On Monday, ROI Acquisition Corp. II announced that the proposed merger with Ascend Telecom Holdings would not be completed. As a result, all shares of the company will be redeemed for approximately $10/share while the warrants will expire worthless. This means that I will realize a loss of 100% on my position in the warrants, and I agree with my loyal blog reader “pietje” that some reflection on what has happened isn’t a bad idea. At the same time, we have to be careful that we don’t try to extract information that isn’t there since we are talking about a sample size of just one. Expecting Value made the same point a few days ago when talking about the Globo situation, and I totally agree with him. Just because an investment didn’t work out it doesn’t mean that it is a failure that shouldn’t be repeated nor did you necessarily made the right call when you make money. Evaluating success and failure is hard when there is a lot of noise.
So far this probably sounds like I’m creating a narrative where I conclude that the ROIQ deal is just a case of bad variance and that it’s pointless to reflect on it. That’s not completely the case. I did screw up, and I learned a lot from it. I just didn’t do it this week. When I initially posted about the deal in Augustus I was pretty clueless with respect to the dynamics in a SPAC deal and I missed some of the most important factors. So while I now think that my initial thesis was total crap it happens to be the blog post that generated the highest number of page views since I started writing. I hope that those readers came for the high-quality comments on the post, and not the post itself. Because thanks to some knowledgeable readers who commented I quickly realized that I was wrong, and I exited my position (that was sized too big) with a nice gain. A nice example of how a bad thesis can generate a good result…
I continued following the deal and learning more about SPAC acquisitions (this is, for example, a paper worth reading). At some point, I decided to re-enter my position in ROIQW because I thought it more likely than not that a deal would be completed. Recognizing that it was far from certain that a deal would be completed I sized my position very conservative at approximately 30bps of my portfolio. Unfortunately the deal didn’t go through, but I still think that I made a decent bet with good odds. Besides the fact that the deal didn’t go through there is actually no new information, so it’s tough to argue that there is something that I should have known that I missed. The second part of the story is probably a case of a good thesis with a bad result.
If there is one thing we can learn from this it is how valuable it is to receive feedback from other investors on your ideas. Perhaps a blog is not the right idea for everyone, but I can highly recommend it. Sometimes it feels like you are giving great ideas away without getting anything in return, but one avoided disaster makes it worth it. And that’s not the only reason to blog.
Disclosure
Technically I’m still long ROIQ warrants…
I’m glad the initial comments were helpful, and I’m sorry to see that the ultimate outcome wasn’t what you’d hoped for. I think you’re right not to beat yourself up too much on that though, as your position sizing was wisely managed. The other lesson to draw from this might have something to do with what SPAC targets are most likely to result in a completed deal and what indicators might suggest that completion is more or less likely, but every situation is a bit different. Thank you for writing about your experiences so candidly!
A SPAC trying to get a deal done at the last minute is probably not an indicator of success 😉
You’re welcome!
This seems like a really good decision rule, all else equal. It’s helpful if the SPAC still has several months to find another target if the proposed transaction falls through.
And thanks for your comment on the other post, that was part of what made me realize my initial mistake. Perhaps I’m now going to learn that the second part of the story was a case of bad thesis bad outcome :p
I think the real lesson is that if an optimal size is 30 basis points is it even worth doing? You need 10 of them that work out to even move the needle assuming they are doubles (3%) and I don’t think there are 10 of them in a year. And that’s on top of the fact that to figure these out it takes a fair amount of work.
I think it’s definitely worth doing. A normal merger arb deal is maybe a 2.5% position for me with a 4% return, for a net impact of 10bps on the portfolio when everything goes as planned. If this thing would have been completed it would have returned >100% for a net impact of 40/50bps or something like that. It doesn’t sound like much, but when you do a lot of special situations in a year it starts to add up.
The merger arbitrage is a bad business
Downside much bigger then upside
1 failed deal kill profit of 10 good deals
That’s not necessarily true nor is it an important statistic. If just one in 20 deals fail there is no problem.
I just wonder if merger arb is worth the effort vs. other things that one could be spending time on. If a normal merger arb deal earns 10 bps you would have to find 100 of them to earn 10% for a year. This one, perhaps, was worth it but it really depends on how much time you had to spend and your opportunity cost.
Assuming the total amount of investment capital is limited (less than $10 million) there should be investments in small caps and other situations that offer better return.
I think you should see it as a way to complement your returns from your normal portfolio. Adding just one or two percent per year is going to be huge in the long run.
2 percent a year minus fail deals minus transaction cost minus tax = not worse the time and risk (As was mentioned long time ago by Greenblatt who worked for Risk arbitrage firm at beginning of his carreer and notice that 2 % upside and 15% downside is not better then Casino. in the long run you lose