Merger Arbitrage Analysis And Spread Performance - June 2, 2019

by: Malcolm Spink, CFA

Global Brass and Copper rallies on announcement of date of special meeting.

CIRCOR International declines as hopes of a higher offer recede.

Merger arbitrage cash spreads remain wide following continued market turbulence.

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

Global Brass and Copper (BRSS) may not have been the best performing cash merger arbitrage spread during the week but still finished up 0.95%. During the week the firm filed a DEF14A listing the date for the special meeting as July 9 2019. This caused the stock to rise $0.41. The estimated completion date was originally given as the end of the year. However, this now appears more than generous given the date of the special meeting. The spread now stands at 1.26% against an offer price of $44.00 from Wieland-Werke AG. With dividends available and a fixed date for the special meeting we may very well initiate a position in this spread if there is a slight pullback during the coming week.

CIRCOR International (CIR) was the biggest loser this week. The stock was down 2.63% to $42.26 against a hostile offer from Crane (CR) of $45.00. Other than a conflict minerals filing there was no other news in the popular press. However, the stock declined sharply on Friday to leave a spread of 6.48%. We expect an update on this deal soon. This deal is still a hostile one so we expect a higher amount of deal spread volatility in the coming days. The fluctuations depend on whether Crane (CR) will walk away, or whether they will make a higher offer.

This is a similar situation to Wageworks (WAGE). In these hostile spreads we try to take advantage of the spread volatility before an agreement is reached. However, we were already long CIR prior to the drop. We shall continue to hold our position and look to take some profits on a rebound. In the meantime, having previously been long WAGE, we sold (prematurely again!) just above the $50.00 mark and took a small short position in the options market. We will be happy to exit this position in the low $49's.

Pacific Biosciences of California (PACB) again found itself amongst the biggest losers for the week. This week the stock finished down a further 1.47%. Once again there were no regulatory filings and no new deal news or commentary. However, during the week an initial rise gave us the opportunity to exit part of our position which we have subsequently bought back. This is consistent with our long time strategy of actively trading this spread. The deal spread on PACB is now once again the largest available at 19.40%. This is a $1.30 discount to the $8.00 a share offered by Illumina (ILMN)

Honorable Mentions

For the sake of completeness we also mention the closing of Travelport (TVPT). Despite the rumor mongering from the previous weekend this deal closed successfully at a price of $15.75. We previous stated we were a bit quick to enter this deal but a successful conclusion means a profit was made. We're happy to avoid any Russian regulatory issues and will now look to redeploy the capital. Aquantia (AQ) also rose during the week, more on this next week, but we are estimating a 2 month closing timeline (excluding any additional influences). We may initiate a position if the stock pulls back during the coming week.

Merger Arbitrage & Market Data

The broader market fluctuated during the early part of the shortened trading week and saw large losses at the end on Friday. The escalation of the US-China trade war with China now imposing increased tariffs on US imports continues to weigh on global markets. This is further compounded by president Trump's imposition of tariffs on Mexican imports. The S&P 500 ETF (NYSEARCA:SPY) finished down 3.65% for the week.

Surprisingly, the MNA ETF held up well and eventually finished in positive territory for the week. By Friday the MNA ETF was up by 0.86%. (You can read more about the MNA ETF in the "Strategy" section at the Merger Arbitrage Limited website).

Merger Arbitrage Returns June 2, 2019

Merger Arbitrage Portfolio Analysis

U.S. based cash merger arbitrage positions saw 12 winners and 7 losers this week with 0 non movers. The top 20 largest cash merger arbitrage spreads as defined by declined by 0.07% and the standard deviation of returns was 1.28%, marginally above the 3 month and long term averages. The flat performance of the portfolio was attributed to the large rebound and closing of TVPT offset by the declines in stock specific deals such as PACB and CIR.

The portfolio of cash spreads remained steady during the week. The top 20 discount spreads now offer an average of 4.11%. The T20 portfolio has 20 deals and 0 vacant spots filled by cash. The return figure is more broadly based than ever as spreads have declined across the board.

Merger Arbitrage Strategy

Positive portfolio performance going forward has a greater diversity than in previous months. Investors have a number of option to choose from for a healthy return as deal spreads have generally widened across the board. However, new deal announcements have slowed recently which may be as a result of the ongoing trade impasse. In addition, the portfolio may no longer be as reliant on a small number of spreads as noted in a previous article, although PACB remains significantly large.

We have extensively warned for some time, and continue to do so, of the failure to resolve the US-China trade talks. We had suggested traders keep some power dry for such a decline as we saw during the week. The decline in the market and widening of deal spreads has presented these opportunities for which we were waiting. We have increased our long exposure yet again during the week to take advantage of this weakness. As we approach full investment we continue to actively trade various positions as detailed above so as to free up capital when possible

The spreads on our top 20 list (available from the Merger Arbitrage Limited website) have now risen sufficiently above the level of return available for simply holding cash, circa 2.30% pa. This should entice more arbitrageurs back into the merger arbitrage space. Early closing such as BRSS mentioned above could provide a very attractive return. We discuss deal closing schedules in a previous article. We maintain our positive outlook for the profitability of merger arbitrage. Market volatility is providing us with a number of opportunities not seen in this strategy space for some time.

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.