American Farmland merger arbitrage

This year seems to be the year of the attractive merger arbitrage idea’s. After Kahala and Glacier Water there is now a third deal that I think has a limited amount of risk, but a double digit upside. American Farmland Co (NYSEMKT:AFCO), an agricultural farmland REIT,  is being acquired by Farmland Partners Inc (NYSE:FPI), another farmland REIT, in an all stock deal. Shareholders will receive 0.7417 shares of FPI for every share of AFCO. With FPI trading at $11.49 while AFCO is trading at $7.53 the spread is a juicy 13.2%.

American Farmland Co transaction highlights

Why the spread is this big is a question I can’t answer. Unlike the earlier mentioned deals this is a simple transaction with no difficult to value consideration, and while both REITs have a market cap around $150 million the shares of both companies are quite liquid. There is also no regulatory risk, nor is there financing risk, so the only real risk that remains is that shareholders could vote the deal down. Given that this is a merger between two small REITs I think it’s a deal that makes sense simply to get some scale benefits, but based on the market reaction of Farmland Partners on the day the merger was announced not everybody was enthusiastic.

On the day the deal was announced the stock went from $11.10/share to $10.42/share which is 6.1% drop. It’s not a great market reception, but it’s also not so big that I think it’s likely that the deal will be voted down. It’s quite common for the acquirer to drop a bit when a deal is announced, and usually it doesn’t cause a problem. In addition, the FPI stock has now more than fully recovered, although that might have more to do with the Trump market rally.

In case the deal gets voted down the downside is not disastrously high. On the day before the merger was announced AFCO was trading at $6.04/share. If it would fall back all the way to that level it would represent just a 19.1% drop, and it probably would go down less since the company would receive a sizeable ($6 million) break-up fee, the market in general has been going up since the deal was announced, and it’s positive for AFCO shareholders that management is willing to sell the company.

So it seems like that the market is pricing in an almost 50% chance of failure for this deal which seems excessively high. This deal going through is not a sure thing or a 99% thing. But I think the correct odds should probably be around 90% or 95%. One possible reason that I can offer for the spread being so big is that shorting Farmland Partners is not practically possible. There are almost no shares available for borrow, and the fee rate is close to 20%. My hypothesis is that most shares are hold by parties that don’t lent out their shares (probably a lot of retail investors in a farm REIT) and as a result arb’s cannot hedge their FPI exposure. But it’s totally possible that I’m missing something else here. What do you think?

Disclosure

Author is long AFCO, no position in FPI

28 thoughts on “American Farmland merger arbitrage

  1. JG

    I have been just setting up a position over the last week as well as the spread has been widening.

    Similar conclusion: Can’t arb this due to lack of short availability. However, I really like this deal as it is seems to be a win/win.

    I don’t mind that I can’t short FPI, if you always do deals where odds are in your favor, you win over the long term.

    I was still doing some last DD, if I find something, I’ll let you know

    JG

    Reply
  2. Bighorny

    Looks like around the the time of the acquisition, FBI’s reported NAV was $10 and the implied value was $8.20 or so. Seems like some of the analysts wanted the company to pursue either a liquidation or share buybacks so this was not the preferred option. Regardless, with the large retail shareholder base – don’t see why it would necessary get voted down on that basis.

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    1. Alpha Vulture Post author

      I don’t totally follow. If FPI’s NAV was $10 while the share price was $11+ using stock to do a deal would be a smart thing right? Not share buybacks or a liquidation.

      Reply
  3. BasedShark

    From what I’m seeing, it looks like certain AFCO holders filed a class-action lawsuit on November 11th related to the consideration they would be receiving in the deal. http://www.marketwatch.com/story/shareholder-alert-brower-piven-announces-the-filing-of-a-class-action-lawsuit-in-connection-with-the-sale-of-american-farmland-company—-afco-2016-11-11. Could this be dilating the spread at all?
    That same morning is when the share price of FPI started increasing from the mid-10s to the mid-11s now. I think this could be the direct reason for the increase in FPI’s price, because the Trump rally started two days prior. Let me know what you think.

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  4. Bram de Haas

    I’m not a big fan of FPI at all. I looked into it a few times and I don’t get why its valued at a substantial premium to book. In a subscriber http://seekingalpha.com/research/11236431-bram-de-haas/4916017-fan-fpi-buying-afco article about the deal (which I didn’t like) I wrote:

    “FPI guides towards the deal being 10% accretive to FPI’s AFFO per share in 2017 and 20% accretive after synergies. If that works out it’s a solid deal and it’s hard to argue against using overvalued shares to buy ones less so.

    At the heart of the matter lies my disbelief that when you put x acres of farmland into a corporation and slap a label on it and some tax advantages these acres are suddenly worth a lot more than book value. Which is exactly what FPI investors seem to believe.

    To get on point of today’s acquisition, the strategic rationale makes little sense to me. Out of five reasons cited only one makes sense, meanwhile FPI paid a “meaningful”(their words) premium to market for the AFCO acres.”

    or in this outdated public one: http://seekingalpha.com/article/3679196-farmland-partners-strong-performance-leaves-unconvinced-management-will-deliver-sustained

    “There is about $180 million of debt on the balance sheet in addition to some mezzanine financing. With about 16 million shares on a fully diluted GAAP basis that’s in excess of $10 per share. Meanwhile, the company relies on an end market of commodity producers to rent out its acres. This is no can’t go wrong business model.”

    Having said I don’t like FPI as an investment at all, with the closing date looming and a 13.75% spread and a target that isn’t as bad to own, as an arb it is much more attractive. I’ll look into this again!

    Reply
    1. Alpha Vulture Post author

      If you think FPI is too expensive shouldn’t that also be an indication that this is a good deal and that shareholders should approve it? You can’t have a problem with both the deal, and the (possible) overvaluation.

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      1. Bram de Haas

        There’s some truth to that but sometimes these overvalued acquisitive companies suddenly come to a screeching halt and there’s some risk in the value of its stock. The deal is all in stock after all. Having said that, I might still buy AFCO. Just saying I’m not thrilled getting FPI shares.

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    2. JG

      I agree with you on the feasibility of an (medium term) investment in FPI. If any, it might be a short candidate somewhere next year if dividend coverage remains troubled and macro factors move against them.

      However, if you are currently IN FPI, I don’t see how you can’t like this, given that this is the strategy that FPI has communicated to shareholders and are executing on (growing by acquisitions, trying to close the gap between distributions and AFFO)

      Apparently they believe that this acquisition will be positive for AFFO, and I expect their shareholders to go along. AFCO shareholders will receive a pretty good premium, especially with where FPI is standing today. Whether this merger will actually be as positive as FPI/AFCO expect remains to be seen, and the acquisition effect will most likely be dwarfed by macro factors and commodity prices anyway. I remain skeptical, but as I am in for the Arb spread, I don’t really care 🙂

      Reply
  5. work22

    I agree, that’s the standard ambulance chasing lawyer stuff.

    The limited borrow in FPI available went from 8% cost to 20% cost. The rally in FPI recently is most likely a short squeeze, so i would not count on getting this final spread if the deal closes. AFCO may stay up here and FPI could sell off.

    This deal also comes after AFCO ran a strategic review, so nothing else came up that was better. Hopefully shareholders understand that and vote the deal through.

    I am long AFCO.

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    1. Alpha Vulture Post author

      I don’t think this is a short squeeze (for example just a small percentage of the float is short), but it might be true that when the deal is completed FPI will sell off if there are a lot of people in AFCO betting on a merger without having already an offsetting short position in FPI.

      Reply
  6. Vincent

    This is quoted from the CEO at the Q3 earnings conference call of FPI on nov 3:

    “Post the closing of this transaction, which is expected to be in January 2017..”

    “The transaction, in my view, will likely happen. I have, at this point, spoken with most of the investors on both — shareholders for both AFCO and for Farmland Partners their overwhelming support for the transaction. So we certainly expect the shareholder votes to go through later this year.”

    Reply
  7. Tom Sandlow

    I appreciate reading your articles, but isn’t it a bit disingenuous to entitle this a merger “arbitrage” when you can’t short the shares need to create the arbitrage? This is really a discounted long in FP which blows up if the deal doesn’t get completed.

    Reply
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  10. ADL

    I agree with Bram, above: it’s a small opportunity and these are middling entities, and as such there’s a question mark about what the price will be post-merger. Reminds me of YUMA earlier in the year (not sure whether you were following), where there was a complicated merger with a private entity with a better balance sheet, with pref converting into common, a reverse split, and further bells and whistles: the vagueness about closing date (ended up being delayed by around 3 months), and the fact that it was two small entities, one of which was distressed, led to the YUMA preferred (less liquid than the common) trading at around half of its merger value at pre-merge prices, and then, very quickly, at about 80% as the common shares it converted into tanked after deal close. They have subsequently recovered, however. A perfect example of risk (or at least uncertainty) providing the reward, just as it does here.

    Reply
  11. ADL

    Will let you know if anything similar comes up on the radar!

    Have you looked at US SPAC rights? I’m thinking specifically of BHACR and OACQR–each converts into 1/10 of a share of common when the blank check acquires a company, and expires worthless if no deal is made. Obviously the cos’ managements are incentivized to make a (usually bad) deal, since that’s how they’re paid, but these rights trade at 1-2.5% of the value of a SPAC share, vs. 10% in notional value. OACQ holders are voting on Dec 12 on whether to extend the time limit to purchase a company by 3 months, and there’s a very real chance they liquidate, in which case the rights are worthless; BHAC has until Feb 2017. I like the risk-reward on these (and holders of rights in TFSC, which became LMBH, actually did very well this year), but the very real possibility of a zero and the likelihood of a poor purchase (since sponsors are paid mostly on a deal, and less on deal quality) make these something less than a slam-dunk.

    I’d get into the idea about shorting BPT because of the likely reaction to the SEC pricing NAV which will be published in Mar 2017, but that’s more than enough already!

    Reply
    1. Alpha Vulture Post author

      I haven’t looked at the two you mention, in general not a big fan of SPACs although the warrants often seem interesting. Do have a small position in the LMB warrants simply because they are cheap compared to the common shares.

      Reply
      1. ADL

        Ja, any idea having to do with SPACs is mostly a trading idea, since the post-deal incentives are so misaligned (though BLBD is another recentish SPAC that has traded above deal price, which is rare). I prefer rights (when part of the unit) to warrants, since warrants now usually seem priced 15% above unit price (and sometimes require 2/share purchase) whereas rights are for a fixed 1/10 share with automatic execution, and also seem to trade at a somewhat wider discount.

        Adjusting for sponsor quality and other factors, I usually figure a deal will destroy 50% of value initially and that there’s an 80% chance of a deal getting done, so the “generic” worth of a SPAC right is ~40 cents ($10–though usually there’s a bit more in trust per unit– x 1/10 x .5 x .8) and a generic SPAC warrant is worthless (though not, of course, in the case of a good deal). Thoe two mentioned SPAC rights are trading at .11 and .2, roughly, so are interesting.

        Reply

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