Johnson & Johnson: Odd Lot “Arbitrage” Opportunity

Investing in businesses that are simple, predictable, profitable, and replicable at attractive prices is our primary strategy. However, occasionally we enjoy delving into more unique investment opportunities. Recently, Johnson & Johnson's offer to exchange its shares for Kenvue shares caught our eye.

This exchange offer presents a chance to earn approximately 7.5% on a modest sum of money (around $17,000), resulting in a profit of approximately $1,300 over a few days. Although this trade carries some risks, it has a relatively high likelihood of success.

While this idea won't make anyone wealthy, we appreciate these opportunities as a chance for EPC to offset some or all of our clients' management fees and trading costs, depending on the account size. 

In May, Johnson & Johnson sold 10% of its consumer staples unit, Kenvue, in an IPO. Kenvue owns well-known brands like Band-Aid, Johnson's, Aveeno, Listerine, and Tylenol. It is the largest pure-play consumer health company in the US.

Today, Johnson & Johnson owns 90% of Kenvue and is extending an offer to exchange up to 80% of Kenvue for its own shares. This represents a large stock buyback by Johnson & Johnson, funded by Kenvue shares instead of cash.

To incentivize shareholders to exchange their Johnson & Johnson shares for Kenvue shares, the company is providing a 7.5% discount on Kenvue shares. For every $100 of Johnson & Johnson tendered, shareholders will receive $107.53 in return. There is some very important fine print to be aware of in this deal.

Firstly, the exchange is subject to an upper limit ratio of Johnson & Johnson to Kenvue. This safeguard is in place to prevent a significant appreciation of Johnson & Johnson shares in relation to Kenvue shares.

The upper limit is 8.0549 and is not currently not in effect. If it does take effect, shareholders tendering their Johnson & Johnson shares may receive less than $107.53 worth of Kenvue shares in return. Johnson & Johnson made a website to easily watch the indicative exchange ratio, which will be finalized after the market closes on August 15th.

Second, Johnson & Johnson is willing to exchange a maximum of 1,533,830,450 of its own shares for Kenvue shares. Given the high likelihood of oversubscription (due to the appealing 7.53% return), proration is likely.

There is a strategy to avoid proration: tender fewer than 100 shares. According to the exchange offer detailed in Form S-4, shareholders who own "odd-lots" (less than 100 shares) of Johnson & Johnson and tender all of their shares will be exempt from proration.

Stockholders who beneficially own “odd-lots” (less than 100 shares) of J&J Common Stock and who validly tender all of their shares will not be subject to proration.

It's important to note a few risks. Firstly if the exchange ratio reaches the upper limit, tendering shareholders may receive less than $107.53 worth of Kenvue shares. Fortunately, both J&J and Kenvue are large, stable, blue-chip companies, making drastic price fluctuations unlikely, though still possible.

Second, the market price of Kenvue shares might decline after the exchange but before you can sell them. However, if the upper limit isn't triggered, there's a 7.5% buffer against this risk. Once again, Kenvue is a large, stable, blue-chip company, making a 7.5% drop improbable, though not impossible.

If all goes well and the upper limit remains untriggered, investors could buy 99 shares of Johnson & Johnson for approximately $17,045 and tender them all for exchange. The deadline is August 18th. Investors would receive roughly 784 Kenvue shares valued at $18,328 which could be sold for a profit of $1,283.

Addendum - August 16, 2023

Barron’s wrote an article about this situation and cited various brokerage cutoff times for tendering shares. The deal’s cutoff is midnight on Friday (i.e. 11:59 PM) but the brokers need extra time to tender the shares.

• Fidelity — End of day Thursday, best-effort basis until 2 PM EST Friday.

• Merrill — End of day Thursday (5 PM EST).

Additionally I spoke with representatives at Schwab and Interactive Brokers.

• Schwab — End of day Monday (8/14), so it has already passed.

• Interactive Brokers — 11 AM EST Friday.

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Disclosure: The author, Eagle Point Capital, or their affiliates may own the securities discussed. This blog is for informational purposes only. Nothing should be construed as investment advice. Please read our Terms and Conditions for further details.