of just $2.
Says Mr. Woodberry: "You have a lot of historical data that give you a certain degree of comfort that you're locking into pretty good value.">> |
