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%.
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
Today I sold the remaining piece of my stake in American Farmland. I had already sold the majority of my stake last year since the spread quickly collapsed after I entered the trade. It started with a juicy 13.2% spread while now just 2.6% is remaining. Since I was only long American Farmland without a corresponding short position in Farmland Partners I didn’t capture the whole shrinkage of the spread. I bought American Farmland at $7.45 and sold my last shares today at $7.98 for a 8.0% return (taking into account a $0.0625/share dividend). If this would be a cash deal I would have tried to capture the last remaining percentage points since this deal will probably close very soon, but since I’m not that thrilled to own Farmland Partners I’m happy to leave a little bit of money on the table.