Pharmasset Merger Arbitrage update

It has been a bumpy ride being long VRUS calls. Pharmasset announced on 16 December that it had detected abnormalities associated with liver function in subjects receiving PSI-938, and while this did not trigger the “key product event”  clause it was enough to pressure the stock price below 124$. Fortunately that was the only negative development, and today the Gilead announced that it has almost completed the tender offer. The calls have returned a quick 20 percent in one month, but it’s hard, if not impossible, to evaluate if it was a good trade or not. Could easily just have been luck.

5 thoughts on “Pharmasset Merger Arbitrage update

  1. rijk

    i think that if you purely look at probabilities, you will arrive at the conclusion that this was a good investment

    assuming you bought at $127, i.e. $10 upside left
    and assuming 95% chance of success and 5% chance of failure (key here is that both parties publicly communicated that the merger would proceed after the unfavorable trial results appeared, so 95% is probably still conservative)

    you can calculate a return of $5.65 (95% * 10 – 5% * $77)
    77$ assumes price would drop back to 50 in case merger deal breaks

    5.65/127= 4.4%/month = 53% annualized

    even if vrus would drop to 0 on failure, the estimated result would have been 3.15/127=2.5%/month = 30% annualized…….

    so, based on probabilities, if you take this bet often enough, you will become very wealthy……

    the key fact in this situation was that both parties publicly confirmed the merger after the unfavorable trial results, otherwise it would have been impossible to estimate the probability of success and failure……. and this would not have been a wise investment but a pure gamble…..


    you can calculate a positive return of $7

    1. Hielko

      I bought before the unfavorable trial results were known (but I did know that only adverse results in the main drug could be a reason for failure or antitrust issues). And I obviously did some math along the lines what you did here, and I bought because I did like the odds, but there is no way of really knowing what the true odds for succes and failure were. If you assume a 95% succes rate it was obv a great trade, but if you would assume a <80% succes rate it wouldn't be.

  2. writser

    @rijk: to me, it looks as if you pick an arbitrary probability (95%) to show that this would be a good investment “based on probabilities”. The math makes it look foolproof, but you assume you can estimate the chances of this merger succeeding better than the market. In fact, you think the market is completely clueless in a multibillion merger because you can make 30% on an annual basis.

    Do you have experience in the field of merger arbitrage? Do you have a medical background? The key question is how did you arrive at this specific percentage?

    1. Hielko

      You could also argue that the market could be clueless exactly because of the size of the merger. How much market participants are out there that do have the knowledge and money? According to google hedge funds that focus on merger arb have approx 16B of AUM, while VRUS had a 10B market cap @ tender offer price. If you assume that most funds have a max position limit of 5% or something along those lines there could easily be imbalance between supply and demand.

      But that’s only a theory, hard to prove or disprove…

    2. rijk

      agree that estimating the probabilities is tricky, however:
      – i believe that the success rate of mergers where the target and the buyer have publicly announced that the merger would not be affected after a potential deal breaking issue emerged is higher than 95 out of 100 mergers………
      – the very fact that a potential deal breaking issue emerged would make is highly unlikely that another deal breaking issue would emerge, there is a recent focus bias at work here
      – how many “professionals” got scared and pushed the sell button when the unfavorable trial results appeared and before the “all clear” confirmations were issued by target and buyer? my guess is many
      – how many of these “forced sellers” bought back after buyer and seller confirmed the deal would not be affected? my guess is very few
      – how many “professionals” were comfortable to hold this rotten apple through year end and show this holding to investors? i guess very few…
      – all of this spells buying opportunity……
      i am not saying that this was an all in opportunity, all i am saying is that if you repeat investments with these characteristics and odds often enough, you will do well…….



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