Merger Arbitrage Analysis And Spread Performance - April 7, 2019

Includes: BBX, BXG, MNA, ONCE, SPY
by: Malcolm Spink, CFA

Bluegreen Vacations rebounds following last week's warning from Bass Pro.

Spark Therapeutics declines on Roche's response to low take up in tender offer.

Cash based merger arbitrage spreads narrow as BXG and the broader market rally.

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

We speculated last week that the decline in Bluegreen Vacations Corporation (BXG) due to the announcement by Bass Pro could provide an attractive investment opportunity in the right circumstances. If Bass Pro were forcing a renegotiation at such a point in time where BXG would be forced to agree so as not to jeopardise the announced deal with BBX Capital Corporation (BBX) then the sharp decline in the spread would make it attractive. You can read more about Bass Pro's announcement here.

Following this decline, BXG was the significant gainer this week from the T20 list. The stock climbed a 3.90% to close the week at $15.44. There was no news announced during the week so we can assume the rebound was due to the previous week's collapse regarding the statement from Bass Pro. As per the T20 rules, we do not include stocks trading at a premium in the portfolio. 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. Therefore we were able to avoid the losses incurred following this statement but the portfolio does benefit from the gains this week as the stock was at a discount to the $16.00 offer price. We were able to take a small position in this stock at below $15.00 in accordance with our risk control procedures and have already taken some of that money off the table. The spread currently stands at 4.78%. A dividend of $0.17 is expected to be paid at the end of next month.

Deal Specifics

In contrast to the BXG performance, this week’s worst performer was Spark Therapeutics (ONCE). The stock declined 1.15% or $1.31. The spread now stands at 1.71% for a tender offer that was originally expected to close April 2nd. However, with only 29.4% of the stock tendered, Roche has extended the offer until May 2nd. This caused the stock to fall and it appears traders are not speculating on a higher bid forthcoming to sweeten the deal following Roche's comment on the issue "All terms and conditions of the offer shall remain unchanged during the extended period". In addition to this Roche has also withdrawn and refiled the Premerger Notification and Report Form under the HSR act effective as of April 2nd and is expected to refile on or about April 10th. As this is a tender offer, the waiting period will expire on the 25th April.

Trader chat has suggested that the low tender figure could be a result of the uncertainty surrounding the HSR application. It is interesting to note that if the deal was unsuccessful the price could collapse to around a price of $50.00. One would therefore expect a higher level of shares tendered. The stock has traded as high as $114.20 against an offer price of $114.50. Roche clearly is in no rush to raise the offer on those grounds. This deal looked like it was going to close early and the spread reflected that. If the tender offer becomes a "slow burner" and the timeline is dragged out we will see a widening of the spread until closure timing becomes more certain. We will monitor this spread and look for an entry point if the spread widens sufficiently.

Merger Arbitrage & Market Data

The broader market saw huge gains for the week focused on renewed optimism of a resolution to the U.S. - China trade deal. A strong start to the week was followed by a steady increase each day and cemented a very positive week for the market. The S&P 500 ETF (NYSEARCA:SPY) finished up 3.30% for the week.

Likewise the MNA ETF produced an impressive return to finish the week up by 1.01% for the week. This is largely due to the long positions held by the ETF and benefited immensely from the rise in the broader market as opposed to the performance of any individual spreads. This once again 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 April 07, 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 0.24% and the standard deviation of returns was a higher than usual 0.98%. The performance of the portfolio was largely attributed to the rebounding of BXG and the higher standard deviation because of the decline in Spark Therapeutics (ONCE).

Cash spreads narrowed during the week mainly due to the renewed optimism surrounding the BXG deal and that there were no new deals that made our list. The top 20 discount spreads now offer an average of 1.88%. 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 1.23% when PACB and MLNX are omitted whose spreads, currently at 10.19% and 5.14% are the largest available.

Merger Arbitrage Strategy

With the T20 list now back to full strength (no cash positions) we are now beginning to relax our point of view that positive portfolio performance going forward would be reliant on a small number of spreads with the capacity to move profitably.

However, we have repeatedly warned that geo political situations should not be underestimated by the merger arbitrageur despite the recent optimism. Spreads could suffer noticeably. The rise in the broader market this week has broadly helped existing spreads move towards their offer prices. In fact, as we noted in last week's article, the new deals that have been recently announced have very quickly moved towards their respective offer prices despite the lengthy closing times (In a previous article we discussed deal closing schedules and how understanding this facet of merger arbitrage can help to maximize profitability).

The majority of the spreads on our top 20 list (available from the Merger Arbitrage Limited website) are not above the level of return available for simply holding cash, circa 2.50% pa. Therefore, some spreads on an annualized basis, do not justify inclusion in an investment portfolio when using the official timeline guidance. We remain positive on the profitability outlook for merger arbitrage but with the market going from strength to strength the key will be the quantity and quality of new deals that become available.

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 associated with the author of this article.

Disclosure: I am/we are long PACB, BXG. 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.