Merger Arbitrage Analysis And Spread Performance - September 20, 2020

Sep. 21, 2020 3:30 PM ETBREW, FIT, LVGO, MNA, RRGB, WMGI, TIF1 Comment

Summary

  • Tiffany corrects inaccurate statements by LVMH regarding the merger agreement.
  • LVMH submits a deal for European Commission for approval.
  • Merger arbitrage cash spreads narrow as the broader market continues its downward trend.

This weekly column 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.

Tiffany & Co. (TIF)

Tiffany & Co. continued its volatile ride of late and once again featured in the largest movers of cash merger arbitrage spreads. We've written extensively about this deal already, but during the past week on Wednesday, an SEC filing by TIF noted:

Tiffany & Co. (NYSE: TIF) today responded to the opposition filed today by LVMH Moët Hennessy-Louis Vuitton SE ("LVMH") to Tiffany's motion to expedite its lawsuit in Delaware Chancery Court. LVMH asked the Court to hold the trial in six or seven months. Tiffany also corrected multiple inaccurate statements by LVMH regarding the Merger Agreement between the parties.

The 8-K filing goes on to list a number of points as to why the deal should consummate as arranged and that there is not an argument from LVMH (OTCPK:LVMHF) to be made.

It appears that LVMH's case rests on the issue of language used. An "order" from the French Government means LVMH is not required to close the deal. Whether this is what was received by LVMH will be a matter for the courts. What we suspect here, however, is that there could be additional involvement from the French government that has not yet been disclosed. This is speculation on our part, but Tiffany's language suggests they are adamant it's a done deal. Whereas LVMH appears to be somewhat blasé about the matter as if they know something we don't. We repeat, this analysis is speculative on our part.

We still believe the most likely solution then is the negotiation and possibly a lowering of the offer price. However, on Friday, LVMH confirmed it has submitted the deal to the European Commission for approval after an anti-trust review thus continuing its obligation to advance completion of the deal.

With this in mind and following a slight recovery in the stock price, we have decided to lower our position. As we added to the position previously, we are happy to take some money off the table. This also gives us the flexibility of re-entering the stock if the opportunity arises. By the end of the week, the stock had risen $3.03 or 2.66% to $116.26 against an offer price of $135. This return calculation includes the dividend payment of $0.58. The deal is now offering a simple spread return of 15.54%.

Merger Arbitrage and Market Data

The broader market continued to experience volatile times during the week and, ultimately, continued its downward trajectory. Despite there not being any significant economic data released during the trading week, the sheer size and weighting of the largest tech stocks in the S&P 500 have now come to dictate the market's direction. Approximately 70% of the index was in positive territory by the end of the week but that was not sufficient to counterbalance the dominance of big tech. However, despite an initial positive start to the week, by the close on Friday, the broader market in the U.S. as defined by the S&P 500 ETF (SPY) was lower by 0.62% for the week.

The IQ ARB Merger Arbitrage ETF (MNA) in addition to the Accelerate Arbitrage Fund (ARB.TO) demonstrated why merger arbitrage can be a valuable addition to a diversified portfolio. Both funds produced an impressive return contrary to the broader market. A significant rise in Livongo (LVGO) assisted the rise in Tiffany & Co. and were the main drivers of the positive performance in the MNA. (You can read our analysis of advantages and disadvantages of investing with the MNA ETF in the "Merger Arbitrage Trading Guide" section at the Merger Arbitrage Limited website). By the end of the week, MNA was showing a gain of 1.09%.

Product Weekly Change Product Weekly Change
T20 Index 2.15% SPY (0.62)%
Index Dispersion 5.04% VIX (3.87)%
Winners 13 MNA 1.09%
Losers 4 ARB.TO 1.56%
Week Ending Friday, September 18, 2020

Merger Arbitrage Portfolio Analysis

U.S.-based cash merger arbitrage spreads demonstrated great resilience and proved now more than ever why a diversifying strategy is wise in light of the market dominance by the largest technology companies. Craft Brew Alliance (BREW) has seen their deal effectively close as the DoJ gives the green light to the previously discussed asset disposal, and this comes on top of the 58.com (WUBA) merger successfully consummating. New deals have, however, continue to be announced in drips and drabs. It is still difficult to call whether this is the unwinding of historical demand of the beginning of a full economic recovery. In light of this, we remain cautious but optimistic about future M&A activity.

The T20 winners regained the upper hand and outpaced by the losers by 13 to 4 with 2 non-movers. There were 19 spreads in the index last week as the index of cash merger arbitrage spreads is no longer calculated with a full complement of 20 deal constituents. The top 20 largest cash merger arbitrage spreads as defined by MergerArbitrageLimited.com gained 2.15% whilst the dispersion of returns was 5.04%. This figure is above both the 3-month average and the long-term look-back periods.

The index of cash merger arbitrage spreads now offers an annualized average return of 12.23%. This is lower than last week's figure of 15.99% and is due to the impressive returns made during the week by a number of stocks such as RRGB, BREW, TIF, FIT, and WMGI. For this coming week, the T20 portfolio has 18 deal constituents.

For additional merger arbitrage discussion and insight into this event-driven strategy be sure to catch our exclusive interview with Seeking Alpha "SA Interview: Merger Arbitrage Investing With Mal Spink, CFA."

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 comprehensive Glossary 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

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.

Disclosure: I am/we are long TIF, FIT. 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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