Merger Arbitrage Analysis And Spread Performance – April 26, 2020

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.

Kemet (KEM)

Kemet provided some good news this week as the company announced it had received clearance from Committee on Foreign Investment in the United States (CFIUS). This news follows on from the previously announced approval from the Taiwan Fair Trade Commission (TFTC). In a press release issued on April 24th, the company went on to say

The parties continue to expect the transaction to close in the second half of 2020 with the goal of closing by the end of the third quarter of 2020, subject to additional customary closing conditions and the receipt of the remaining required regulatory approvals, which include approvals under the Anti-Monopoly Law of China and approval from the Investment Commission, Ministry of Economic Affairs in Taiwan.

This announcement may in part explain part of last week’s movement as traders speculated on a regulatory announcement. This week, the stock moved upwards by $1.14 to $26.77, a rise of 4.45% against an offer price of $27.20 from Yageo. The simple spread now stands at only 1.61% and when annualized becomes approximately 5%. Regulatory approvals are still required in China and Taiwan although there is no reason to expect them not to be granted. However, they can be notoriously difficult to predict in terms of timing even during normal market conditions. Deal extension risk in this regard could greatly affect the annualized return.

We believe the rise in the stock price this week does not leave much meat on the bone. We no longer have a position in this spread. Having took a very small position following our previous analysis we reasoned this latest rise was sufficient to take some money off the table.

Tiffany & Co. (TIF)

Tiffany & Co. (TIF) is the clear loser this week. The stock fell throughout the week following the announcement that Sycamore Partners notified L Brands that it is terminating the deal to acquire a stake in Victoria’s Secret. Although this action has not yet prompted analysts to call the Tiffany deal into question, is has forced some traders to consider the overall risk to their portfolio following the COVID-19 outbreak and how the risk of deal failure has increased across the board. In the meantime, the date for the Annual General Meeting has been set for June 1, 2020. Note: this meeting is not to vote on the proposed takeover by LVMH.

Data by YCharts

However, following the $2.80, or 2.17% decline in the stock to $126.35, the deal is now offering a simple spread return of 6.85% against an offer price of $135 per share from LVMH. Assuming the deal closes later on in the year, it should allow for at least one more dividend payment. This could help boost the annualized return to around 30%. Early closing may of course increase this annualized return but at the same time could potentially reduce the number of dividends paid and thus reduce the return. Even though we believe the possibility of this deal falling apart is extremely low, even at these levels, we do not consider this deal to offer a sufficient return worthy of an investment.

Merger Arbitrage and Market Data

Countries across the globe continue to explore ways in which they can begin to reopen businesses in light of the devastating economic impact of the COVID-19 pandemic. However, experts warn too much too soon could lead to a second wave of infections if not handled correctly. The markets of course have their own view. A new unprecedented stimulus package was signed into law by President Trump during the week aimed at helping small business and hospitals. The market responded as expected and began to claw back the losses sustained at the beginning of the week when the price of oil turned negative. This was in spite of another 4 million jobless claims taking the total figure to close to 26 million since the outbreak. The broader market in the U.S. ultimately underperformed for the week and by the close on Friday, the S&P 500 ETF (SPY) finished down 1.31%.

The IQ ARB Merger Arbitrage ETF (MNA) by contrast declined steadily through the whole week, helped in large part by its holding in Tiffany & Co. The ETF which had recovered to be within striking distance of the levels at which it was trading before the COVID-19 outbreak retreated inline with the broader market. (You can read our analysis of advantages and disadvantages of investing with the MNA ETF in the “Merger Arbitrage Strategy” section at the Merger Arbitrage Limited website). By the end of the week, the MNA was showing a loss of 0.86%.

Product Weekly Change Product Weekly Change
T20 Index 0.79% SPY -1.31%
Index Dispersion 2.22% VIX -5.82%
Winners 11 MNA -0.86%
Losers 7
Week Ending Friday April 24, 2020

Merger Arbitrage Portfolio Analysis

U.S. based cash merger arbitrage positions saw a decent performance this week as the winners triumphed over the losers by 11 to 7 with 2 non-movers. There were no cash positions last week as the index of cash merger arbitrage spreads maintains its full complement of deal constituents. The top 20 largest cash merger arbitrage spreads as defined by MergerArbitrageLimited.com gained 0.79% and the dispersion of returns was 2.22%. This number, although high, is now significantly below the recent all-time highs and is also below the 3-month medium-term and long-term look back periods. The positive performance of the portfolio was primarily attributable to the gain in BITA and accompanied by additional strong performances in KEM, & FIT.

The index of cash merger arbitrage spreads now offers an average of 17.32%. This is marginally lower than last week’s figure of 18.27% and builds upon the rally which started three weeks ago. For this coming week, the T20 portfolio has 20 deals and 0 vacant spots filled by cash.

For additional merger arbitrage discussion 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 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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Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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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