Pharmasset Merger Arbitrage (VRUS)

On Kid Dynamite’s World I stumbled on an attractive looking merger arbitrage idea. I’m going to keep this post short, so check his post for some background and thoughts on the merger arbitrage dynamics. GILD has made an offer to buy VRUS for 137$/share, and the deal should close 12 January 2012. The stock is currently trading at 129$ making it possible to make a +/- 6 percent return in one month.

Odds of the deal not going through seem to be very low. GILD can only walk away if they don’t get regulatory antitrust approval, or when they discover that something is seriously wrong with the main drug of VRUS. But if that happens the downside would be huge. If they don’t get regulatory approval the stock probably drops to the level before the tender offer was made (~75$) and if something is seriously wrong with the main drug of VRUS the downside could be close to 100%.

Suddenly finding something wrong with the main drug of VRUS in just a month time, while previous trials have been very successful, is certainly not what you would expect, but it’s always a possibility. Regulatory antitrust approval should not be a big issue: both companies are not that big and VRUS value comes from one treatment for chronic hepatitis C virus. Hard to see how that would cause problems, but I’m certainly not an expert on these issues and I certainly could be too naive and simplistic here.

It’s hard to assign exact probabilities, but with a 6% return we would be break-even if the stock goes to zero 1 out of 18 times, or if the stock halves in value we be break-even if that happens 1 out of 9 times. That certainly seems very pessimistic for something that’s basically a done deal.

Just buying the stock seems to be an attractive trade, but with options we can create a risk reward profile that looks even more attractive. The Jan 20 ’12 call option with a 135 strike trades at 1.55/1.65 (bid/ask). If the deal goes through on 12 January 2012 we make 35 cent per option for a 21% return, and if the deal is cancelled or delayed we lose 100%. We do introduce a new risk here: since just a delay is now also bad, but I would guess that the odds of a delay or cancel are significantly below the 1 out of 6 that the option is implying.


Author is long VRUS Jan 20 ’12 calls with a 135$ strike.

4 thoughts on “Pharmasset Merger Arbitrage (VRUS)

    1. Alpha Vulture

      That would give you potentially a huge downside risk if the deal does not go trough (depending on the strike of the puts). Buying calls is actually already a bit like sellings puts in this case. The ‘premium’ that we get is the difference between the deal price and strike + call premium, and if the deal doesn’t go through we ‘pay’ the call premium to the counter party.

  1. Peter

    Also, the tender offer expires on Jan 12 while the options expiry is Jan 20. How can you ensure that you will be able to find liquidity in the options? Otherwise, you will need to use an awful lot of balance sheet to exercise and tender your shares – all for a very skinny profit.

    1. Alpha Vulture

      Not sure what you are saying here: you can simply buy and hold the options and exercise, they should be cash settled if the tender offer goes through.


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