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…

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?

Disclosure

Author is long ROIQW