Merger Arbitrage Analysis And Spread Performance - September 8, 2019

by: Malcolm Spink, CFA

Mellanox rises as China's SAMR formally starts its review of NVIDIA's proposed takeover.

Red Robin Gourmet Burgers volatile as offer is unanimously rejected.

Cash merger arbitrage spreads narrow following an increase in the broader market.

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.

Spark Therapeutics (ONCE)

Spark Therapeutics rebounded strongly this week following recent declines. The company announced an extension to the tender offer. This is now scheduled to close on October 1. However, with the ongoing investigation into the merger it is almost certain this will have to be extended again. The stock closed down another 3.76% at $101.07 this is against an offer price of $114.50 from Roche (OTCQX:RHHBY). Investors may also have been reading positive signals from comments by Roche CEO Severin Schwan who stated,

"Ongoing U.S. Federal Trade Commission (NASDAQ:FTC) scrutiny of Roche's $4.3 billion takeover of Spark Therapeutics came as a surprise...It is now expected (to close) by year's end"

and who went on to say,

"We thought we should close this relatively quickly without a more-detailed review. That was not in line with our expectations."

Although it is quite possible the stock, along with other merger spreads was caught up in the broader market upturn. However, in light of these comments we maintain our position.

Mellanox (MLNX)

Perhaps one of the most positive pieces of news to grace the ears of merger arbitrageurs in recent times came from Mellanox during the past week. On Wednesday, it was announced China's State Administration for Market Regulation formally started its review of Nvidia's acquisition of Mellanox. The investigation started last month and has a 180-day review period. This helped lift the stock by 2.38% to $109.60 versus the $125 offer from NVIDIA (NVDA).

In other Mellanox news, the firm is demonstrating its LinkX products as well as showcasing the full line of 100/200/400G cables and transceivers at the China International Optoelectronic Expo (CIOE) September 4th in Shenzhen. We considered the stock had underperformed during the week when considering the scheduling of trade talks between the U.S. and China and the initiation of the investigation. However, once again we maintain our position and will await further clarification in the global trade arena.

Acacia Communications (ACIA)

Acacia Communications was the other significant gainer for the week. The stock rose 2.08% to close at $64.36 against an offer price of $70 from Cisco (CSCO). This leaves the simple spread at 8.76%. This rise marks a pleasant recovery for this spread. However, as mentioned, the rise in the broader market during the week helped a number of merger arbitrage stocks. As with Spark and Mellanox, we maintain our position and await further clarification in the global trade arena.

Red Robin Gourmet Burgers (RRGB)

Red Robin Gourmet Burgers (NASDAQ:RRGB) continued its rollercoaster ride this week. The stock finished down $0.44 or 1.31% at $33.05 against an offer of $40 per share from Vintage Capital. This leaves a spread of $6.95 against a buyout price of $40. It was a volatile week for RRGB. On Thursday, an announcement read "Red Robin Board of Directors Unanimously Rejects Unsolicited, Conditional Proposal from Vintage Capital". Surprisingly (to some) that helped push the stock higher. Investors cheered the clarification. There was also no immediate response from Vintage Capital suggesting they are not yet prepared to walk away. The statement also went on to say,

"The Board and management team also note that they appreciate the constructive dialogue with Vintage, and look forward to future engagement with Vintage and all of the Company’s shareholders as Red Robin continues to focus on driving shareholder value."

We maintain our position and await further news.

Merger Arbitrage & Market Data

The broader market continued its recovery this week building upon last week's gains. Optimism returned as investors celebrated the proposed trade talks in October between the U.S. and China. Despite manufacturing activity being subdued, non-manufacturing activity (by far the greater of the two) expanded at a growing rate when compared to July. Jobs data revealed a slowdown in hiring but not enough to increase the rate of unemployment. The S&P 500 ETF (NYSEARCA:SPY) finished up 1.91% for the week.

The IQ ARB Merger Arbitrage ETF (NYSEARCA:MNA) also had an impressive week. By Friday, the MNA ETF was up 0.53%. (You can read our analysis of the MNA ETF in the "Strategy" section at the Merger Arbitrage Limited website).

Merger Arbitrage Returns September 6, 2019

Merger Arbitrage Portfolio Analysis

U.S. based cash merger arbitrage positions saw 15 advances and 4 declines this week with 1 non-mover. The top 20 largest cash merger arbitrage spreads as defined by improved 0.50% and the standard deviation of returns was 1.08%. This is below the level experienced during the over the medium term 3-month and long-term averages. The performance of the portfolio was attributed to the large gains in ONCE, MLNX & ACIA but tempered once again by the decline in RRGB.

The top 20 discount spreads now offer an average of 6.44% due to the aforementioned rises made during the week. The T20 portfolio has 20 deals and 0 vacant spots filled by cash. The portfolio (available from the Merger Arbitrage Limited website) is once again becoming reliant on a handful of spreads for the high average return. This is signified by the widening of the PACB simple spread to more than 43%.

Merger Arbitrage Strategy

This week was a good week for cash merger arbitrage spreads and builds upon last week's gains. However, the majority of these gains have come from spreads that were previously wider and therefore have more room to move and more potential for profit. We have highlighted previously how spreads with a lower deal closing probability (DCP) such as these are more susceptible to broader market movements.

For this reason, we advise arbitrageurs to analyze their portfolios and consider the amount of concentrated or grouped risk. That is, deals with common risk factors such as Chinese regulatory issues. Although we are sticking with our positions for the time being (as well as opening a new position in WBC as of last week), the rising broader market may offer the opportunity for some to trim some positions if they feel there are areas of over exposure.

Once again, this week saw no significant new deals that fit our criteria for monitoring. There has been cash deals announced but for the criteria stated on the merger arbitrage limited website, we do not see these deals as being valid investment propositions for most investors. Average traded volume or a wide bid-ask spread makes trading these spreads extremely problematic. This lack of new deal opportunities is causing us to be more cautious in our outlook. No trader wants to be in a position where they feel pressured into making an investment because of a lack of valid opportunities. We will await further activity in this area before revising this view.

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.

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Thank you.

Disclosure: I am/we are long ONCE, MLNX, RRGB, ACIA. 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.