Ubid, an Internet auction firm and subsidiary of Creative Computers, a catalog distributor of computer and computer peripherals released its IPO recently. Creative Computers plans to expand its distribution network by opening retail outlets. However, the direct pressure on profits margins in the computer business forces the firm to sell Ubid. SCM, a hedge fund which looking forward to putting the fund and to get positive return, closely monitors and researches the IPO price of Ubid.
On December 9, 1998, Creative Computers was trading at $22.75 and Ubid was trading at $35.6875. At that time, Creative Computers had 10,238,703 shares outstanding and Ubid had 9,146,883 shares outstanding. Since stock Valuation equals to stock price times outstanding shares, the stock valuation of Creative Computer equals to 22.75*10,238,703=232,930,493.3 and Stock Valuation of Ubid is 35.6875*9,146,833= 326,429,387.1.
After the IPO of Ubid, Creative Computer holds approximately 80% of Ubid’s security. Add an account “Security” in the left side of the balance sheet to reflect the market value of Creative Computer’s stake in Ubid. ((9146883-1817000)*35.6875=261,585 thousands of dollars).
On the right side, calculate the market value of Creative Computer’s stock by timing $22.75 with 10,238,703 shares to get 232,930 thousands of dollars.

Consolidated Balance Sheet of Creative Computer
Assets
(thousands of dollars)
Liability & Equity

Cash and Equilvalent
15,528
Accounts Payable
75,877
Accounts Receivable
40,564
Short-term Debt
2,969
Inventory
44,958
Other Current Liabilities
15,336
Other Current Assets
12,428
Capital leases
29
PPE
15,040
Notes Payable
154
Securities (Ubid)
261585

Other Long-term Assets
14,313
Stock holder’s equity
232,930
Total Asset
404,416
Total Liability & Stockholders’ equity
327,295

According to the adjusted balance sheet gotten above, equity value of Creative Computer is smaller than its asset value. It can be concluded that the stock price of Creative Computer is relatively undervalued; therefore, the stock price of Ubid is relatively overvalued. To achieve the spread of the prices of two stocks, hedge fund should long Creative Computer and short Ubid. Now the ratio of long and short should be determined. In its IPO, Ubid sold 1,817,000 shares, which means Creative Computer now holds 7,329,883 shares of Ubid in its asset. (9,146,883 -1,817,000=7,329,883 shares). In this case, each shareholder of Creative Computer will get 0.7159 shares of Ubid in the spin-off. (7,329,883/10,238,703=0.7159). The ratio should goes by long one share of Creative Computer and short 0.7159 shares of Ubid at the same time.
As discussed before, Creative Computer is undervalued and Ubid is relatively overvalued. In this specific spin-off case, the one share value of Creative Computer is $22.75 and 0.7159 share value of Ubid is $25.55. So there is an