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

February 25, 2011

How far will EGPT fall when the market opens? Or how much is the Egypt ETF suggesting the Egyptian market will rally? The answer may surprise you.

After yesterday’s webinar on emerging markets, I got a note from someone who’d been poking at the premium/discount issue with everyone’s favorite broken ETF, the Market Vectors Egypt Index ETF (NYSEArca: EGPT). Closed for creations since Jan. 29, EGPT is now trading at a notional 22 percent premium. That premium is notional because the gap will be closed when one of two things happens after the market reopens in Cairo: Either the price of EGPT will plummet back toward the NAV where it stood in late January, or the Cairo Stock Exchange will open and the prices of the underlying stocks will soar.

Here’s a quick chart to show how EGPT and its underlying holdings have diverged.

But how far does the gap have to be? Answer: Not 22 percent.

Here were the holdings going into yesterday in the fund, with yesterday’s closing prices. The securities in bold are actually still trading, on London and Canadian exchanges.

Holding

Ticker

Shares

Price

Market Value

% of net assets

Net Other Assets / Cash

 

0

$1.00

$ 9,536,874.14

41.14%

Orascom Construction Industries

ORSD LI

52,884

32.74

$ 1,731,422.16

7.47%

Orascom Telecom Holding SAE

OTLD LI

557,227

3.245

$ 1,808,201.62

7.80%

TRANSGLOBE ENERGY CORP

TGL CN

77,331

13.5

$ 1,062,022.89

4.58%

Commercial International Bank Egypt SAE

COMI EY

160,224

36.49

$ 993,386.08

4.29%

Centamin Egypt Ltd

CEY LN

477,174

1.253

$ 964,769.86

4.16%

YeTalaat Moustafa Group

TMGH EY

685,124

6.53

$ 760,149.47

3.28%

Telecom Egypt

ETEL EY

238,577

16.03

$ 649,798.54

2.80%

Egyptian Financial Group-Hermes Holding

HRHO EY

151,426

26.42

$ 679,751.07

2.93%

Juhayna Food Industries

JUFO EY

631,632

5.47

$ 587,040.53

2.53%

ElSwedy Cables Holding Co

SWDY EY

69,322

45.74

$ 538,745.78

2.32%

Egyptian Kuwaiti Holding Co

EKHO EY

470,748

1.26

$ 100,780.30

0.43%

Egyptian Co for Mobile Services

EMOB EY

22,589

133.21

$ 511,270.19

2.21%

Ezz Steel

ESRS EY

202,446

15.93

$ 547,950.86

2.36%

Citadel Capital Corp/Cairo

CCAP EY

378,528

7.14

$ 459,211.61

1.98%

Palm Hills Developments SAE

PHDC EY

456,343

4.87

$ 377,604.35

1.63%

Six of October Development & Investment

OCDI EY

27,065

80.63

$ 370,784.29

1.60%

Maridive & Oil Services SAE

MOIL EY

118,444

3.06

$ 61,581.62

0.27%

Sidi Kerir Petrochemicals Co

SKPC EY

143,652

12.82

$ 312,907.76

1.35%

Medinet Nasr Housing

MNHD EY

57,211

23.81

$ 231,449.14

1.00%

Egyptian Financial & Industrial Co

EFIC EY

55,164

15.62

$ 146,404.16

0.63%

Egyptian for Tourism Resorts

EGTS EY

561,548

1.52

$ 145,026.41

0.63%

Arab Cotton Ginning

ACGC EY

229,041

3.08

$ 119,861.74

0.52%

Heliopolis Housing

HELI EY

37,361

18.34

$ 116,421.84

0.50%

Naeem Holding

NAHO EY

265,469

0.4

$ 18,042.24

0.08%

Pioneers Holding

PIOH EY

236,311

2.46

$ 98,772.42

0.43%

South Valley Cement

SVCE EY

153,197

3.79

$ 98,652.05

0.43%

Nile Cotton Ginning

NCGC EY

47,455

11.25

$ 90,709.16

0.39%

Cairo Housing & Development Co SAE

ELKA EY

74,624

4.7

$ 59,592.69

0.26%

We reported previously on that big cash number, a result of taking in a big creation order when the fund couldn’t go buy enough underlying securities. But how that skews the premium/discount number is nonintuitive. Effectively, 41 percent of the premium in EGPT is linked to the cash, an asset that should never have a premium of any kind since it’s completely fungible.

So here’s how to really think about the math:

EGPT has 1.550 million shares outstanding at a price of $18.34. That puts the market value of the ETF at $28,427,000. Based on the above table, we know the actual value of the holdings is quite a bit less than that:

Cash/Trading Holdings: $15,136,019
Egyptian Holdings (stale): $8,076,580
NAV: $23,212,600

 

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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