Merger Arbitrage Analysis And Spread Performance - March 24, 2019

by: Malcolm Spink, CFA

Spark Therapeutics withdraws and refiles under HSR to reset the waiting period.

Integrated Device sinks on CFIUS concerns.

Cash based merger arbitrage spreads widen following Friday's broader market sell off.

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 intend to take based upon the analysis given.

Deal Spotlight

Spark Therapeutics (ONCE) continued its run of poor form following on from last weeks drop. The stock was down another 0.52% for the week. During the week the company filed a SC 14D9/A which stated "The required waiting period with respect to the Offer was to expire at 11:59 p.m., Eastern Time on March 18, 2019. According to the Offer to Purchase, Roche Holdings has withdrawn the March 1, 2019 filing effective on March 18, 2019. Roche Holdings refiled a Premerger Notification and Report Form under the HSR Act with respect to the Offer and the Merger with the Antitrust Division and the FTC on March 18, 2019."

This new HSR refiling will take 15 days to expire as the deal is structured as a tender offer. No reason was given for the refiling other than the standard text. But the fact that it occurred is not out of the ordinary and gives the firms more time to furnish the required information and avoid the ongoing uncertainties of a second request. However, also contained in the filing was the details of 3 complaint filings known as The Wang Complaint, the Kent Complaint, and the Newman Complaint which the company intends to vigorously defend. This new waiting period is expected to expire at 11:59pm on April 2nd 2019.

Following this drop the spread is now at 1.33% or a $1.50 discount to the $114.50 offer price from Roche (OTCQX:RHHBY) for a deal that is expected to close by the end of Q2. We consider this timeframe to be chronologically generous as tender offers tend to complete faster than standard mergers. At this level or even any further decline (assuming no additional adverse news) coupled with the potential for early closing makes this stock an attractive potential candidate for investment. The annualised potential return would be in excess of 10%. We shall be watching extremely closely in the coming days and will be keen to make an investment.

Deal Specifics

Integrated Device Technology (IDTI). The stock declined 1.06% or $0.51. The spread now stands at 2.53% for a deal that was originally expected to close in the first half of 2019. During the week there had been concerns that there was a problem with the CFIUS review. The deadline for a decision expired on Friday but to this end there has not been any official announcement by IDTI or acquirer Renesas (TSE: 6723). The stock dropped only $0.05 on Friday which is mostly attributable to the large decline in the broader market. It strikes us as odd there was not greater coverage of this stock and trader chat seems to have gone quiet. We shall update readers via our twitter feed @MergeArbLimited on any breaking news of significance.

As appears standard procedure nowadays, Pacific Biosciences of California (PACB) gave up last weeks gains to finish the week down 0.82% at $7.30. There was no deal specific news that caused the movement and it appears that general market gyrations were the primary driver. This continues to suit our previously stated strategy perfectly. During the previous week we had sold some of our position and this week we were able to buy part of that back in the mid $7.20's compared with Illumina's (ILMN) offer price of $8.00. We will, as always continue to trade the volatility of this spread.

Merger Arbitrage & Market Data

The broader market saw a volatile week initially focused on the Fed's decision not to raise rates and causing the market to rally hard on Wednesday. A large selloff on Friday however cemented a negative week for the market. The S&P 500 ETF, SPY, delivered a negative performance to finish down 0.71% for the week.

Likewise the MNA ETF however suffered another negative week to finish down by 0.84% for the week. This third weekly drop in a row now puts the MNA ETF almost back to where it was trading when we started calculating and publishing the T20 performance figures more than 5 months previously. Once again this shows the shortcoming of investing in this particular product. (You can read more about that at the Merger Arbitrage Limited Website).

Merger Arbitrage Returns March 22, 2019 Merger Arbitrage Portfolio Analysis

U.S. based cash merger arbitrage positions saw more winners than losers this week and the negative performance now means the portfolio has been negative 3 out of the last 4 weeks. The top 20 largest cash merger arbitrage spreads as defined by fell by 0.13% and the standard deviation of returns was a subdued 0.51%. The performance of the portfolio was hampered largely because of Integrated Device Technology (IDTI)

Cash spreads widened during the week continuing a slight trend which has appeared over the last few weeks. New deals are appearing seldom, such as Mellanox (MLNX) and despite our reservations (see last week) this has helped increase the top 18 discount spreads which now offer an average of 1.86%. The T20 portfolio now has 2 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 2 portions of cash to fill the vacant arbitrage spots in the top 20 list. This action reduces the overall average spread to 1.67%. This figure falls to just 1.00% when PACB and MLNX are omitted whose spreads, currently at 8.70% and 5.88% are the largest available.

Merger Arbitrage Strategy

Last week's article stated that any positive portfolio performance going forward would rely on a small number of spreads with the capacity to move profitably. However, PACB's continued fluctuations exude a huge influence on the portfolio return and this week moved the portfolio negatively. We continue to watch closely the previously announced deal extension by Integrated Device Technology (IDTI). This simple spread now offers 2.53% but additional clarification regarding the CFIUS situation is needed before an investment should be made. If this is favourable we will be happy to execute our preferred entry point around the $48 level.

The decline in the broader market this week has helped widen the existing merger arbitrage spreads. We have repeatedly warned that geo political situations should not be underestimated by the merger arbitrageur. Spreads could continue to suffer noticeably. There are not many deals that are returning more than the level of return available for simply holding cash, circa 2.55% pa. Therefore, some spreads on an annualized basis, do not justify inclusion in a portfolio. New deals have been announced but have been bid up aggressively despite the obvious risks, see Mellanox (MLNX). Arbitrageurs need to pay extra special attention to deal closing schedules and potential dividend payments that may materialise to maximize annualized. Whilst simultaneously maintaining a substantial portion of available cash to take advantage of any further declines.

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 sitemap associated with the author of this article.

Disclosure: I am/we are long PACB. 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.