Pep Boys Versus the Arbs
What's the problem with betting on takeovers? Ask Manny, Moe and Jack.
The Pep Boys car-maintenance chain said Monday morning that it's being sold to a unit of Bridgestone for about $835 million. That's a 23 percent premium to its value last week and sounds like a decent offer -- but for arbitrageurs, any chance to make a good chunk of change evaporated within a minute of the press release, which hit at 8:30 a.m. New York time. Before regular trading even opened, Pep Boys' stock surged to just pennies shy of the $15-a-share offer. By early afternoon, the difference -- or spread -- between the offer and the share price was a measly 1 cent.
To grasp why this matters, understand how the merger-arbitrage strategy is supposed to work: Traders are seeking to profit from the gap between the target company's stock price and the value of the acquisition offer. This spread is the strategy's linchpin, and it's determined by the risks surrounding the transaction (such as the odds that antitrust regulators will try to block it or that the acquirer can't obtain necessary financing) and the estimated amount of time it will take for the deal to close.
But in the case of Pep Boys, and so many other deals lately, the spread is so minuscule it's hardly worth the while. And that's a problem for the once-lucrative trading approach. Arbs have been complaining about tight spreads for nearly two years, partially because of low interest rates. The merger boom, which should have generated plenty of opportunities, ended up doing little to help.
Even amid almost $3 trillion of M&A worldwide this year, long-time merger-focused funds are shutting down because it's become too difficult to make money. Allen & Co., which has bet on deals for 40 years, said last month that it's calling it quits. Also in September, Ken Griffin's Citadel was said to have stopped investing in corporate deals and restructurings. And Bloomberg's Simone Foxman and Saijel Kishan reported last week that Hutchin Hill Capital liquidated one of its event-driven portfolios, which bet on various types of deals and corporate news. The HFRI event-driven index has lost 2.9 percent this year, after posting gains (usually more than 10 percent) during most of the past decade -- the exceptions being 2011, when deal activity was relatively weak, and 2008, when markets tanked.
These types of funds face another conundrum: While there are some pending deal situations out there offering spreads of 10 percent or more, they are too risky to wager on or the timing is too uncertain. So that money is better left on the table. That seems to be the case, for instance, with the merger of Baker Hughes and Halliburton as well as Dell's acquisition of EMC. (For the former, it's a question of securing necessary approvals, while for Dell it's a question of funding the purchase.) Even for event-driven funds with broader mandates, the spinoff market isn't that attractive right now either, and it's not like the broader stock market is doing that great. The Standard & Poor's 500 is up less than 1 percent year-to-date.
At one point Monday morning, Pep Boys shares were trading slightly higher than the $15 bid price, usually a sign that investors anticipate a competing offer. If one were to emerge, that would certainly turn this into an interesting play for arbitrageurs. It's a long shot, though. The agreement with Bridgestone states that Pep Boys can't solicit other offers nor engage in discussions with other suitors.
Also, some may remember that Pep Boys agreed in 2012 to sell itself to Gores Group, a private-equity firm, which got cold feet when the chain's sales decelerated. The price was also $15 a share, and worked out to about 7.6 times Ebitda at the time. Bridgestone's offer is almost 12 times Ebitda, reflecting the decline in Pep Boys' profitability. After essentially being in play for years, it's hard to imagine another bidder stepping in now to compete with $30 billion Bridgestone.
So in the 2015 arbitrage yearbook, this is just another dud.
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