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Hedging A PayPal Spin-Off Arbitrage Investment Strategy

PYPL and EBAY stocks are expected to start trading in the “when-issued” market this week. Introducing four investment strategies for different levels of risk tolerance. The PayPal spin-off investment scenario reflects an expected return of 2% to 11%. The long waiting period is finally coming to an end as PayPal (Pending: PYPL ) and eBay (NASDAQ: EBAY ) are getting closer to the first spin-off milestone – July 8th, the spin-off record date. The record date has some significant meanings in this context: Holders of EBAY shares will be entitled to receive PYPL at the distribution. The first batch of (largest) shareholders will receive their distributed shares. Trading at the “when-issued” market begins based on shares distributed in the first batch. After the previous article published about the PayPal spin-off arb strategy, I received many questions about how to create an optimized position that would benefit from this spin-off arb opportunity in a hedged environment. I answered some of this questions, and I want to present some scenarios that will assist readers and potential investors to tailor the best position to meet their unique characteristics. At the beginning, I wish to address two primary issues that are fundamental to this investment strategy: risk aversion and outflow theory. Before investing in the PayPal spin-off (if investing at all), investors should know exactly what their risk appetite is. Some investors take high risks in anticipation of higher returns than usual, and other investors take small risks and expect moderate gains. Both approaches are perfectly fine, but an individual investor should think of that before engaging with a spin-off arbitrage strategy and create an investment strategy that fits his or her risk aversion preferences (institutional investors assess their risk appetite regularly). Investors looking to gain from a short-long position should accept the outflow theory that I presented in a May article . An investor who believes that both eBay and PayPal will soar after the split should engage in a different strategy, which I will not cover here, and hold both equities long. To create a trading scenario for the spin-off, I will assume that most readers will receive the distributed shares between a week after the record date and the distribution date. At this point, EBAY.wi and PYPL.wi shares already reflect a 10% price fluctuation. Let’s discuss the four possible scenarios: Scenario A: take no action during the spin-off; Scenario B: hold only long position (sell 100% EBAY); Scenario C: hold long and short positions at a 2:1 ratio (sell 50% EBAY); Scenario D: hold long and short position of the same size. I also assume that the PYPL.wi price will increase by 5% during the period I described above, 3% during the weekend between the distribution date and PYPL’s first trading day, and an additional 10% on the first trading day. All figures are within the reasonable spin-off fluctuations that were presented in the previous article. I also assume that the positive changes in PayPal’s stock price equal the adverse changes in eBay’s stock price. I calculated the return and volatility based on a distributed share price of $32 for a PayPal share and $28 for an eBay share, assuming cash from selling the EBAY stock was not reinvested. The four scenarios presented above yielded the following return and volatility figures: Scenario A B C D Return 2.1% 7.1% 9.0% 10.9% Volatility 1.05% 2.80% 3.39% 4.01% Investors highly averse to risk can choose to take action and get an estimated return of 2% of scenario A or just sell all units of the EBAY stock once received and gain 7% from a PYPL long-only position as presented in scenario B in the period between the moment the distributed shares are received until the end of the first day of trading in PYPL shares. Investors who have some tolerance for risk can choose a long-short strategy that maximizes return from the spin-off but is accompanied with a slightly higher risk. Scenario C, which suggests to sell 50% of eBay’s distributed shares and short the other 50%, offers a lower risk for investors than scenario D. Investors who are somewhere in the middle between complete risk aversion and total risk taking could choose a larger/smaller quantity of EBAY shares to sell in order to hedge PYPL fluctuations. Investors who hold options of eBay pre-distribution can add an additional hedging layer with post-distribution options and protect their positions better from any downside. However, since the outflow of cash that is expected from PYPL and EBAY will trigger a possible movement in prices, it might be easier to hedge the position by playing with the ratio between the long and short positions. Disclosure: I am/we are long EBAY. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. Additional disclosure: Information provided in this article is for informational purposes only and should not be regarded as investment advice or a recommendation regarding any particular security or course of action. This information is the writer’s opinion about the companies mentioned in the article. Investors should conduct their due diligence and consult with a registered financial adviser before making any investment decision. Lior Ronen and Finro are not registered financial advisers and shall not have any liability for any damages of any kind whatsoever relating to this material. By accepting this material, you acknowledge, understand and accept the foregoing.

PAK: Your Ticket To The Hidden Gem In Emerging Or Frontier Markets

Investors look for exposure to the frontier markets to diversify their portfolios, but have shied from investing in Pakistan. Although Pakistan attracts a lot of negative news, its economy is improving while the local stock market remains one of the top performing in the world. Pakistani stocks can be a great diversification tool for U.S. investors as they offer zero correlation with the S&P-500. The recently launched Global X MSCI Pakistan ETF gives U.S. investors exposure to this market. Investors look for exposure to the frontier markets to diversify their portfolios, given some of these markets have demonstrated little to no correlation with the S&P-500, but most steer clear of Pakistan. In the media, the country’s name is often followed by Osama bin Laden, Taliban, sectarian violence, protests and blackouts. However, Pakistan has also been making significant progress on the economic front and may very well be, in the words of Renaissance Capital’s chief economist Charlie Robertson, “the best, undiscovered investment opportunity in emerging or frontier markets.” Pakistan was created back in 1947 following its partition with India. But unlike its bigger neighbor, the political setup in Pakistan has been far from stable, thanks to corrupt politicians and frequent military takeovers. However, democracy has been taking hold following the departure of the last military ruler Pervez Musharraf in the 2008 general elections. In 2013, for the first time in its turbulent history, a civilian government successfully completed its term in office and transferred power to another. Those elections paved the way for the pro-business politician Nawaz Sharif to form a government. Sharif immediately moved to stabilize the economy, bolster public finances, lift foreign reserves and increase infrastructure spending. Although there is significant room for improvement, so far, the Pakistani government’s performance has been impressive, which was also acknowledged by the IMF. Besides, the country has received positive commentary from Moody’s and Standard & Poor’s. The two rating agencies have recently upgraded Pakistan’s credit rating. Betting on Pakistan’s future is its strongest ally China which has planned to inject $46 billion into South Asia’s second leading economy. China’s confidence stems partly from Pakistan’s latest, and perhaps its biggest, military offensive against the local militants. The country’s security situation, which has been one of the biggest concerns for foreign investors, has improved dramatically. Last year, Pakistan witnessed the lowest number of civilian casualties in terrorist attacks over the last seven years, and the number has improved considerably this year. Meanwhile, Pakistan’s economic growth has improved from 3.7% in 2013 to 4.1% in 2014. The economy currently appears to be posting its strongest growth since the global financial crisis while inflation has been slowing down over the last twelve months, dropping to their lowest level since 2013 of 2.1% in April due in part to the slump in oil prices. The foreign exchange reserves on the other hand, have climbed to their highest level ever of $18.2 billion. Meanwhile, the Sharif government has been doubling down on the construction and infrastructure sector. This has led to a construction boom which is driving the economic growth. As per data from Bloomberg, in the last fiscal year, the nation’s cement stocks have climbed by 57%, outperforming the benchmark index by three times. For the current fiscal year, the government has raised infrastructure spending by 27% to Rs 1.5 trillion/$14.74 billion, which will play an important part in fueling the country’s growth. As per IMF’s projections, growth is expected to tick up to 4.5% in the current fiscal year beginning July 1. With improving economic outlook, Pakistan’s stock markets have rallied. The Karachi Stock Exchange, the nation’s biggest and most liquid market, has generated one of the highest returns in the world over the last five years. During this period, the KSE 100 index has climbed by a whopping 200%. For the fiscal year ending June, the benchmark KSE-100 index has climbed by 14.9%, becoming one of the top performing markets of the world, despite declines coming from oil and gas, tobacco, telecom and banking sectors. Despite the rally, Pakistani stocks are still priced at a discount to their MSCI frontier market peers Bangladesh, Sri Lanka, and Vietnam. A great way for U.S. based investors to gain direct exposure to Pakistani stock markets is through the recently launched Global X MSCI Pakistan ETF (NYSEARCA: PAK ) – the only ETF that is tracking this frontier market. This can be a good diversification tool, since Pakistani stocks showed zero correlation with the S&P-500 last year. The $2.3 million fund, which charges just 0.88%, gives investors exposure to 33 of Pakistan’s leading companies, most of which operate in the financial, energy and materials sector. The fund’s top holdings include two of the country’s largest banks – MCB Bank and Habib Bank-as well as the top E&P company OGDCL, leading chemical fertilizer producer Fauji Fertilizer and the biggest producer and exporter of cement Lucky Cement. These five companies, which give Global X MSCI Pakistan ETF exposure to four diverse sectors, represent 44% of the fund. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Aberdeen Indonesia Fund: Invest In The Indonesian Market’s Growth

Summary Indonesia is on track for future economic growth, as GDP Growth and consumer spending are both projected to substantially increase. The Aberdeen Indonesia Fund is the most attractively valued fund, and provides exposure to strong companies in the banking and consumer products industries. The main risks of investing in Indonesia include exchange rate movements, inflation, and relatively high valuation of the consumer products industry; apart from this, invest looks very favorable. The Aberdeen Indonesia Fund is potentially the best way to gain exposure to Indonesia’s future growth. Emerging Indonesia is clearly on track for considerable future growth in 2015 and 2016, as the Asian Development Bank has projected GDP Growth of 6.4% and 6.3% in 2015 and 2016 respectively. Moreover, Indonesia’s president has set a target GDP growth of 7% for 2017 , as infrastructure development and foreign direct investment are expected to attribute to this growth. Future growth in Indonesia’s economy, in multiple industries, provides the opportunity for investors to profit off of the current setback. However, Exchange Traded Funds are not allows an accurate reflection of a country’s performance, and choosing the appropriate vehicle is crucial. Based on an examination of valuation, I have decided that the Aberdeen Indonesia Fund (NYSEMKT: IF ) is the most appropriate fund for investors who wish to profit from Indonesia’s growth. The Aberdeen Indonesia fund is a closed end fund, and has the comparative advantage of having lower valuation than Indonesian Exchange Traded Funds. Moreover, its liquidity looks very favorable, as its average trading volume is 18,579 . The fund currently has a P/E ratio of 8.8 , which is considerably lower than other alternatives; the Market Vectors Indonesia Index ETF (NYSEARCA: IDX ) has a P/E ratio of 16 and the iShares MSCI Indonesia ETF (NYSEARCA: EIDO ) currently has a P/E ratio of 12 . Another key advantage of this fund is its Beta of 0.78, making it less volatile in the market. Although the fund has had a 1 year return of -20.86% , an assessment of Indonesia’s economy and respective industries of the fund’s holdings provides a favorable outlook; its current valuation and past performance should merely be viewed as an opportunity to buy while it is low. The price of the fund has been on a sharp decline, which can mainly be attributed to its slowed GDP growth, which is expected to recover. An assessment of the performance of the fund’s main holdings further attributes to the logic of having a bullish outlook of Indonesia, specifically through this fund. Macroeconomic Outlook Examining Indonesia’s past macroeconomic performance, particularly in 2012, it is clear that a rebound in the country’s growth is highly feasible. The country is on track for recovery from the currently slowed GDP growth of 4.7, and will return to the higher growth experienced in 2012. If growth goes as anticipated up to 2017, Indonesia will be able to surpass its economic performance in 2012. (click to enlarge) Source(Trading Economics) Inflation is another struggle in Indonesia, that has a more positive outlook for 2015 and 2016. The country’s finance minister projected that inflation rates would fall to 4.5-5% in 2015, representing recovery and a return to levels in late 2014. However, 2015 has so far only produced slight recovery from the inflation rate during the beginning of 2015. (click to enlarge) Source(Trading Economics) 2015 has also witnessed a significant improvement of the country’s balance of trade, as the country began to have a trade surplus in 2015. The turnaround in 2015 is attributed increased economic growth and the recovery of commodity prices; with further growth projected for 2015 and 2016, Indonesia’s trade surplus certainly has room for increase. (click to enlarge) Source(Trading Economics) Positive Overall Outlook Combined with FX/Inflation Risks Investment into Indonesia overall looks very favorable, especially into a fund with very low valuation. Indonesia is on track for recovery in GDP Growth, and its balance of trade has drastically improved in 2015. Areas of concern for investors include inflation, which is expected to improve to conditions in 2014. Since 2015, the Indonesia Rupiah has fluctuated approximately between 12,500 and 13,400, stabilizing at 13,332 in June of 2015. The rupiah has been the worst performing currency in Asia, and in December the Rupiah hit its lowest since the economic crisis 1978-1979 Asian Financial Crisis. I believe that the low valuation of the fund, increased GDP growth, and improved balance of trade are strong enough to counter the inflation and currency risks. Moreover, the financial performance of the fund’s holdings has been very impressive, considering the issues of inflation and slowed economic growth. Fund Holdings The fund mainly invests into the banking and consumer products industries, while one of the holdings operates in the construction industry. Banking Industry An observations of the fund’s holdings in this industry produces a favorable outcome, with attractive valuation and financial performance. The average P/E ratio for the top holdings in this industry is 13.6, which is substantially lower than the average P/E ratio of 21.89 of the Jarkata Stock Exchange Composite Index. The average growth in net revenue for 2014 was 11.8% The average growth in net income for 2014 was 8.1% Overall the growth was not very strong, but is still relatively impressive, considering that this industry was able to achieve growth despite the country’s decrease in GDP growth. With attractive valuation, and increased growth projected in the future, this industry can be considered a strength of the fund’s holdings. Despite excellent financial performance and attractive valuation, a survey from PWC characterizes the industry in 2015 as being volatile and uncertain, along with progression in a variety of areas. Loan growth is projected to grow around 10% to 20% in 2015, mainly driven by Small and Medium Enterprise growth. Credit, Liquidity, and Operational risk remain major threats for banks, which can be offset by enhancing the processes of monitoring and distributing loans, as well as limiting exposure to high risk industries. Banks will catalyze the projected growth in infrastructure, although it is only estimated to be less than 10% of its portfolio. Bankers stated that the Rupiah exchange rate will continue to be under pressure, but expects inflation to continue easing. Despite uncertainty ahead, particularly regarding exchange rate movements, the banking industry has multiple positive outlooks, and the specific holdings of this CEF are very attractive. Consumer Products Consumer spending has been on a consistent rise since 2012, attributed to the high performance of this industry and the fund’s holdings. The lag in GDP growth did not hinder growth in consumer spending, and with increased GDP growth projected for 2015 and 2016, the future outlook for this industry is very favorable. Consumer spending is projected to increase to 1,231,249 by the 2nd quarter of 2016, and to 1,243,356 by 2020. There is still room for growth in this industry, although growth will slow by 2016; although entering in 2012 would have been most strategic, there is certainly room for profit in the current environment. (click to enlarge) Source(Trading Economics) Eyes have already been on Indonesia as a destination for the consumer products industry. Euromonitor calculated in 2014 that Indonesia will gain 80 million new consumers , accounting for 40% of new consumers in the ASEAN region. Strong growth is clearly ahead for this industry, which may provide suitable justification for the valuation of the holdings in this industry: The average P/E ratio for the holdings in this industry is 31.2, which is not very attractive for an emerging market. However, the high potential for future growth, combined the projected GDP growth, is substantial enough to justify this valuation. Net Income increased by 28.6% in 2014, while net revenue increased by 11.5%; these companies are an accurate reflection of the industry’s growth. Conclusion Indonesia certainly holistically presents itself as an attractive investment opportunity, with the Aberdeen Indonesia Fund being an appropriate vehicle. For those wishing to navigate the acceptable amounts of risk presented, the opportunity for profit is incredibly feasible due to Indonesia’s projected growth, the overall favorable outlook of the banking and consumer products industry, and the attractive valuation of the Aberdeen Indonesia Fund. Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.