Merger Arbitrage Spread Performance – 10 November 2019

Red Robin Gourmet Burgers was the largest decliner this week following a set of less than satisfactory results. Even though GAAP EPS was lower than expected and turnover decreased slightly the stock was pummeled from the moment of the announcement on Tuesday after the market close until the end of the week. RRGB finished down 14.46% at $26.68, a drop of $4.51.

What however is perhaps more significant is the lack of news regarding the takeover approach from Vintage. There has been no mention of the proposed takeover in any official filings made by the target and Vintage itself is yet to make an announcement. We believe this has caused the stock to deteriorate further than would have otherwise been expected.

RRGB has always been among the riskier merger arbitrage plays as the takeover is considered hostile. Red Robin management have refused to engage in dialogue and maintain the offer undervalues the company. This type of “just say no” defense can be surprisingly effective. However, in addition to this is the current performance of the target. Many merger arbitrageurs avoid poorly performing targets for two reasons. Firstly, a company specific risk where an underperformer continues in this vein of negative growth thus reducing the value of the company, or exposing it to issues that were not previously known such as accounting irregularities. Secondly, the macro environment where the company operates in a business segment that may be struggling as a whole. These two issues significantly increase the likelihood that the acquirer will walk away. In this instance, the possibility is increased further as there is no definite agreement between Vintage and red robin that Vintage needs to abide by.

Obviously, we, along with the market have been aware of these risks and they have clearly been represented in the volatility of the spread. Indeed, we previously suggested additional caution should be taken over the earnings announcement period. To take advantage of the spread volatility we implemented an active arbitrage strategy to trade in and out of our position as the market moves. 

Following this drop the stock is now trading at a price similar to where the stock was prior to the announcement of the proposed takeover. After accounting for the continued decline in company performance we believe the market (via the stock price) is effectively calculating the probability of this deal being consummated as being somewhere between “no chance” and “very unlikely“. However, we are yet to hear from Vintage. We previously calculated a rough entry price in the low $30’s for Vintage although we very much assume they have adjusted their position since the initial investment.

The speculative stakes have been raised high above the comfort level of most merger arbs which may also have forced the price lower. The immediate future of this stock price relies very heavily of the decision to be made (announced) by Vintage. Does the declining performance make the BoD more inclined to engage in dialogue with Vintage? If not, do they walk away and sell, if they have not done so already, or undertake a lengthy and expensive proxy battle. Either way, we expect more volatility to come in this stock.

 Pacific Biosciences of California (PACB)

PACB once again finds itself in the worst performers following last week’s partial recovery. The stock price finished the week at $4.69 down 4.29%. This leaves the spread at 70.58%. As expected, there was no deal news announced this week. Traders are braced for the CMA decision following their Phase II investigation. This has a statutory deadline of December 11 2019. At these levels, we have maintained our position and will do so for the time being.