Merger Arbitrage Analysis And Spread Performance - January 27, 2019

by: Malcolm Spink, CFA

Arris International (ARRS) gains on hopes of early closing.

Pacific Biosciences of California (PACB) declines despite positive key shareholder vote.

U.S. based merger arbitrage cash spreads remain tight.

This article explains the reasons behind the movement in a selection of the largest U.S.-based cash merger arbitrage spreads from the past week. We also analyze the attractiveness and profitability of each spread going forward and indicate the trading position or action we have taken (if any).

Deal Specifics

Arris International (ARRS) gained 0.94% during the week on little merger related news. Analysts now expect EPS to be $0.76 on when the company reports earnings on February 13 as opposed to $0.81 previously. Despite this, it is assumed traders are taking their positions in anticipation of a favourable regulatory outcome. The spread is still at 2.09% and as previously stated by the ARRS and acquirer CommScope (COMM), the deal remains on track to close in 1H. An early closing to this deal could provide a handsome return to investors on an annualised basis. In light of this analysis we maintain our long position and are not looking to bank any profits until the stock moves closer to the offer price.

Integrated Device Technology Inc (IDTI) was up 0.62%. Analysts expect IDTI to report $0.37 EPS on February, 4th, unchanged from previous estimates. Hopes of an end to the Government shutdown sufficient to help clear the CFIUS backlog has helped the stock this week. As noted previously week, "antitrust approvals have already been received from a variety of global agencies in addition to the expiration of the HSR waiting period. But the CFUIS delay is sufficient to cause the spread to widen as forecasting a completion date becomes more treacherous." We no longer have a position in this stock but are monitoring the situation closely and ready to re-enter at any time.

Redhat (RHT) had yet another volatile week and finished in positive territory up 0.56%. If this rise continues at this pace we will be looking to take some money off the table and redeploy the capital elsewhere. IBM's offer of $190 a share now leaves the spread at 7.65%. The extended time frame of expected completion for this deal, even if it were to close early would not warrant keeping a full position.

The volatile spread of Pacific Biosciences of California (PACB) continued this week. During the past week two filings were made. Form S-8 showing detailing information on the issuance of new shares as part of than employee benefit plan. But more importantly was the 8-K showing the results of the special shareholder meeting held on the 24th January. As expected, shareholders voted overwhelmingly to accept the offer from Illumina, Inc. and FC Ops Corp. The market was less than impressed and punished the stock as the delay caused by a second request for information combined with the government shutdown adds to the uncertainty regarding the anticipated closing date. The stock declined 2.32%, $0.17 this week following last weeks rebound and now offers a return of 11.58%.

Aspen Insurance Holdings (AHL) announced on Thursday that 4Q results will be released after market close on February 6th. However of greater note was the increased put buying on Friday. The stock was down 0.97% but still only offers a spread of 2.13% for a deal which is expected to close in the middle of the year. This decline on little news about Apollo Global Management's (APO) proposed takeover and large put buying maybe results related but has caught our attention. We stand ready to exit this position should negative developments occur.

On a final note, Avista Corp (AVA) merger with HydroOne has finally been officially terminated. This has come as no surprise following the recent orders by state regulators in Washington and Idaho which denied approval of the merger.

The Broader Market

US based cash merger arbitrage positions saw more winners than losers this week for the fifth week running. This is consistent with a rising/flat market. Although the performance for the top 20 largest spreads was negative 0.07% largely due to the performance of PACB. This compares with the MNA ETF which returned a positive result for the fifth straight week running up 0.34%. The S&P 500 ETF, SPY produced a negative return to down up 0.26%. This partial recovery (so far) in the broader continues to have a positive effect on the spreads and remains the primary factor of cash spread movement. This reflection of the performance of the broader market is making it difficult to justify the level of return for the level of risk/volatility currently available from market arbitrage spreads at the portfolio level. Some individual deals however do offer attractive returns, for instance IDTI, whose closure may occur sooner than the market anticipates. The ongoing trade dispute between the U.S. and China could still provide yet another twist and send stocks into tailspin causing havoc in the merger arbitrage space. We remain long but have started to reduce positions where profits are available with regards to deal completion schedules.

Merger arbitrage trading is not without risks as the AVA deal mentioned above demonstrates. This strategy, although accessible to individuals as well as professionals should be understood in-depth before any capital is put at risk. You can find supplemental literature such as "how-to" guides, introductory guides, a reading list and much more at the website listed above.

Disclosure: I am/we are long RHT, AHL, ARRS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.