Merger Arbitrage Analysis And Spread Performance - November 03, 2019

Nov. 04, 2019 11:31 AM ETFitbit, Inc. (FIT)ACIA, ILMN, MLNX, MNA, PACB, RRGB, GOOG, GOOGL4 Comments4 Likes
Mal Spink, CFA profile picture
Mal Spink, CFA


  • Alphabet (Google) takes out Fitbit in a $2.1bn all cash offer.
  • Pacific Biosciences of California rebounds following CMA investigation.
  • Red Robin Gourmet Burgers continues volatile run.
  • Cash merger arbitrage spreads narrow following strong weekly performance.

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.

A slight change to the format of the article this week. We have for some time voiced concern about the lack of new deals being announced in the cash merger arbitrage space. However, with the announcement of Alphabet's (commonly referred to as Google and done so throughout the rest of this article) (GOOG) proposed takeover of Fitbit (NYSE:FIT) this week, we thought we should analyze the deal in a bit more detail. Following this analysis, we'll give a quick round up of some of the larger moves during the week followed by our regular market & portfolio analysis.

Fitbit (FIT)

Although rumors first circulated of an offer for Fitbit on October 28, it was on the morning of October 31 that the market was given confirmation of Google's takeover approach. The table below summarizes the key offer details.

Target Stock Name Fitbit
Target Stock Ticker FIT
Acquirer Stock Name Google LLC
Announcement Date November 1, 2019
Expected Completion Date March 31, 2020*
Offer Price $7.35
Payment Method All Cash Deal

* User generated estimate. Official statement reads, "The transaction is expected to close in 2020".

At Friday's close of $7.14 the spread is currently offering 2.94%. When annualized using the above date (estimated) we have a figure of 7.36%. Under normal circumstances we would assume 150 days is ample time to close this deal, in fact, we would expect it to close sooner. However, a recent Bloomberg article quoting a person familiar with the transaction said,

Google and Fitbit expect the deal to face a protracted regulatory review in light of the current political focus on competition and privacy issues in the tech industry"

From past experience, this could push the deal out to 6-9 months, bringing the annualized spread down to around 5%. The reason cited for this level of scrutiny is because of the sensitive nature of Fitbit's user data and what Google may do with it. However, Google have already begun to make it clear how they intend to respect the privacy of that data.

The two companies already have a partnership in the health systems space as Fitbit has tried to leverage its user data and enter the wider health care market. James Park, co-founder and CEO of Fitbit stated,

“With Google’s resources and global platform, Fitbit will be able to accelerate innovation in the wearables category, scale faster, and make health even more accessible to everyone.

Analysts appear to agree. The deal is seen as a logical fit for Google. Fitbit has struggled against Apple in the wearables tech market. Ramon Llamas, an IDC analyst, said Google & Fitbit should "try to become the gold standard of what a health and fitness smartwatch should offer."

The downside however could be significant. Were this deal to break, traders could lose as much as 60% from the current price. A takeover premium of this size is not uncommon when such a large company buys a relatively smaller one.

A chance of a higher offer seems unlikely at this stage. As can be seen from the graph below, Fitbit has been declining for some time. Prior to 2017, the stock was above $45. There are not many suitors that are in the position to turn this business around or make the required investment.

ChartData by YCharts

With an existing business relationship in place and a buyout premium almost 100% higher from where the stock was trading 3 weeks ago, it makes a competing bidder unlikely to challenge Google's financial prowess.

Therefore, the problem for us is the potential regulatory scrutiny and the deal delays this would involve. We have talked extensively about deal extension risk in previous articles. On first take, we would love to have this spread in our portfolio. Large company buys ailing small company, minimal competition issues, domestic acquirer & target... the list goes on. With the other deals we own right now registering Chinese regulatory issues or CMA investigations, Fitbit would indeed make a great fit. However, with the potential deal delay, we expect the spread to widen before it narrows. For now, we'll sit on the sidelines but will be ready to act should the opportunity arise.

Pacific Biosciences of California (PACB)

A recovery from last week's nosedive sent Pacific Biosciences of California to the top of the best performers this week. The stock price finished the week at $4.90 up 4.03% against an $8.00 offer price from Illumina (ILMN). This leaves the spread at 63.27%. As expected, there was no deal news announced this week. Traders are braced for the CMA decision following the completion of their Phase II investigation. This has a statutory deadline of December 11 2019. At these levels, we have maintained our position and will do so for the time being.

Red Robin Gourmet Burgers (RRGB)

Red Robin Gourmet Burgers was the largest decliner this week. The only news being the release date for earnings will be November 5. The stock fell by 1.79% to $31.19 against an offer price of $40 from Vintage Capital. Our active arbitrage strategy is now in full swing and we continue to trade in and out of the position as the market moves. We shall continue this strategy as long as the stock continues to behave in this volatile manner. However, we will be exercising additional caution over the earnings announcement.

Merger Arbitrage and Market Data

A sharp rise on Thursday helped the broader market continue its upward trajectory. A combination of lower interest rates, a positive jobs report and a de-esclation of the U.S. - China trade dispute helped send the market into new all-time highs. Corporate earnings also continued to deliver robust results. As a result, volatility appears to have been temporarily subdued. The S&P 500 ETF (SPY) finished up 1.52% for the week.

The IQ ARB Merger Arbitrage ETF (NYSEARCA:MNA) also had a positive week. By Friday, the MNA ETF was up 0.49%. (You can read our analysis of the MNA ETF in the "Merger Arbitrage Trading Strategy" section at the Merger Arbitrage Limited website).

Merger Arbitrage Returns November 01, 2019

Merger Arbitrage Portfolio Analysis

U.S. based cash merger arbitrage positions saw 13 advances and 5 declines this week with 0 non-movers. There were two cash positions last week as the index did not have sufficient candidates to monitor. The top 20 largest cash merger arbitrage spreads as defined by improved 0.48% and the dispersion of returns was 1.32%. This is below the level experienced over the medium term 3-month and long-term averages. The positive performance of the portfolio was attributed to the rebound in PACB, along with significant rises in MLNX & ACIA.

The index of cash merger arbitrage spreads now offers an average of 6.89% and thus remains reasonably high. The T20 portfolio now has 17 deals and 3 vacant spots filled by cash. The portfolio (details available from the Merger Arbitrage Limited website) continues to be dominated by PACB. The PACB simple spread continues to be the largest and remains above 46%.

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.

Author's note: If you enjoy Merger Arbitrage Limited, please consider following us by clicking on the "Follow" button at the top of this page and hitting the "like" button below.

This article was written by

Mal Spink, CFA profile picture
Merger Arbitrage Limited is a successful Event Driven & Special Situations Investment fund. Along with the website Merger Arbitrage Limited the fund specializes in Merger Arbitrage (Risk Arbitrage). The investment process focusses on the following key elements i) Evaluation of relative risk/return characteristics ii) Time frame analysis iii) Entry/exit points This focus has resulted in multiple variants of the traditional merger arbitrage strategy each having their own unique characteristics. In concert, these strategies produce an attractive source of alternative beta with less risk than traditional plain vanilla merger arbitrage thus producing an attractive sharp ratio consistently above 2. The key areas listed above have been intensely researched and build extensively upon existing academic literature resulting in a series of proprietary algorithms. The primary geographic area of operation is (but not restricted to) the US and encompasses all deal types. MAL also designs, continuously develops and execute various other automated quantitative strategies. These strategies primarily involve the use of (but not limited to) equities and equity options which are synchronised to the risk appetites of individual clients. Strategies are coded and automated in R and Visual Studio, with some arbitrage and special situation plays requiring additional manual input to optimise execution and performance.

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

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