This weekly column explains the reasons behind the movement in a selection of the largest U.S. cash merger arbitrage spreads from the past week as calculated by Merger Arbitrage Limited. We analyze the attractiveness and profitability of each spread going forward and indicate the trading position or action we have taken or intend to take based upon the analysis given.

Virtusa (VRTU)

The last time we commented about Virtusa was following the recent earnings announcement during a week which saw the stock decline significantly. This week also finds VRTU as the worst performer in our index despite some positive deal announcements.

This stock is currently the subject of a $51.35 per share takeover offer from Baring Private Equity Asia. The deal was formally announced in mid September.

The fall comes despite the company announcing the results of the recent shareholder vote at the extraordinary meeting. As expected, shareholders voted to accept the takeover offer and proceed with the deal. An 8-K filed with the SEC on November 20 stated

At the special meeting of Virtusa stockholders held on November 20, 2020, approximately 98.7% of the shares voted were cast in favor of the Transaction, representing approximately 81.1% of Virtusa’s total outstanding shares of common stock. Virtusa will file a Form 8-K disclosing the full voting results.

All positive news, however, the announcement also went on to say

The Transaction, which is expected to close in the first half of 2021, is subject to customary regulatory requirements, including approval from The Committee on Foreign Investment in the United States (CFIUS), and customary closing conditions.

Since our previous note, regulatory clearance from New Zealand has been granted. However, the lack of progress from obtaining CFIUS was a cause for disappointment amongst investors. In addition, there has been no further mention of a possible higher bid. By the close on Friday, the stock declined $0.28 for the week, or 0.72% to $50.02. The simple spread now stands at 2.66%. The current annualized return is approximately just over 4.45%. If the deal was to close in 6 months, the return moves up to 5.39%.

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We currently have a medium size position in this stock which we added to earlier in the month. We rarely speculate on the possibility of higher bids so we maintain our previous guidance. Should the stock move up further we will trim our position unless there is reasonable evidence to suggest an alternative bid is likely.

Merger Arbitrage and Market Data

The broader market paused for a breather this week following the recent new highs. Markets are still waiting to see a smooth transition of power begin now that the election result is effectively settled. Along with disappointing jobs data during the week, traders had no reason to further fuel the market’s rise. Investment managers continue their sector rotation with natural resources coming back into fashion in anticipation of a business environment where the spread of the virus could be controlled. The broader market in the U.S. as defined by the S&P 500 ETF (NYSEARCA:SPY) at the end of the week was lower by (0.75)%.

The IQ ARB Merger Arbitrage ETF (NYSEARCA:MNA) however moved ahead to resume its upward run. The ETF has recently followed the volatile performance of the broader market and demonstrates this once again as positions in target companies involved in stock swap deals are allowed to run unhedged. (You can read our analysis of advantages and disadvantages of investing with the MNA ETF in the “Merger Arbitrage Trading Guide” section at the Merger Arbitrage Limited website). Positive performances from Concho Resources (NYSE:CXO), WPX Energy (WPX) and Parsley Energy (PE) (all natural resource stocks) were notable as their acquirers moved higher. By the end of the week, MNA was showing a gain of 0.65%.

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Product Weekly Change Product Weekly Change
T20 Index 0.09% SPY (0.75)%
Index Dispersion 0.37% VIX 2.60%
Winners 12 MNA 0.65%
Losers 6 ARB.TO 1.69%
Week Ending Friday, November 20, 2020

Merger Arbitrage Portfolio Analysis

U.S.-based cash merger arbitrage spreads moved ahead yet again during the week despite a decline in the broader market. This marked the eighth straight week of positive returns. There were two successful deal closures from the index during the week. AMAG Pharmaceuticals (AMAG) & MyoKardia (MYOK), deals announced less than two months ago, both signed off during the week.

Although new deals have been announced, as we have previously mentioned, we caution traders on the positive movement of the T20 index this week as existing spreads become even tighter. New deals have entered the index and allow for a continuation of potential returns. However, as these stocks increase, the available level of return decreases whilst simultaneously increasing the potential downside. We maintain a positive outlook for the strategy, although traders should be wary of chasing slim returns simply as a means of employing capital.

The T20 winners maintained the upper hand and outpaced the losers by 12 to 6 with 1 non-mover. There were 19 spreads in the index last week as the index of cash merger arbitrage spreads is no longer calculated with a full complement of 20 deal constituents. The index of the largest cash merger arbitrage spreads as defined by improved again by 0.09% whilst the dispersion of returns was 0.37%. This figure is significantly below both the 3-month average and the long-term look-back period and reflects the fact that spreads have become exceedingly tight. In the absence of any negative news, there is not much room for spreads left to move.

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The T20 index of cash merger arbitrage spreads now offers an annualized average return of 5.14%, which is below above last week’s figure of 3.78%. This increase was due to the closing of two existing deals and the removal of a SINA which traded above the offer price. Two of these deals were replaced with new deals increasing the potential average return whilst also extending the average expected completion date. For this coming week, the T20 portfolio has 18 deal constituents.

For additional merger arbitrage discussion and insight into this event-driven strategy, be sure to catch our exclusive interview with Seeking Alpha “SA Interview: Merger Arbitrage Investing With Mal Spink, CFA.”

Disclosure: I am/we are long VRTU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.


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