J&J’s Swap Offer for Kenvue Is About to Expire. Proration Figure Will Be Key.

The exchange offer is expected to be oversubscribed because of the financial incentive that J&J offered its shareholders as an inducement to swap their stock for Kenvue (KVUE), the consumer health company that J&J took public in May. Kenvue controls such brands as Listerine, Band-Aid, and Tylenol. J&J allowed its holders to get Kenvue stock at a 7% discount, although the discount has shrunk in the past two days.

The uncertainty is just how oversubscribed the offering will be. The current thinking on Wall Street is the proration will be in the 25% to 30% range. That means a holder of 100 J&J shares would get 30 shares converted into about 241 Kenvue shares and retain 70 shares of J&J. 

J&J said Wednesday that each J&J share tendered in the exchange offer would receive roughly 8.03 Kenvue shares. So 30 shares of J&J in the example above would get swapped for about 241 Kenvue shares.

The exception to the proration are holders of 99 shares or less of J&J who submit all of them in the exchange. They will get a full allotment of Kenvue stock. The proration is likely to be announced by J&J early next week, possibly on Monday.

Johnson & Johnson stock was off 0.7% Friday to $172.74, while Kenvue was down 0.5% to $22.67, near its low since the IPO. The current value of the exchange offer is roughly $182 per J&J share on Thursday’s close, about 5% premium. 

“The proration assumptions have been coming down,” says Roy Behren, co-manager of the Merger Fund (MERFX). He said estimates were as high as 40% initially, adding that proration projections are more “art than science.” 

The J&J exchange offer, known as a split-off on Wall Street, is by far the largest ever, double the size of

General Electric
’s
exchange offer for

Synchrony Financial

in 2015, which had a proration of about 30%. 

The sheer size of the deal and high retail ownership of J&J stock may hold down participation and raise the proration since many retail investors won’t participate in part due to the deal’s complexity. 

But many institutional holders may decide to make the swap to gain exposure to Kenvue at a discount and there likely are plenty of arbitragers involved and that would raise participation and reduce the proration. Arbs have gone long J&J and short Kenvue to capture the spread.

If the J&J proration is 30%, it would mean that about 25% of J&J shareholders elected to make the swap. 

The arbs need to make an assumption about the proration to adjust their hedges. Some arbs are “underhedged,” meaning they have shorted less Kenvue than they expect to receive in the exchange, betting that Kenvue stock will rally next week.

Kenvue stock has been depressed by arb activity and trades more than 5% below where it stood before the exchange offer was announced while J&J is higher.

One plus for Kenvue likely will be its inclusion in the

S&P 500
at an undetermined date after the exchange offer ends. That will create demand, and some think the inclusion could come as early as next week. Index funds could wait to make the swap when the Kenvue inclusion comes rather than participate in the exchange offer.

Citi analyst Filippo Falorni wrote in a note Tuesday he anticipates Kenvue could rally once the exchange offer is over. 

“KVUE shares have been under pressure from event-driven funds during the exchange tender period and we expect additional volatility during the averaging period (8/14-16), and on 8/21-22 as event-driven funds readjust their positions post-close. We anticipate KVUE will outperform in the following weeks, as shares return to trading based on fundamentals. Additionally, we expect tailwinds from index-fund demand for KVUE shares following last week’s announcement by S&P Global that the company will be added to the S&P500 following completion of the exchange offer period.”

Kenvue now trades for about 18 times projected 2023 earnings and yields 3.5% while J&J fetches 16 times estimated 2023 profits and yields 2.8%.

J&J said it will retire about 191 million of its own shares in the exchange offer, assuming that it offers1.5 billion Kenvue shares in the exchange. 

Wall Street is assuming that J&J offers 1.7 billion Kenvue shares, its entire stake of about 90%, due to strong likely demand for the exchange offer. That would result in more than 210 million shares of J&J being retired, Barron’s estimates, or about 8% of J&J’s shares.

The exchange offer amounts to a giant stock buyback funded by Kenvue stock. J&J opted for the more complex exchange offer, which is confusing many of its huge base of retail holders, rather than a straight spinoff in which J&J holders would have automatically received Kenvue stock.

The offering is nearing its conclusion and Wall Street will be focused on the proration news next week and how the stocks trade. The betting is that J&J declines and Kenvue rallies, but surprises often happen.

Write to Andrew Bary at [email protected]