August 30, 2013 - 2:54pm EST by
2013 2014
Price: 5.99 EPS $0.00 $0.00
Shares Out. (in M): 105 P/E 0.0x 0.0x
Market Cap (in $M): 625 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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  • Arbitrage
  • India




Hundreds of ADRs trade on U.S. stock exchanges.  These represent ownership in shares of a company based in another country.  For the most part, the underlying company’s shares also trade on the local exchange(s), and the U.S.-traded ADRs represent one (or a multiple or fraction of one) share of the shares traded on the local exchange.  (In some situations, the company does its IPO in the U.S., but no stock is traded locally.)


By and large, the market for ADRs in the U.S. is pretty efficient.  The prices of ADRs tend to track the price of the underlying stock very closely, adjusted for exchange rates and the share ratio.  A simple example: BP plc’s ordinary shares trade on the London Stock Exchange.  BPs closing price in London today, a couple of hours ago, was 446.2 pence.  With the five-hour time difference, the U.S. markets are open several hours after London has closed.  At the current exchange rate of $1.5485 per pound sterling, this translates to $6.909 per London-traded BP share.  The U.S. traded ADR is equivalent to 6 ordinary shares.  $6.909 x 6 = $41.45.  As of this writing, the BP ADR is trading at $41.31, or about 0.3% below the London-equivalent closing price.


This close relationship between the underlying stock price and the ADR price tends to hold for the most part.  There are two significant exceptions.  The first is when there is a rapidly evolving “event” which creates news that could move a company’s ADRs well above or below the home country closing price.  Think BP’s 2010 Deepwater Horizon oil spill.


The second exception is when there is great demand for the ADRs, and it is difficult or impossible to buy stock in the home country.  In that kind of situation, which is common enough, the ADRs tend to trade at a premium, sometimes very large, to the underlying stock.


But it is rare to find an ADR which trades at a significant discount to the underlying stock, particularly for any period of time.  Intraday you might occasionally find discounts of 1% or 2%, but ADR prices generally track the underlying stock prices very closely, usually at premiums or discounts of well under 1%.


I believe that I have just identified the rare exception where an ADR is trading at a very significant discount (between 12% and 13% of the home country price), with a clear reason for why this discount exists.  I’m also confident that the discount is very temporary, and that within a week it will very likely have disappeared.


Because time is scarce, and I am keen to submit this idea to VIC well before today’s market close, this is a quick and dirty report, and I will address questions later.


Sterlite Industries ADRs (SLT) have been trading on the NYSE for many years.  The ADR price tends to follow the pattern I have described above, i.e. very small discounts or premiums most of the time to the underlying shares of Sterlite Industries, which trade on the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) in India.  One ADR is (or was) equivalent to 4 Indian common shares of Sterlite Industries.


This close price relationship has suddenly changed.  Sterlite Industries in India merged with Sesa Goa, another Indian company, early this week.  The ratio of ADR to common shares is now one SLT ADR is equivalent to 2.4 shares of Sesa Goa.  The U.S. ADRs have maintained the Sterlite Industries name for now, while the Indian Sterlite Industries shares have ceased trading.


At today’s close in India, Sesa Goa’s price was Rs. 188.75 on the NSE, which is where the vast majority of the trading volume occurs.  The exchange rate is currently about $1 = Rs. 65.72.  Because the exchange rate has been fluctuating – mainly depreciating – dramatically in recent weeks, I am using an exchange rate of Rs. 66 to the dollar.  At a ratio of 2.4:1, the Indian price of Rs. 188.75 translates into a US$ “value” of $6.86.


The ADR is trading at $5.99 at this moment, for a discount of 12.7%, or upside potential of 14.5%.


Given the nature of the trade, I am giving no time here to the underlying business or the intrinsic value of Sesa Goa.


The best way to do this trade is to buy the SLT ADRs in the U.S. and short Sesa Goa stock in India when the market opens there on Sunday night U.S. time.  For those who cannot short in India, an alternative is to buy SLT naked.  Some of the risks of doing this are obvious.  Sesa Goa’s stock could decline meaningfully before the discount narrows enough.  The Indian rupee could depreciate further, again hurting a naked long position here.  Both of these are very real possibilities.  A third risk is that the discount does not narrow.  I think that this risk is minimal, and that the discount will close, in one form or the other.



I do not hold a position of employment, directorship, or consultancy with the issuer.
I and/or others I advise hold a material investment in the issuer's securities.


Recognition of the price discrepancy by investors, and a closing of the discount.  The SLT ADRs will be changing their name to Sesa Goa ADRs, and will later trade under the ticker SSLT.
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