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Cummins Inc. (NYSE:CMI) / Atmus Filtration Technologies (NYSE:ATMU)

March 1, 2024

Type of situation: Stock split-off and Odd-Lot tender offer, opportunity to make $1000+ in 2 weeks  


Why look at this?

This is a pretty standard split-off situation, where odd-lot holders can potentially make $1000+ within about two weeks. Borrow cost is already through the roof and of limited availability and the exchange ratio not as favorable as at the announcement of the transaction, but I still would like to highlight the case given that it’s just about two weeks to closing. Further, shares in both entities have risen quite a bit since the announcement, so that should be kept in mind here. This is a trade that won’t make anyone rich but a potential way to make a quick buck over the very short term.


In my personal view, this is a rather risky odd-lot tender situation so I am staying on the sideline as of now but want to share the set up for anyone who is interested.

 

In May 2023, Cummins Inc. (NYSE:CMI) sold 19.5% of its Atmus Filtration Technologies (NYSE:ATMU) division in an IPO, raising $275m. Cummins retained 80.5% of shares in Atmus following the IPO and is now looking to distribute almost its full position in a tax-efficient manner to its shareholders. The companies maintain a website dedicated to the transaction with all information relevant published there.

 

The last similar split-off situation in this area of special sits investing was the exchange offer by Johnson & Johnson (NYSE:JNJ) last fall to exchange shares for its Kenvue (NYSE:KVUE) consumer healthcare division. There are a number of good write ups on that past situation available online, like this one by Eagle Point Capital (Link).

 

Atmus is a leader in filtration solutions for on- and off-highway commercial vehicles and equipment. The company’s products lower emissions for vehicles and aim to minimize maintenance costs. The company’s sales are predominantly from replacement and maintenance and thus not very cyclical. However, this article is aimed at only looking at the technical trade of the tender offer and will not go into depth of the companies and their business models involved here.

 

Exchange offer

Cummins is offering a 7% discount on Atmus shares in order to incentivize investors to tender their shares for exchange. For every $100 in Cummins shares tendered, investors will receive $107.53 in Atmus shares. The tender expires on March 13, 2024.

 

The exchange is subject to an upper limit of 13.3965, which is expressed as the ratio of the price of Cummins stock divided by the price of Atmus shares. This is a kind of safeguarding measure to keep shares within the target price range of the exchange. A website is available with daily updated information on whether the upper band of the exchange ratio has been breached (Link).

 

These situations are usually oversubscribed, thus opening up the risk of being prorated (meaning that not all shares tendered will be accepted in the exchange due to oversubscription). However, small individual retail investors can avoid the proration as there is an odd-lot provision in the tender offer. Investors tendering fewer than 100 shares (99 or less shares) are guaranteed to being able to tender all their shares in the exchange.

 

Quick background: What is a split-off transaction?

This split-off transaction is a situation in which a parent company is distributing shares in a subsidiary that it has previously listed on a stock exchange to its shareholders in exchange for buying back its own stock. 

 

This can make sense for the parent if it feels that its own shares are undervalued and can be purchased back at a discount.

 

In order to incentivize shareholders to tender their shares, the parent gives shareholders a discount in the exchange of its own shares for shares in the subsidiary. In this case, shareholders of Cummins receive $107.53 of Atmus shares for every $100 tendered. However, only a very small number of shares are accepted for tendering in these transactions, exposing investors to the risk of being prorated (3% for CMI).  

 

Since almost the entire stake in Atmus is distributed to Cummins shareholders, this type of seemingly “riskless” arbitrage is almost guaranteed to be oversubscribed.

 

Usually, these tender offers have a provision for small odd-lot shareholders that guarantee them to be able to tender their shares regardless of oversubscription. This is also the case for this specific transaction. Bear in mind that only 99 shares or less can be exchanged per shareholder. There are many reports out there on the question on whether this works for multiple brokerage accounts. Some have had success with tendering numerous odd-lots through different brokerages, for others the brokers aggregated their stake and therefore not tendered all shares. It is certainly safest to play this with just one odd-lot tender.

 

The exchange ratio will be determined based on the 3-day VWAP of both shares on the three days before the expiration of the deadline to tender shares (March 7, 8, 11). 

 

Shares in both Cummins and Atmus have risen substantially post the announcement which is something to definitely keep in mind here.  

 

Risks

While this transaction seems riskless at first glance, there are obviously caveats to bear in mind. Perhaps the biggest risk is that the transaction gets cancelled for whatever reason. I don’t know of any example of this happening in the past with other such transactions but one never really knows. Another risk may be the cancellation of the odd-lot exemption, thus eliminating the guarantee that odd-lots are accepted on a priority basis.

 

Further, it is not exactly known how many shares will be exchanged exactly. While there usually is a website available that updates the math on the exchange ratio daily, the exact ratio is not known until the deadline for the tender offer. This is particularly important for the hedged trade, given that one does not know exactly how many shares are needed to short-sell in the transaction in order for the hedging to be “perfect”.

 

Another caveat is that potentially, the upper limit will be in effect and that one may receive less than the $107.53 of Atmus stock for the $100 tendered in Cummins shares. Currently, the upper limit is not in effect and substantially below it, but this may change in the coming days.

 

On the hedged side of the trade (Long parent, short subsidiary), investors may be forced to close out their short position prematurely given that there is only very limited float available for shorting which may become completely unavailable, thus forcing people to buy into the shares they had sold short before the short position is automatically closed out with the delivery of exchanged shares in the subsidiary. Just today, shortable shares decreased from 200k to about 50k so the call-in risk is certainly there.

 

On the unhedged side, share price fluctuations may impact the expected return: If shares in the distributed subsidiary fall significantly following the distribution due to increased float, arbitrageurs closing their positions or a general market correction, one may end up with a loss-making transaction. Given how much both stocks have risen and by what a large amount the float will be extended, a sharp sell-off is a very real risk here.

 

Hedging vs. not hedging the trade

This trade can be done either by an unhedged or a hedged position, with the former offering a potentially higher return but faces significant risks and the latter a lower return with lower risk.

 

Trade structure (unhedged)

Structuring this trade unhedged is the most straight forward way to play this, however, faces the significant risk of share price volatility, given that shares in both entities have traded up so much since the announcement of the tender offer. One can simply purchase 99 shares of CMI which will then be exchanged into approx. 1,206 shares of ATMU at the current exchange rate (this also works with less shares but 99 is the maximum allowed under the tender rules). These ATMU shares could then be sold off immediately once they hit your brokerage account. At current price levels, this trade would make about +$2,000 for a 99 odd-lot tender. However, share price fluctuations in ATMU post the distribution are likely and could potentially eat away all profits from the exchange and even potentially result in a loss.


Illustrative calculation for the unhedged trade:

Trade structure (hedged)

Investors looking to make a lower gain at a lower level of risk may do so by purchasing 99 shares in CMI stock and shorting about 1,206 shares in Atmus. Since the odd-lot shares in Cummins will be accepted in the tender no matter what if it is oversubscribed, one will then receive about 1,206 shares in Atmus (based on current exchange ratio (per 02/29) a couple of days post the tender deadline which then closes out the short position.

 

One may also think about shorting a slightly larger amount of ATMU stock at the upper end of the exchange ratio (1,325 shares) in order to mitigate the risk that the exchange ratio will actually be set higher than what is currently indicated.

 

However, borrow cost is already through the roof for Atmus shares (46% at IBKR) and these fees will significantly eat into the return here with about $500-700 in borrow cost for about 15-20 days from now. Also, availability of shortable ATMU stock is very limited and dropped significantly today from 200k to 50k. As a placeholder, I am estimating a 17-day holding period for the short position from today until the ATMU shares are delivered. Delivery of ATMU shares should take anywhere between 3 and 10 business days post expiration of the offer, but this is depending on your brokerage and how fast they handle this situation.


Illustrative calculation for the hedged trade:

The main risk in this scenario is a) how long it will take for delivery of Atmus shares post tender deadline (and thus potentially further increasing borrow fees that eat into the return) and b) whether at some point borrow will become unavailable which could lead to a risk of needing to close out the short position prematurely c) whether borrow cost further spike.

 

Timing

The transaction was announced on February 14 and is set to close on March 13. One needs to be aware that the best time for doing these tenders is right after the announcement which is evident by how much the shares have already traded up. One could also think about initiating a position right before the end of the deadline to avoid borrow costs, but will likely see a lower expected return (if borrow is even available then).  

 

Conclusion

This is a super short term trade originating from a stock split-off transaction. Due to the very high borrow fees and the high risk of volatility in ATMU shares destroying the return, I am currently staying out. However, given that it is an interesting set up for smaller special sits investors, the idea will be added to the “quick idea” section and I will report the results of the trade here at a later date once the transaction has settled.

 

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