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 the past year or so, there hasn’t been a great deal of activity in this space thus making it more difficult than usual to find good opportunities. All of that changed in the last month or so where we have seen a significant pick-up in merger and acquisition activity on the ASX. This article will describe some of the processes involved 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 of the different types of event. Vitamin manufacturing company Vitaco Holdings (VIT) will be used as an example of a takeover that has been included in the Rivkin Event Strategy. VIT is a vitamin manufacturer that 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 a consortium of Chinese companies. After learning of this opportunity we applied our standard process, detailed below, for deciding whether or not to invest.
Our analysis on 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 $2.22 the most likely upside from our buy price of $2.09 is $0.13. This doesn’t capture the full potential, however, 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 $2.22; 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 go back to where it traded before the announcement. In the case of VIT, that would be approximately $1.65 and would therefore produce a loss of $0.44 from our buy price. While the downside here is clearly larger than the upside, we must next look at the probability of success for this deal 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 VIT example, there are four main approvals/requirements that must be passed. First, we consider whether shareholders are likely to vote for this deal. In this case, the major shareholder (who owns 15%) is supportive of the deal 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 is in a different industry to VIT and therefore there is no consolidation in the number of vitamin retailers so we find it unlikely that this will be an issue. The merger is very unlikely to create a real or perceived monopoly in this industry. Third, the deal has what is called a Material Adverse Charge (MAC) clause that can potentially scuttle the bid. In this case, the MAC clause specifies that VIT’s forecast revenues and profits can’t be more than 15% down compared to the previous year. This would be a very large drop to occur within the three-month time frame of the deal and in our experience it is highly unlikely for this to cause the deal to fail. Finally, approval from the foreign investment regulator (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 (VIT) is too small for there to be an issue. After evaluating these conditions, we estimate the probability of success to be 90%. Combining the probability 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 trade. This example provides the specific requirements that must be satisfied for this particular trade but we perform the same procedure for other trades taking into account the unique situation for each trade.
Not all event situations satisfy our criteria for being included in the portfolio. For example, one potential event trade arose when Simonds Group (SIO) received a takeover offer from a consortium named SR Residential. This takeover satisfied some of our criteria however there was an unusual term in the agreement that would allow the bidder to terminate the deal. We decided that we couldn’t accurately determine the likelihood of this condition being satisfied and therefore that we should avoid the trade. Although the outcome of this event is still uncertain, the conditions on the bid have become even more restrictive and make the outcome very hard to predict. We are therefore happy with our decision to avoid this trade despite the fact there is potentially some upside on this trade.
The VIT trade is just one example of seven recommendations currently in the event portfolio. Members of Rivkin Local are able to 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.
