Stub Trading Case Study

2390 Words5 Pages

Why Stub-Trading Might Not Work
-using negative stub trading as an illustration

In this section, we’re interested in the potential problem and difficulty people could encounter in adopting the stub-trading strategy.
Stub-trading, is a strategy trying to detect and utilize the opportunity of mispricing of a parent company and its subsidiary to arbitrage, usually, this kind of opportunity would occur when the parent company uses equity carve out to separate some of its businesses from the company to establish an independent company- the subsidiary. Most of the case, after the equity carve out, the parent company will use a partial IPO to raise capital for its subsidiary, with the parent company still holding major ownership of the subsidiary, and then, the parent company would announce to spin-off the subsidiary, that is, to distribute the remaining shares of the subsidiary to share holders of the parent company.Then, arbitrageurs would decide whether to invest by comparing the proper stub value of the parent company with the stub value implied by the current market price, if there exists a mispricing, then it’s a chance to arbitrage.
The formula used in this paper to calculate the stub value is as following:

P_A=P_(A/B)+X(P_B )

Where P_A means share price of the parent company, P_B means share price of the subsidiary, X means the spin-off ratio, and P_(A/B) means the stub value of parent company. By looking for historical stock price and announcement of the spin-off, we could find out P_A , P_B , and X directly, and thus could calculate the stub value implied by the market. However, since to figure out the proper stub value is relatively difficult as it requires lots of information of the company, we use another approach to det...

... middle of paper ...

...ng the two examples used in this study were mainly from IT industry, and took place in the era of IT stocks at their peak, from the late 1990s to early 2000s. The examples that have been discussed throughout the study, the spin of 3Com/Palm, and Ubid/Creative are some of the most extreme cases of mispricing that the market has ever observed.

Table 2 in appendix is the list of 18 selected Equity Carve outs from 1995 to 2000, along with the stub values of each of the case. Even though it was the time period that the market has experienced the greatest number of negative stub value spin-off cases, the number of cases with actual stub value accounts only for a third of the sample. It has become incomparably harder to find such cases with negative stub value after this period, thus it will be a very tough job to find spin-off with negative stub values to take arbitrage.

Open Document