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Share2 inShare0Bank of Ireland’s NYSE-listed ADRs (IRE) are trading at a significant premium to the bank’s London/Ireland listed shares (symbol BKIR).
There does not seem to be any legitimate reason why IRE is trading at a much higher price than BKIR. We first wrote about this phenomenon on 28 July.
Since then, the IRE overvaluation (versus BKIR) has increased to a record level.
This article will show that in order for IRE shares to move to parity with BKIR, the stock should fall by about $0.71 (or 63%) from $1.12 to $0.41. In other words, investors are paying $0.71 more for IRE than they would pay for the equivalent stock in London.
In our 28 July article we gave a price target of $0.78 for IRE shares. Based on calculations outlined below, we now reduce our price target to $0.68, substantially below the 9 September closing price of $1.14.
Share price parity calculation – background information:
BKIR shares are denominated in euros, and not British pounds.
IRE ADRs are denominated in US dollars.
The ratio of ADRs to London listed shares is 1:4.
Share price parity calculation as at 11.30am New York time on Friday 9 September 2011:
BKIR (ask) in EUR
0.074
EUR/USD exchange rate
1.3670
IRE (bid) in USD
1.12
To convert BKIR to a theoretical IRE equivalent:
0.074 EUR * 4 (number of London shares for each ADR) = 0.296 EUR
0.296 EUR * 1.3670 = 0.4046 USD
Therefore the theoretical IRE share price is about $0.41. But at that time, the prevailing IRE bid in New York was $1.12.
Price difference between the two securities:
$1.12 – $0.41 = $0.71
0.71 / 1.12 = 63.39% decline required for IRE to reach parity with London listed shares of BKIR.
0.71 / 0.41 = 1.7317
IRE is overvalued by 173.17% when compared to BKIR.
How long has this overvaluation been in place, and why?
The BNY Mellon web page for IRE ADRs states that “Bank of Ireland Group – Books Closed for Issuance” on 3 December 2010. This means that it was no longer possible to submit BKIR shares and request IRE ADRs in exchange from that date.
According to our calculations, the difference between the prices of BKIR and IRE was less than 1% on 3 December. Following this, when conversions (from BKIR to IRE) were no longer possible, the premium widened quickly, and reached 50% on 20 December 2010. The following table shows the wild and unexplained fluctuations in the IRE share price when compared to the BKIR equivalent.
Date
BKIR (ask)
EUR/USD
Theoretical price (USD)
IRE
Percentage overvaluation as % of theoretical price
Percentage drop from IRE to theoretical price
9 September (11.30am)
0.074
1.3670
0.4046
1.12 (bid)
176.79%
63.87%
9 September (11.05am)
0.070
1.3704
0.3837
1.12 (bid)
191.89%
65.74%
28 July 2011
0.110
1.4311
0.6297
1.53 (bid)
142.98%
58.84%
20 December 2010
0.322
1.3124
1.6903
2.54 (low of day)
50.26%
33.45%
3 December 2010
0.326
1.3366
1.7429
1.75 (low of day)
0.41%
0.40%
Fundamentals of BKIR and downside price target – no higher than $0.68
Bank of Ireland recently underwent a recapitalization by raising billions of EUR of additional capital. It sold additional common stock at 0.10 EUR per share, and completed a debt for equity exchange, with the conversion of debt priced at 0.1156 EUR per share.
It’s unlikely that the BKIR price (which should influence the underlying value of IRE) will rise beyond 0.1156 EUR, due to the "anchoring" of the share price to the rights issue price and the debt for equity exchange price.
Furthermore, due to the ongoing problems in Greece, Ireland, Portugal, Spain and Italy, it’s hard to see the EUR/USD going above 1.47, the high from early June.
Using a maximum price of 0.1156 EUR for BKIR and maximum price of 1.47 for EUR/USD, the maximum fair value for IRE can be calculated as:
0.1156 EUR * 4 * 1.4700 = $0.68.
However it should fall lower than $0.68 if the EUR/USD stays below 1.4700 and/or BKIR stays below 0.1156 EUR.
What are buyers of IRE thinking?
It’s fair to assume that if it was possible to convert BKIR shares to IRE, then this premium would quickly disappear, as investors wanting to buy IRE cheaply could just buy BKIR and then ask BNY Mellon to convert these to IRE ADRs.
In any case, one wonders what the buyers of IRE at $0.85 and above have been thinking in the last eight months – they could have purchased the shares at a much lower price in London.
Catalyst for the spread between IRE and BKIR to close
We find it remarkable that this arbitrage opportunity has existed for so long, especially after the publication of our 28 July article discussing this phenomenon. We can only assume that IRE investors do not understand that the stock is an ADR representing four BKIR shares and not a separate security of the Irish bank.
However we are encouraged by the decline in IRE below the $1.20 level in September, a support level that held for the second half of August. Furthermore the $1.20 level represents the 50-day moving average for IRE. Now that IRE has broken these two technical levels, it is reasonable to assume that IRE will continue its decline towards its 52-week low of $0.85, and then toward parity with BKIR shares.
Some readers may believe that this arbitrage opportunity is “too good to be true." We encourage all readers to independently work through the above calculations, and to view the Bank of Ireland page and the BNY Mellon page to confirm the ratio of ADRs per London/Ireland listed shares.
Disclosure: I am short IRE and long BKIR. The above commentary is provided for informational purposes only. This article does not take into account your personal circumstances, and as such, you should consider whether its content is relevant to your situation. Before buying or selling any stock you should conduct your own research and analysis, and seek advice from an independent financial adviser. We have a short position in IRE and a long position in BKIR.
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