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Merger Arbitrage Analysis And Spread Performance - May 5, 2019

by: Malcolm Spink, CFA

Bluegreen Vacations Corporation continues its recovery.

Attunity reports earnings and becomes the only negative performer for the week.

Merger arbitrage spreads narrow across the board following a positive economic data.

This article explains the reasons behind the movement in a selection of the largest U.S. cash financed merger arbitrage spreads from the past week as calculated by Merger Arbitrage Limited. We analyze the attractiveness and profitability of each spread and indicate the trading position or action we have taken or intend to take based upon the analysis given. To conclude, we give brief summary and outlook for the overall merger arbitrage market.

Merger Arbitrage Spread Analysis

The significant gainer this week for the second week running was Bluegreen Vacations Corporation (BXG). The stock climbed 1.32% to close the week at $15.37 compared to the $16.00 per share offer from BBX. Despite there being no official filings or official news during the week, the stock appears to continue its rebound. The spread has now reduced to 4.10%.

There was one report suggesting an alternative arbitrage strategy. This involved shorting the target stock because of a high expectation of a deal break. Whilst simultaneously taking a long position in the acquirer. We not do not intend to question the authors reasoning, but we do caution our readers to approach this strategy carefully. The strategy suggestions rely on the deal breaking to maximize profitability whilst still aiming to make a small profit should the deal succeed. The strategy variants considered in the article are not "pure" merger arbitrage. As such, they come with a unique set of risks not considered in the article. An excessive amount of market risk is inherent in this approach. Should the deal stall and the market decline the investor could suffer large losses at the hands of market risk. This may render this strategy unsuitable for followers of merger arbitrage.

Pacific Biosciences of California (PACB) moved $0.06 higher during the week. This 0.82% increase was enough to trigger yet another trade for us in this stock. Currently trading at $7.41, the stock is still $0.59 below the $8.00 offer price from Illumina. This still gives the stock plenty of room to move. We continue our active arbitrage strategy and are now looking to buy back some stock on weakness.

Global Brass and Copper (BRSS) made a debut entry in the biggest movers category this week. A gain of 0.76% or $0.33 was enough to gain 4th place (we have omitted LXFT from this analysis on the grounds of insufficient news) in a strong week for the portfolio. During the week, the company issued an earnings announcement. Although earnings were light, revenue was above analysts' expectations. The company declared a dividend of $0.09 and goes ex-div on May 10. The deal is expected to close in the final quarter of the year and therefore could possibly include three more dividend payments. Against a $44 per share offer from Wieland-Werke AG, the spread would still only amount to 1.42% following this week's rise. We have no position in this stock and it is extremely unlikely that we will initiate one in the near future.

Merger Arbitrage & Market Data

The broader market saw marginal gains for the week. Consumer confidence and productivity were up whilst unemployment remained low. Investors continue to search for a reason to cut interest rates as inflation pressures recede. The Fed however continues to put things on hold. The S&P 500 ETF (NYSEARCA:SPY) finished up 0.21% for the week.

Perhaps surprisingly, the MNA ETF produced a positive return to finish up for the week by an impressive 1.32%. The hedging strategy for stock financed deals used by this product once again delivered an outsized return akin to having a straightforward long stock position. Despite articles written in support of this product, the continued negative performance shows its shortcomings. (You can read more about the MNA ETF in the "Strategy" section at the Merger Arbitrage Limited Website).

Merger Arbitrage Portfolio Analysis

U.S. based cash merger arbitrage positions saw 16 winners to 1 loser and 1 non-mover last week. There were 2 cash positions. The top 20 largest cash merger arbitrage spreads, as defined by our research organization, improved by 0.38%. The standard deviation of returns was 0.37% and was significantly lower than the long-term average. The positive performance of the portfolio was attributed to the broad increase of all constituents with one exception.

Merger Arbitrage Returns May 5, 2019 The gains from the portfolio of cash spreads during the week have had a noticeable effect on the returns available for the coming week. The top 20 discount spreads now only offer an average of 1.96%. Going forward, the T20 portfolio has 17 deals and 3 vacant spots filled by cash.

Merger Arbitrage Strategy

It is important to remember the benefits of diversification in a merger arbitrage portfolio. Returns such as those experienced this week often mask the risks involved in this type of event driven strategy. The increase in positive sentiment surrounding the market is sufficient to raise asset prices across the board. As investors speculate on a cut in interest rates, deal spreads become more attractive. Investors are looking for investments considered "safe" that can outperform cash and merger arbitrage is an ideal candidate. However, there may still lie hidden traps within specific deals ready to snare even the most seasoned investor.

New deals seem to have quietened down for the last week or two and the portfolio continues to struggle to attain a full complement of takeover targets. Although the new deals that have appeared still have room to offer profitable opportunities. Deals such as these still have a long way to go until completion. For instance, WABCO Holdings (WBC) is not expected to close until early 2020. This makes the stock in question far more susceptible to market movements. The broader market is trading at all-time highs and we may well experience a period of both frenzied buying coupled with profit taking. At this point, the benefits of deal diversification will surely come to the fold.

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. 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.