Is EGPT Going To Pop 60%, 20% Or Not At All?

February 25, 2011

All that gives us a nominal premium of 22.46 percent—quite the whopper.

The problem is that this premium only applies to the actual undervalued securities. After all, the cash and those few securities I listed above in bold are represented with complete accuracy in the NAV. There’s no reason to ascribe any of the premium to those securities at all. Instead, for the gap between EGPT’s market value and its book value to close, those Egyptian holdings have to rise in value. A LOT. That $8 million worth of local stocks needs to open up and be worth $13.2 million—a staggering 64 percent pop. Here it is in handy table format:

EGPT Shares outstanding 1,550,000
Market Price 18.34
Market Cap $28,427,000
Cash Holdings $9,536,874
Traded Holdings $5,599,145
Egyptian Holdings $8,076,580
Holdings Value $23,212,600
Premium/Discount 22.46%
Implied Necessary Value of Egyptian Holdings $13,290,980
Rise in Egyptian Holdings needed 64.56%

That’s a mighty big bet for anyone buying EGPT here, and this was the backbone of the question I got from an anonymous industry participant yesterday. It seems like an enormous, outrageous bet. Even more critically, should it happen, EGPT would actually miss out on a huge percentage of that gain, because of the massive cash drag in the overall portfolio. There’s one little missing piece here though. The way ETFs actually work.

Van Eck isn’t stupid. In fact, they’re flat-out some of the smartest guys in the ETF business. So buried on page 26 of the Statement of Additional Information for EGPT is this little gem:

“In such cases where the Trust makes Market Purchases, the Authorized Participant will reimburse the Trust for, among other things, any difference between the market value at which the securities were purchased by the Trust and the cash in lieu amount.”

In English, what it means is that when Van Eck took the creation order way back on Jan. 28 that resulted in the enormous cash balance, it did so at the then-current cost of going and getting a certain number of shares of all those underlying securities. If the Egyptian market opens precisely where it last closed, that cash will just go to work, and the premium will collapse all the way back down to NAV. If, however, the securities do in fact open higher, Van Eck can go back to the APs who created shares and demand a true-up payment. So, in fact, EGPT doesn’t need to open up 64 percent. EGPT needs to open up 29 percent, assuming Van Eck claws back the cash it needs.

Today

Market Open up 29%

Cash Holdings

$9,536,874

$12,360,231

Traded Holdings

$5,599,145

$5,599,145

Egyptian Holdings

$8,076,580

$10,467,623

Holdings Value

$23,212,600

$28,427,000

 

Premium/Discount

22.46%

0%

So what’s the likelihood of that happening? Consider how far Egyptian stocks have fallen. Orascom, which is trading in London, is down 26 percent since mid-January. That implies a simple return to normal would send it well over the required hurdle—it takes a 35 percent increase to earn back a 26 percent decline. But it’s still trading, and it’s down that much. In fact, almost all of the still-trading holdings of EGPT are down near their lows of Jan. 31. And yet, EGPT remains bid heavily up.

My conclusion? EGPT has now diverged from the expectations of its underlying securities, suggesting that the premium embedded in the fund is now a real liquidity premium—one that may very well collapse on the open of the Egyptian exchange. Those stocks don’t need to pop the amazing 64 percent to bring the fund in line, but they do need to pop back to near precrisis levels instantly. And that seems unlikely.

EDIT: I received a few emails pointing to the excellent work done over at Kid Dynamite's blog documenting his own investigations of EGPT's pending premium collapse. While I hadn't seen this before I sat down at the keyboard, I wish I had, as he makes some excellent points. I just feel bad he never managed to get the short position on. I'd note that as of the Feb. 15 short sale report, short interest in EGPT had skyrocketed to 826,180 shares, up from just 70,000 or so a month prior.

 

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