PennantPark Floating Rate Capital closed the merger with MCG Capital today. This was one of my higher conviction merger arbitrage idea’s, but it didn’t exactly work out. The higher HC2 bid fell through while PFLT started trading at a discount to NAV. As a result, MCGC shareholders will receive approximately $4.37 value in share according to my calculations, based on PFLT trading at $12.90/share. I managed to exit a little bit higher than that, but the result is a very small loss despite the merger actually going through (can’t complain though since it is less than 4bps).
With PFLT now trading at a 10% discount it might actually be a decent long. Historically it has been trading right around NAV, and now that it is bigger it should, in theory, have some economies of scale and be a bit better as well. I’m not really interested in buying something at a 10% discount, but it is probably not a terrible idea.
No position in MCGC or PFLT
ROI Acquisition Corp. II is a blank check company that consummated an IPO on September 20, 2013 that raised $125 million. At the end of July the company announced that it had found a suitable target and that it would buy Ascend Telecom Infrastructure, a provider of telecom infrastructure in India (investor presentation). Concurrent with the merger the company intends to exchange its outstanding warrants. Initially the company wanted to exchange all warrants for $0.50/share in cash, but that offer was revised today to the following:
Under the revised Warrant Amendment Proposal, warrantholders would have the option to either:
- have their warrants survive and become exercisable for Ascend Holdings ordinary shares following the closing of the Business Combination in accordance with the terms of the Warrant Agreement, as amended; or
- have their warrants exchanged at the closing for $1.00, comprised of $0.50 in cash and 0.05 of an ordinary share of Ascend Holdings.
While I already had a position in the warrants (subtle brag) before this announcement I think that the warrants are today even more attractive than before for a merger arbitrage play. The value of the warrants has increased with 100% while the price has lagged and is up just ~70% (as of this moment). With the warrants at $0.60 you can make a whopping 66.7% return when the merger is completed. That’s a pretty insane return for a merger arbitrage.
At the same time, the fact that the exchange proposal has been revised higher and to include an option for warrant holders to keep their warrants is probably a positive signal. The only reason for keeping your warrants is when you think that the surviving company will be worth a lot more than $10/share in the future. The warrants have a strike at $11.50 while they are callable when shares start trading at $24.
While the possible return is very high this is also a deal that has more risk than your average merger arbitrage. When the merger isn’t completed the warrants are going to be worthless because in that case ROIQ will be wound-up and cash will be returned to shareholders. When you own a normal stock instead of warrants during a merger arbitrage your downside is usually a couple of dozen percent to something in the direction of the pre-deal price. Because of this I think that ROIQ warrants should offer a return that is roughly three or four times higher than a normal merger arbitrage, and the position should also be sized accordingly.
But even when we adjust for the higher risk the deal appears to be very attractive. A 65% return divided by four is still more than 16%, and usually something like 4 or 5% is already a pretty big spread. The current spread is basically implying that the probability of this deal going through is just 60%, which I think is way too low. But perhaps I’m missing something?
Author is long ROIQW
I exited my position in Conrad a week ago and I sold my position in AIG today. I bought both stocks in 2012, and they were both big winners (although I could have done a lot better if I sold Conrad earlier). Including dividends Conrad returned 114.7% while I made 92.6% on AIG. At this point in time, they were both low conviction ideas, and I needed to make some room. My portfolio is currently 102.7% long and 5.0% short for a net long exposure of 97.8%, so I’m still almost fully invested. Luckily a couple special situations will also be concluded this month.
Northern Offshore reported that the merger with Shandong Offshore was completed earlier this week and that the cash payment will be made on August 12. MCGC has scheduled their shareholder meeting for August 14, and if enough shareholders vote in favor for the merger it should and could be completed shortly thereafter. There is a risk that the company will not be able to gather enough votes because a lot of shareholders are retail investors who might not take the trouble to cast a vote. I don’t think people will vote against the merger because they are unhappy that the deal with HC2 didn’t go through since that deal is now totally dead after HC2’s stock price dropped ~40%.
Author is long NOF.OL, MCGC, no position in AIG and CNRD anymore