Merger Arbitrage Performance Review – November 29, 2020

Front Yard Residential (RESI)

Front Yard Residential was the standout performer amongst cash merger arbitrage stocks last week following a revised offer on Monday November 23. The company had originally entered into definitive merger agreement with a partnership led by Pretium which included funds managed by the Real Estate Equity and Alternative Credit strategies of Ares Management Corporation (NYSE: ARES) to acquire RESI $13.50 per share. Immediately following the announcement, which was made on October 19th of this year, the stock traded at an intra-day high of $13.69 but subsequently returned to just below the offer price where it remained until last Monday.

During this range bound trading period, the merger arbitrage spread was offering an approximate 1% simple spread return. With an expected closing during Q1, 2021 the annualized spread was between 3-4%. This is perhaps on the lower side of existing cash spreads at the time but certainly not extraordinarily low. It is fair to assume a higher offer or superior proposal was not widely expected.

On Monday morning however, Rochelle R. Dobbs, Front Yard’s Chair of the Board was quoted as saying

After receiving a binding proposal reflecting a higher purchase price for Front Yard, Front Yard advised the Pretium Partnership of the proposal as required by the terms of the merger agreement, which led to the Pretium Partnership increasing the price of our transaction with them. Following these discussions, our Board approved the amendment to the merger agreement. 

This amended agreement resulted in an increase in the offer price to $16.25 per share. Again, the transaction is expected to close in the first quarter of 2021. The stock price responded accordingly and rose immediately. However, this time the price has stubbornly remained above the revised offer price since the announcement in a $16.25-$16.45 range.

RESI has of course previously attracted the attention of other suitors. Back in February, the stock was the subject of a $12.50 offer from Amherst, before the acquirer backed out by paying the termination fee. This latest offer then might not have come of much a surprise given that the firm has historically traded at a discount to NAV despite embarking on a period of increased profitability and improving an business environment.

The question now becomes “Will there be an even higher offer?“

ARES appear to be committed to making this deal happen. Don Mullen, Pretium’s Chairman and Chief Executive Officer is quoted as saying 

We believe in this Company and the Front Yard team and remain committed to completing this transaction

This may be enough to deter rival bidders but we would not expect a statement from Pretium’s CEO to say anything less. The stock is now almost two thirds higher than the pre offer trading price in October. Even factoring in subsequent market and economic movements, the stock is comfortably 50%+ above the floor price.

A quick P/E value comparison amongst industry peers would suggest a higher bid is unlikely. RESI management have stated the agreement is the result of a well run sales process which indicates that they themselves are not expecting further offers. However, with the stock currently trading at a premium to the offer price, it does suggest market practitioners are speculating on further developments. Although, the lack of speculative activity following the original offer suggests the market might not always be indicative of future corporate actions. We conclude however it would be unlikely this stock receives any further takeover interest.

By the close on Friday the stock finished higher for the week by $2.96, at $16.34, a rise of 21.94%. This leaves the simple spread at negative 0.55%. We  do not have a position in this stock and are not comfortable buying above the current offer price. Should this deal evolve further however we stand ready to modify our opinion.

Fitbit (FIT)

Fitbit was perhaps somewhat surprisingly amongst the best performers this week coming in at second place. A report from CTFN on Tuesday claimed the Justice Dept. is not expected to rule on Google’s (GOOG, GOOGL ) acquisition of Fitbit (FIT) until after the EU has made its decision regarding the takeover. 

Currently, the EC is scheduled to conclude up its recently extended investigation by January 8, 2021 having launched a full investigation of the deal in August. The investigation is focused on Google’s potential use of health data in its targeted advertising.

In addition to this, on Friday, in a letter to the EU competition chief, Margrethe Vestager of Amnesty International wrote 

The commission must ensure that the merger does not proceed unless the two business enterprises (GOOG & FIT) can demonstrate that they have taken adequate account of the human rights risks and implemented strong and meaningful safeguards that prevent and mitigate these risks in the future.

Investors did not appear to be troubled by the involvement of Amnesty as the stock traded down just 1 cent on Friday. By the close on Friday the stock finished higher for the entire week by $0.04, at $7.18, a rise of 0.56%. This leaves the simple spread at 2.37%. We will continue to hold but no longer consider the spread to be as an attractive proposition as previously. However, using a forecast closing date of the end of January next year, the return on an annualized basis, at almost 15% does remain viable.