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. (NYSE:TIF)
Tiffany & Co. sparkled during the week as a number of news items encouraged investors to increase the deal closing probability. LVMH (OTCPK:LVMHF), the potential suitor, has for some time made it clear the firm’s intention to back out of the deal. However, with Tiffany pursuing specific performance from LVMH through legal channels, it looks like a deal of at least some description will be struck.
A court filing made on Tuesday afternoon by Tiffany, which was responding to the LVMH countersuit, states, LVMH
pivoted to a new corporate strategy regarding its acquisition of Tiffany so as to explore every available avenue to evade LVMH’s contractual obligations and attempt to pressure Tiffany to agree to a price cut.
With regards to the infamous letter received by LVMH from the French Government (the French version which as yet remains confidential), Tiffany went on to claim,
LVMH’s solicitation of a letter from the French government to be employed as a means to walk away from LVMH’s contractual obligations was a flagrant breach of the merger agreement. So, too, were Bernard Arnault’s admitted meeting with the French foreign minister to discuss the letter without advising Tiffany beforehand and LVMH’s admitted failure to lift a finger to seek the retraction of the French foreign minister’s request.
Following this, and LVMH’s refusal to disclose the letter in French, on Wednesday, it was reported by Reuters that the EU Competition Commission was set to approve the deal. Officially, the EC is scheduled to decide on the deal before October 26. Neither the EU nor Tiffany has so far commented on this report.
Then, on Thursday, in a press release, Tiffany reported strong preliminary sales and operating results for August and September. The announcement which was widely seen as further strengthening its hand in its upcoming courtroom battle with LVMH stated,
While we still expect full-year results to be substantially impacted by COVID-19, we are very pleased with the way the business has rebounded following the first quarter and continues to rebound in the third quarter, especially in Mainland China, and to recover in the United States.
This announcement sent the stock soaring higher by more than $2.60 on the day.
The Situation as it Stands
It appears with the language being used that Tiffany seems by far the more confident should this deal be decided by a legal decision. However, Bernard Arnault is a shrewd operator, and it seems unlikely he would embark upon a futile endeavor to avoid altering the deal if he did not believe he could benefit from it. The damage done to LVMH’s reputation by reneging on an agreed deal may end up being all for nothing. As we previously stated, the involvement of the French Government and the mysterious letter could also provide additional surprises. Despite this subject slipping from the limelight recently, as noted by Tiffany, we continue to suspect there will be further revelations.
Although we believe the deal will eventually consummate successfully, we envisage the journey to be a volatile ride. Even an agreement between the parties, thus avoiding a court battle, even if a lower price was agreed, the negotiations could prove tricky. In this rare instance, we may look to take an option position (initially, delta-neutral) to take advantage of the potential volatility. In addition to this, we maintain our stock position for the time being. By the end of the week, the stock had risen $4.23 or 3.57% to $122.64 against an offer price of $135. The deal is now offering a simple spread return of 10.08%, which excludes the dividend.
Merger Arbitrage and Market Data
The broader market continued to move ahead last week although was at one stage in the red following a poor start on Thursday morning. A rally throughout the rest of the day and a lackluster display on Friday kept the market in the black. A comprehensive stimulus package is yet to be announced, although traders are still hopeful something can be arranged before the election. In the meantime, retail sales continue to climb although the softening in the job market may start to be a concern as the recovery slows. The broader market in the U.S. as defined by the S&P 500 ETF (NYSEARCA:SPY) at the end of the week was higher by 0.14%.
The IQ ARB Merger Arbitrage ETF (NYSEARCA:MNA) continued its positive run. As the broader market and the wider economy display contradictory signals, merger arbitrage has demonstrated via its recent performance why it can be a valuable addition to a diversified investment portfolio. The MNA ETF produced another positive return extending its winning run to six straight weeks. Tiffany & Co., with additional support from Grubhub (NYSE:GRUB), was the main driver 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 0.71%.
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|Week Ending||Friday, October 16, 2020|
Merger Arbitrage Portfolio Analysis
U.S.-based cash merger arbitrage spreads also posted an average increase during the week outpacing the broader market. Rosetta Stone (NYSE:RST) was the only deal among the index constituents that closed although the majority of spreads tightened as the market improved. Although no new deals were announced that made our index, we do note the continued announcements of stock swap deals and smaller cash-only deals are providing merger arbitrage investors with investment opportunities. As M&A activity continues to increase, we continue our increasingly optimistic view of merger arbitrage activity in the near future.
The T20 winners regained the upper hand and outpaced 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 index of the largest cash merger arbitrage spreads as defined by MergerArbitrageLimited.com improved by 0.44% whilst the dispersion of returns was 1.48%. This figure is significantly below both the 3-month average and the long-term look-back periods.
The T20 index of cash merger arbitrage spreads now offers an annualized average return of 12.68%, which is slightly above last week’s figure of 12.13%. This marginal increase in the potential average return is due to the closing of the Rosetta Stone deal whose spread had already narrowed significantly. 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.”
Disclosure: I am/we are long TIF. 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.