The Rivkin Event Strategy is a market-neutral strategy that seeks to take advantage of corporate actions such as takeovers, buybacks and wind-ups. For three to six months, there hasn't been much activity in this space, thus making it more difficult to find good opportunities. However, that is starting to change as we have noticed a pick-up in merger and acquisition activity on the ASX. This article will describe some processes in selecting and rejecting events for inclusion in our Event portfolio.
While there is no ‘typical’ trade for this strategy, one of the more common events is a takeover, where one company buys all of the shares in another company. The rest of this article will deal with the process involved in deciding whether a takeover is suitable for investment; however, there are similar processes for each event type. Vitamin manufacturing company Blackmores (BKL) will be used as an example of a takeover recently included in the Rivkin Event Strategy. BKL has signed a Scheme Implementation Agreement (SIA, essentially an agreement to acquire all of the shares in the target company subject to certain conditions) with Japanese brewer Kirin. After learning of this opportunity, we applied our standard process, detailed below, to decide whether to invest.
Our analysis of this trade included an evaluation of the probability of success vs failure combined with the expected upside vs downside of the trade itself. With a bid price of $95.00 (plus up to $1.43 in franking credits), the most likely upside from our buy price of $93.00 is $3.43. However, this doesn’t capture the full potential, as there is always the possibility of a competing bid or a raised offer, both of which can potentially increase the expected return. In this example, however, we have determined that a competing bid is relatively improbable, and therefore we base our calculations on an upside of $3.43; any upside above this amount is a bonus. The downside is a little harder to predict. The full downside is expected to be realised only if the deal falls over. In that case, it is reasonable to assume that the share price will return to where it traded before the announcement. In the case of BKL, that would be approximately $78.16, producing a loss of $14.84 from our buy price. While the downside here is greater than the upside, we must look at this deal’s probability of success before making a final judgement.
The probability of a trade succeeding consists of evaluating each of the regulatory/legal hurdles that need to be satisfied before the deal can complete. Continuing with the BKL example, four main approvals/requirements must be passed. First, we consider whether shareholders are likely to vote for this deal. In this case, the major shareholder (who owns 18%) is supportive of the offer, and it seems likely that the majority of other shareholders will also accept the bid. Second, we look at whether the competition regulator (ACCC) may have cause to block the deal. In this case, the bidder has no presence in the local market; therefore, there is no consolidation in the number of vitamin manufacturers, so it is unlikely that this will be an issue. The merger will unlikely create a real or perceived monopoly in this industry. Third, the deal has a Material Adverse Change (MAC) clause that can potentially scuttle the bid. In this case, the MAC clause specifies that BKL’s forecast revenues and profits can’t deteriorate beyond a certain level between the time the scheme implementation agreement is signed and final court approval is received. This would be a huge drop to occur within the four-month time frame of the deal, and in our experience, it is doubtful for this to cause the deal to fail. Finally, approval from the Foreign Investment Review Board (FIRB) will be required because this deal involves a foreign bidder. In this case, the same logic applies as with ACCC approval; the target company (BKL) is too small for there to be an issue. After evaluating these conditions, we estimate the probability of success to be above 90%. Combining the likelihood of success with the calculated upside and downside shows that the expected return of this trade (statistically speaking) is positive. It is based on this criterion that we make the recommendation to enter the investment. This example provides the specific requirements that must be satisfied for this particular trade. Still, we perform the same procedure for other trades considering each trade’s unique situation.
Not all event situations satisfy our criteria for being included in the portfolio. For example, one recent potential event trade arose when Alloggio Group (ALO) signed a scheme implementation agreement with a friendly bidder. This takeover satisfied some of our criteria. However, there was an unusual allowance in the agreement that would allow the bidder to still terminate the deal after conducting due diligence. We decided that we couldn’t accurately determine the likelihood of this condition being satisfied, so we should avoid the trade. And ultimately, due diligence provided the bidder with the opportunity to terminate the deal.
The BKL trade is just one example of six recommendations currently in the Event Portfolio. Members of Rivkin Local can see all of our recommendations and receive an SMS text message the instant a new event is recommended. Aside from giving a recommended buy price, we also specify the quantity that should be purchased (as a percentage of the investors’ total portfolio) and a qualitative assessment of the trade risk. In short, we give clients all the information they need to make an informed investment decision.
The Rivkin Investment team has many sources of information that ensure we hear about these events as soon as they are announced to the market. We then perform analysis to determine if the trade fits our criteria, and if it does, we recommend it to our members. One of our key focus points is to look at the possible downside if the trade goes wrong. We typically like trades that have a very low downside and/or a very high probability of success, even if the upside is uncertain. The strong pick-up in corporate actions makes it likely that this strategy will be highly active for at least the rest of the year, although we are generally able to find opportunities even when markets are quiet. Please contact the Rivkin team if you want to hear more about this strategy.
