From briefing.com -
ZD, ZDNet, and Arbitrage
We are still getting emails regarding confusion over ZD and ZDNet. First of all, three clarifications, then an explanation of our original post regarding how to arbitrage the situation.
Tracking Stocks
First, tracking stocks are not separate companies. There is still only one Ziff-Davis, Inc. company. It consists of an internet division, called ZDNet, and all the other divisions (mostly trade magazines such as PC Week), still called Ziff-Davis. The financials of both groups will be reported separately for the purposes of the tracking stocks.
The ZDNet division has its own tracking stock, called ZDZ, which is intended to reflect the performance of this division only.
The other divisions have their own tracking stock, called ZD, which is intended to reflect the performance of all the other divisions. The previously existing ZD stock became ZD tracking stock automatically.
Both stocks together represent all the assets of the company called Ziff-Davis, Inc. The combined market capitalization of all outstanding stock (ignoring for the moment the retained interest ZD has in ZDZ), the total value of both is larger than the value was when it was all just ZD stock.
When you divide something that is whole into two pieces, and the two pieces become worth more than they were as one entity, it truly is "creating value out of thin air."
One emailer wrote "does this mean that any time a stock price goes up, it is creating value out of thin air?" The issue is whether the stock price goes up for business reasons, or stock market reasons. Ziff-Davis' is going up for stock market reasons. Creating the ZDZ stock neither added a new line of business nor improved an existing line, except that the IPO proceeds will reduce Ziff-Davis debt.
The Retained Interest
Ziff-Davis Inc. has a retained interest of 84% in the ZDNet tracking stock. No matter how you cut it, ZDZ stock only represents 16% of the ZDNet business. Emailers wrote that the retained interest is only psychological, or that it can't be counted because it would be "double-counting" are fooling themselves.
One feedback writer rebutted our comments that a $1.00 dividend paid on ZDNet stock would result in an $0.85 credit to the ZD financials, as "ludicrous accounting." We refer you to page 155, 160, and page I-2 of the prospectus, where this is clearly spelled out. Page 155 states :
...at the time of any dividend on ZDNet stock, Ziff-Davis Inc. will credit to ZD, and charge against ZDNet, a corresponding amount in respect of ZD's retained interest in ZDNet.
It may appear ludicrous to you, but that is what would happen. The ZD side of the business has the right to plunder the ZDNet side because of the retained interest. It can't be expressed any more directly. The fact that ZDZ shareholders don't like to hear us say this doesn't make it untrue.
Because the ZD side of the business still has a retained interest in the ZDNet business, ZD stock and ZDZ stock will be inextricably linked in the market. If Ziff-Davis management really wanted ZDZ stock to reflect only the results of ZDNet business, then the company should have made ZDNet completely independent.
However, we believe Ziff-Davis management retained interest in ZDNet so that they can sell more ZDZ shares and reduce their considerable debt burden.
Market Capitalization
The concept that ZD's retained interest in ZDZ is "worth" more than all of ZD is not erroneous, provided you understand the concept of market capitalization.
(Note: The fact that the ZDZ prospectus uses the term market capitalization to mean only those shares issued in ZDZ stocks (currently 11.4 million) times its share price (a definition used primarily for the conversion rights of one stock into the other), does not change the concept of market capitalization as the total worth of a company.)
Market capitalization is based upon the concept that a single share of a company is proportionally representative of the overall value of the entire company.
But you must always consider volume. Whenever a stock trades at a high, then falls over time, was it really worth that high price times all shares? The fact that one person thought it was, does not really give the entire company that proportional value.
This is the root of the problem with ZDZ stock.
Calculating ZDZ's market capitalization using a total share figure of 71.5 million is accurate thinking. That's how many shares there are. The pro-forma historical results for ZDZ stock use 71.5 million shares for per-share calculations.
So how can ZDZ shares times their price be worth more than all of ZD shares times their price?
It is solely attributable to investor willingness to place equivalent internet valuations upon the ZDZ financials, even though ZD has an 84% claim upon them.
Just as a single trade at a high price doesn't really mean all the shares are worth that much, the 11.5 million shares of ZDZ that trade doesn't mean that the whole company, 71.5 million shares, could trade for that price.
As another example, Bill Gates couldn't sell all of his shares all at once for the current market price of MSFT. Who would buy it? Mr. Gates' value is mostly conceptual.
The deduction, of course, is that ZDZ shares are trading at higher than they ought to be, or that ZD shares are trading lower than they ought to.
Which leads us to the arbitrage play.
The Arbitrage Play
In the very first Story Stock we wrote about ZD and ZDZ market inefficiency and how the market is overvaluing ZDZ and undervaluing ZD. We suggested that a traditional arbitrage play would be to short ZDZ and buy ZD in equal amounts to capitalize on the inefficiency.
First of all, equal amounts meant equal amounts of shares, not equal amounts of money. All you are concerned with is the discrepancy between each share. Here's an example of how this works:
4/1: Briefing's First Story Stock4/5 ZD=21 7/16, ZDZ=44 5/84/09 ZD=17, ZDZ=38 1/2Short ZDZ at 48 1/2+4+10 per shareLong ZD at 24-2 1/2-7 per shareGain+1 1/2 per share + 3 per share
The gain comes from the gap closing. It does not matter whether both stocks rise, both stocks fall, or ZD rises and ZDZ falls. Only the closing of the gap matters.
However, because ZDZ is considered an IPO stock, it cannot be shorted for 30 days. Otherwise, this gap would have been narrowed considerably within minutes, as institutional arbitraguers jumped on it. But with ZDZ unshortable, and with so many individual owners apparently acting as if ZD does not have a retained interest, the inefficiency has been allowed to persist. And may persist for some time.
It will be very interesting to see what happens on May 3, when ZDZ shares become shortable at most brokerages. |
