Merger Arbitrage Analysis And Spread Performance - March 3, 2019

by: Malcolm Spink, CFA

Versum Materials (VSM) Adopts a Limited Duration Shareholder Rights Plan.

TransMontaigne Partners (TLP) Announced Unitholder Approval of purchase by Affiliate of ArcLight Energy Partners.

Merger arbitrage performance remained flat despite an increase in the broader market.

This article explains the reasons behind the movement in a selection of the largest U.S. cash merger arbitrage spreads from the past week as calculated by Merger Arbitrage Limited. We analyze the attractiveness and profitability of each spread going forward and indicate the trading position or action we have taken or will take (if any).

Deal Specifics

One of the most interesting stories of the week is the adoption of a limited time poison pill by Versum Materials (VSM). VSM had previously received an all stock offer from Entegris (ENTG). However on Wednesday this offer was blown away by an all cash offer at $48 per share from Merck KGaA (OTCPK:MKGAY), (not to be confused with the U.S. Merck). The stock then proceeded to trade above $49 as investors anticipated a bidding war. However the announcement of the poison pill has dampened that speculation and the stock now trades at $48.22. We took a small short position on the news that management preferred the original offer (to the bemusement of most shareholders) and have now almost exited in entirety. We continue to monitor this position and expect additional developments very soon.

One new deal that was announced during the week was the takeover of Spark Therapeutics (ONCE) by Roche for $114.50 per share. This provided traders the opportunity of something new to cheer about. The deal currently offers a spread of1.08%. As this is a tender offer the deal can receive a faster HSR clearance, thus the expected 2Q closing time frame may provide and attractive opportunity if completion can be done by April/May. This naturally increases the annualized profit and on this basis we have initiated a small position.

Tribune Media Company (TRCO) improved 0.48% during the week. This appreciation comes after our warning last week that the previous unexplained drop might be in some way be related to the asset disposal. However, during the week TRCO released its Q4 results which came in ahead of expectations. Positive results always help allay the fears of the dreaded MAC clause so clearly this is good news. The focus now shifts back to acquirer Nexstar Media Group and how close they are to finalizing a deal with Apollo Global Management for the sale of a group of local television stations. The simple spread now offers 1.25% when two dividend payments of $0.25 are included. This may end up being three payments but this third dividend has historically come unusually late in the year by which time the deal may have already closed if regulatory requirements are completed on time. We are monitoring the situation carefully and will report via twitter (listed above in profile section) any updates. We currently have no position.

One additional note worth making is the announcement by Platinum Equity LLC to acquire Multi-Color Corporation (LABL) at $50.00. This stock already trades at a premium at $50.21 and despite historically paying a dividend we have been quoted directly by the LABL press office that “The Board will continue to determine whether to pay dividends on a quarterly basis.” We have no position.

Merger Arbitrage & Market Data

The ultimate rise in the broader market disguised the indecision and fluctuation observed during the week regarding the outcome trade negotiations between the U.S. and China and President Trump's meeting with Kim Jong-un. It was not until Friday that the market clearly signaled it would be a positive week. The S&P 500 ETF, SPY, delivered a positive performance to finish up 0.45% for the week.

The MNA ETF improved marginally by 0.09% for the week due to a sharp rise on Friday whereas the top 20 largest merger arbitrage spreads as defined by declined fractionally by 0.01%.

There were two deals that closed during the week from the list of largest spreads. TransMontaigne Partners (TLP) and Investment Technology Group (ITG).

Merger Arbitrage Portfolio Analysis

U.S. based cash merger arbitrage positions saw more losers than winners this week and the negative performance ends a nine week winning run. The main positive performance of the portfolio was due in large part to Ellie Mae (ELLI) trading at a premium and the recovery of Tribune Media (TRCO).

Cash spreads continue to remain tight. Opportunities have become increasingly scarce as the pace of new deal announcements slows and previously announced deals are closed. The top 16 discount spreads now offer an average of 1.35%. The T20 portfolio now has 4 vacant spots in our top 20 portfolio due to a number of spreads trading at a premium (ie above the current offer price) rendering them ineligible for inclusion. To maintain a consistent weighting across the portfolio and through time we are allocating 4 portions of cash to fill the vacant arbitrage spots in the top 20 list. This action reduces the overall average spread to 1.08%. This figure falls to just 0.67% when PACB is omitted whose spread, currently at 8.84% is the largest available.

Merger Arbitrage Strategy

As stated in previous weeks, positive portfolio performance going forward will rely on a small number of spreads with the capacity to move profitably, specifically PACB and RHT. Although during this last week it was ELLI that provided the largest return as arbs look for an improved offer. Opportunities for spotting attractive returns are becoming increasingly scarce. However, we are watching very closely the previously announced deal extension by Integrated Device Technology (IDTI). The spread widened during the week and if this continues we will be keen to initiate a position.

The rise in the broader market that has helped raise the target stock prices can only take them so far. Beyond that, future rises in the broader market will have limited effect. New deals have been announced but with minimal or negative premiums. When one deducts the level of return available for simply holding cash, some spreads, even on an annualized basis, do not justify inclusion in a merger arbitrage portfolio. Arbitrageurs need to pay extra special attention to deal closing schedules to maximize annualized returns.

Although we continue to retain some long positions, namely RHT, we have reduced the sizes in accordance with previous guidance. We now hold only a handful of the smallest positions but continue to exploit the volatility associated with those spreads such as PACB.

Merger arbitrage trading is not without risks. This strategy, although accessible to individuals as well as professionals should be thoroughly understood BEFORE investment capital is put at risk. To assist the reader, "evergreen" content such as "how-to" & introductory guides, a reading list and much more including a list of the largest cash merger arbitrage spreads currently available can be found at the Merger Arbitrage Limited website site map associated with the author of this article.

Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in ONCE, PACB over the next 72 hours. 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.