Merger Arbitrage Analysis And Spread Performance - March 31, 2019

by: Malcolm Spink, CFA

Bluegreen Vacations tumbles following announcement and announcement by Bass Pro.

Renesas Electronics Corporation and Integrated Device Technology announce there are no unresolved national security concerns from CFIUS.

Cash based merger arbitrage spreads widen following the announcement of new deals and the decline of Bluegreen Vacations.

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

The standout performer of the week was Integrated Device Technology (IDTI) whose stock climbed a massive 2.53%. The announcement came after the market close at the end of the previous week from CFIUS that "that the investigation of the companies' proposed merger transaction is complete and that there are no unresolved national security concerns with respect to the transaction." Inevitably, the following Monday morning saw the stock shoot up to the offer price of $49.00 and stayed there for the rest of the week until the deal was officially closed on Friday.

What is interesting about this deal is the divided opinion with regards to the CFIUS decision. A second request, as we commented previously, is not necessarily the death knell for a deal. Despite this being a deal in a business segment which is currently undergoing intense scrutiny from regulators common sense has prevailed and the deal has closed. A gain of this magnitude in such a short space of time has provided handsome returns for those brave enough to take a position. Second guessing a CFIUS decision is fraught with danger. What we do know is that these Renesas and Integrated Device Technology and their advisors are the experts in this situation. Legal counsel will have been on hand to advise as well as bankers and other advisers helping with supplying CFIUS with the required information in a complete and timely manner. We must at least have some faith in the company's ability to complete this process and have the foresight to plan for such an eventuality.

It is clear the market misread the severity of the second request and provided a great opportunity for the arbs to make some quick money. This is a great lesson to learn. CFIUS is not the enemy. We will be expanding on this point in subsequent publications

Deal Specifics

Bluegreen Vacations Corporation (BXG) crashed during the week as it announced "Bass Pro intends to cancel the Company’s access to the Bass Pro marketing channels and advertising materials as of 30 days from the notice unless the Company cures certain alleged breaches to Bass Pro’s satisfaction." In response, BXG said it "was both surprised and disappointed by Bass Pro's current position." This obviously has had a hugely negative effect of the spread as acquirer BBX Capital Corporation (BBX) said it is re-evaluating the previously announced short form merger.

BXG was not in our list of largest spreads last week as it was already trading at a premium to the $16.00 offer price. We are always hesitant to buy a stock in the hope of a higher offer and in this case that rule has protected us well. The BXG spread is currently at 8.82% having been as high as 13.47% during the week. The nature of Bass Pro's announcement has certainly had a huge effect. We don't know exactly the nature of the previous discussions between the two companies but it was assumed they were of a genial nature. Why then such a move from Bass? Could this be to force BXG to agree to Bass's demands knowing that if they refuse, the deal with BBX will be scuppered. If this is the case, this spread could prove to be quite attractive. What does Bass have to gain from such a move if the deal does / does not complete? As always, we will be monitoring this situation carefully and will report in a timely manner. In the meantime this is a great topic for discussion if anyone has a unique angle on this deal.

Merger Arbitrage & Market Data

The broader market saw a volatile week initially focused on renewed optimism of a resolution to the U.S. - China trade deal and better than expected earnings. A string finish to the first quarter on Friday however cemented a positive week for the market. The S&P 500 ETF (NYSEARCA:SPY) delivered a positive performance to finish up 1.12% for the week.

Likewise the MNA ETF produced an impressive return to finish the week up by 0.73% for the week. This is largely due to the performance of Celgene Corp (CELG) whose deal with Bristol Myers Squibb is looking likely to close. This once again this shows the shortcoming of investing in this particular product as the short leg of that stock for stock deal is not accurately represented. (You can read more about the MNA ETF in the "Strategy" section at the Merger Arbitrage Limited Website).

Merger Arbitrage Returns March 29, 2019 Merger Arbitrage Portfolio Analysis

U.S. based cash merger arbitrage positions saw more winners than losers this week and the positive performance means the portfolio has regained all the ground lost over the previous few weeks. The top 20 largest cash merger arbitrage spreads as defined by rose by 0.28% and the standard deviation of returns was a subdued 0.65%. The performance of the portfolio was largely attributed to the closing of the Integrated Device Technology (IDTI) deal.

Cash spreads widened during the week due to the complications surrounding the BXG deal. The heavily discounted spread is now eligible for inclusion in the T20 list. Along with two new deals announced during the week the portfolio now has more potential for gain. This has helped increase the top 20 discount spreads which to offer an average of 2.14%. The T20 portfolio now has a full complement of deals and no vacant spots. However, despite this new level of attractiveness, this return figure falls to just 1.29% when PACB and BXG are omitted whose spreads, currently at 10.65% and 8.82% are the largest available.

Merger Arbitrage Strategy

We have stated for some time (most recently in last week's article) that any positive portfolio performance going forward would rely on a small number of spreads with the capacity to move profitably. With the T20 list now back to full strength we are marginally relaxing this point of view. However, PACB's continued fluctuations exude a huge influence on the portfolio return and traders need to be aware that despite making some good profits from this volatility. The spread does have to capacity to turn ugly at a moment's notice.

The rise in the broader market this week has broadly helped existing spreads move towards their offer prices. We have repeatedly warned that geo political situations should not be underestimated by the merger arbitrageur. Spreads could suffer noticeably. The majority of the spreads on our top 20 list are not above 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 when using the official timeline guidance. New deals have been announced but have been bid up aggressively despite the obvious risks, see Quantenna Communications (QTNA) and WABCO Holdings (WBC). In a previous article we discussed deal closing schedules and how understanding this facet of merger arbitrage can help to maximize profitability.

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/we have no positions in any stocks mentioned, but may initiate a long position in BXG 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.