Merger Arbitrage Analysis And Spread Performance - April 21, 2019

by: Malcolm Spink, CFA

Mellanox announces first quarter results.

Bluegreen Vacations Corporation arbitrage spread widens to 8.45% as stock tumbles.

Merger arbitrage spreads widen as new deals are announced.

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 Specifics

Mellanox (MLNX) climbed 0.45% or $0.54 to $119.81 and was the biggest gainer this week. On Tuesday, Mellanox announced Q1 results beating analysts' forecasts. No guidance has been given for future earnings due to the merger with after NVIDIA. Although little news was released with regards to the takeover, a solid earnings report does reinforce the share price should the proposed merger fail. We have previously taken a small position in MLNX and are happy with our gain thus far. However, following this rise we will begin to look at a possible partial exit. The timeline for this deal is still quite lengthy and a continued rise may provide a decent short term return and provide funds for reinvestment.

The significant loser this week from our T20 list was Bluegreen Vacations Corporation (BXG). The stock declined by a disastrous 3.12% to close the week at $14.91 against an offer price of $16.00. During the week BXG announced the confirmation of the next dividend but there were no new filings with regards to the merger. We initiated a small position in this stock during the decline. We may have been a little hasty here but maintain our previous analysis of the actions taken by BASS Pro. Unless there is significant negative news forthcoming regarding the takeover by BBX Capital Corporation, we have no intention of exiting this position.

We should also mention Spark Therapeutics (ONCE) which was also a negative performer this week declining an additional 0.45% or $0.50. This continued decline now sees the stock down 2.86% for the last 3 weeks. No new filings were made during the week so the latest news remains with there being only 29.4% of the stock tendered. Roche has extended the offer until May 2nd. The biggest factor now weighing upon this deal is whether or not the FTC will issue a second request. Sentiment has clearly turned against this stock and we expect to hear further details shortly. We advise against trading this stock until more clarity is observable.

Merger Arbitrage & Market Data

The broader market saw respectable gains for the shortened holiday week as traders focused on the beginning of earnings season and positive economic data from China. The S&P 500 ETF (NYSEARCA:SPY) finished effectively unchanged, down 0.06% for the week.

Surprisingly, the MNA ETF produced another calamitous return to finish the week down by 1.01%. This product is capable of having such a disparity to the performance of the SPY because of its hedging strategy for stock deals. This once again shows the shortcoming of investing in this particular product as the short leg of that stock for stock deal represented by a broader sector ETF product. (You can read more about the MNA ETF in the "Strategy" section at the Merger Arbitrage Limited Website).

Merger Arbitrage Returns April 21, 2019 Merger Arbitrage Portfolio Analysis

U.S. based cash merger arbitrage positions saw an equal number of winners and losers this week with 2 non movers. The negative performance of ends a three week positive run. The top 20 largest cash merger arbitrage spreads as defined by declined by 0.14% and the standard deviation of returns was in line with the 3 month average 0.73%. The performance of the portfolio was largely attributed to the decline of BXG which pushed the standard deviation higher in an otherwise uneventful week.

The portfolio of cash spreads widened during the week as new deals were announced. Mature deals approached their offer prices or exited the list as their deals finally completed. The top 20 discount spreads now offer an average of 2.15%. The T20 portfolio has 19 deals and 1 vacant spot filled by cash. The return figure has become less reliant on the returns available from PACB and BXG indicating greater diversity. The portfolio return now falls to just 1.43% when their spreads, currently at 8.45% and 8.25% are removed.

Merger Arbitrage Strategy

As mentioned, the T20 list now has a 3 part cash component. Positive portfolio performance going forward has a greater diversity than in previous months with some new deal additions. The portfolio is no longer as reliant on a small number of spreads with the capacity to move profitably as noted in a previous article.

However, deals are not appearing as fast as we would like. Political situations should not be underestimated by the merger arbitrageur despite the recent optimism regarding Chinese manufacturing data. The rise in the broader market over the past few weeks has helped existing spreads, many of which are nearing completion. New deals that have been recently announced will be more sensitive to market movements going forward.

Still almost half 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 2.45% pa. It is difficult to understand how some spreads on an annualized basis, justify inclusion in an investment portfolio when using the official timeline guidance. Without the possibility of a higher offer the only option for a sufficient return is for the deal to close early. We discuss deal closing schedules and how understanding this facet of merger arbitrage can help to maximize profitability in a previous article. In light if this, we retain our positive outlook for the profitability of merger arbitrage.

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 BXG, ONCE. 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.

Editor's Note: This article discusses one or more securities that do not trade on a major U.S. exchange. Please be aware of the risks associated with these stocks.