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Continued from here.

OK, to recap the latter part of my previous article, I put forward 2 (hopefully strong) arguments why you should embrace (unhedged) FX risk in your event-driven investing (and, of course, elsewhere in your portfolio). With AGI Therapeutics (AGI:ID/LN), however, I essentially faced no FX risk on the deal in the end.

Remember, AGI traded in EUR (or GBP) but the takeover price was $0.1171 per share (and holders could opt for equiv. EUR proceeds). My solution was to round-trip surplus USD I had available. Yes, I’d incur a small FX spread to convert USD for my EUR share purchases, but by opting to receive USD takeover proceeds I’d eliminate subsequent FX risk, and end up back in USD cash.

Cumulatively, I invested a total 3.2% of my portfolio in AGI. This was somewhat accidental, and a function of limited volume/liquidity more than anything else… In the earlier/less certain stages of an event-driven investment, I might well limit my stake to 1.5%-3% of my portfolio. At a more advanced/certain stage, and presuming returns look sufficiently attractive, I’d have no problem increasing a position up to 5-7.5% of my portfolio. Returning to liquidity: The Irish market, among other smaller markets (AIM, anybody?!), is criticized for high spreads and sometimes low liquidity. But this scenario also offers great opportunity, IF:

i) you can actually place bids or offers – any broker offering Irish market access should also offer this facility… Unfortunately, this ‘market-making‘ ability isn’t possible (or the broker doesn’t bother to offer it) in far too many markets, and

ii) you’re a patient trader – seems like an oxymoron..?! Yes, you need to have a trader’s mindset to be effective with this approach, but also the patience to wait hours & days for the right price, and to know you may actually miss out on trades.

The ability to beat some/all of a wide spread, in a disciplined fashion, is particularly valuable with event-driven investing where it can dramatically transform your expected return. More generally, particularly if you use technical analysis etc. to support your value investing and layer in & out of positions, this approach can be a real plus. With AGI, I might have ended up with a larger stake if I just hit the offers, but then my expected return would be significantly lower, and I’d have to weigh that up against other opportunities. And with wide spread/low volume shares, wildly hitting offer(s) can sometimes be the worst strategy as the (next) offer is likely to be yanked way higher in response. I divide my AGI purchases into 3 phases – the first being purchases prior to the (initial) Offer Acceptance Deadline (Feb 2nd):

Cum. % Stake € Price $ Price Gross Return Gross IRR
0.1% 0.072 0.092 27.3% 921%
0.6% 0.078 0.100 17.5% 372%
0.8% 0.080 0.102 14.6% 270%
0.9% 0.084 0.107 9.1% 131%
1.0% 0.080 0.102 14.6% 270%
1.1% 0.080 0.102 14.6% 270%
1.5% 0.077 0.098 19.9% 569%
1.7% 0.077 0.098 20.1% 709%
1.7% 0.077 0.098 19.4% 712%
2.6% 0.082 0.105 11.0% 258%
2.6% 0.079 0.101 15.5% 353%

This phase accounted for the bulk of my position (2.6%). Most of my transactions, at EUR 0.08 or less, resulted from my bid(s) being hit. As you can see, this contributed significantly to my returns. But even with offers my returns were still v attractive for such a clear-cut deal. My avg. price was EUR 0.079, but what I really focused on was the avg. $0.101 price. The EUR/USD FX rate is changing constantly, so the return at any given EUR price is just as dynamic – which requires constant monitoring. This avg. purchase price offered a 15.5% return, and a fantastic 353% IRR based on my expected timeline (about 34 days).

Remember, all these returns are stated GROSS, simply for comparability purposes, but you should always evaluate deals on a net basis (after broker fees, stamp duty, FX spread/fees etc.). Also, deal timelines can often be somewhat unclear/unpredictable (and conditional), so don’t fall into the habit of being too optimistic. I’d suggest evaluating deals against the worst possible timeline(s), but calculating a min/max. IRR based on a min/max. timeline will obviously be helpful for reference also.

Average prices also raises an interesting question – should you use cheap purchase prices to ‘subsidize‘ purchases at higher prices? In short: No! I wouldn’t go too crazy on this, but ideally each purchase should stack up on a stand-alone basis. Don’t fool yourself a purchase offering a 2% return’s a good deal simply because your average expected return is still at, say 15%! There’s probably a lesson here for all us in terms of general investing also…

The second phase consisted of my purchases during the period when Aravis extended the Acceptance deadline to Feb 17th. Presuming you believe the bidder’s serious about obtaining total 100% control, an extension of the Offer period’s pretty much inevitable. However, on rare occasions, circumstances and intentions can change quite radically before/after key dates, so you definitely need to be v aware of these dates and their potential implications.

btw Your broker may present another complication. This might not be highlighted, but they may well impose earlier/arbitrary dates on you for deadlines & other corporate actions. Always confirm these (preferably in writing), and push them on it if necessary, as this stuff can mostly be settled simply/electronically these days. This can complicate your timeline and uncertainty. For example, say your broker imposes a deadline 1 week earlier than the official offer acceptance date: During that week, should you buy shares?

Sure, why not – but be aware you’ll miss the official offer acceptance date because of your broker’s earlier deadline. You run (an admittedly small) risk the offer’s successful, but NOT extended… This would leave you awaiting a compulsory acquisition (which a bidder can launch once they reach 80-95% control, depending on country), or even end up trapped as a minority shareholder in a delisted company! Yes, I’m highlighting a worst case here, but you have to be aware of these potential risks and set out your game plan in a v deliberate fashion.

Cum. % Stake € Price $ Price Gross Return Gross IRR
0.2% 0.080 0.106 10.7% 1334%
0.4% 0.080 0.105 11.4% 1567%
0.4% 0.080 0.106 11.0% 1420%

The main problem after the first Offer Acceptance date was the lack of liquidity. I was amazed to still get shares that offered an 11.0% gross return – this was (virtually) free money, as one could submit the shares immediately and receive takeover proceeds just 14 days later. The short timeline explains the stupendous 1420% IRR! And the last phase was the purchase of shares that would not be accepted under the Offer, but which would be compulsorily acquired instead (at the same $0.1171 price, as confirmed by Aravis):

Cum. % Stake € Price $ Price Gross Return Gross IRR
0.1% 0.080 0.102 14.6% 227%
0.2% 0.080 0.103 13.8% 286%
0.2% 0.080 0.103 14.1% 256%

My 14.1% return was a little higher vs. my second round of purchases – not surprising, as many shareholders have a knee-jerk aversion to a delisting and/or an uncertain legal timeline. This is a little misguided (as long as a compulsory acquisition’s been definitively confirmed) – the delisting’s a red herring, and you know your expected return, so all you need to worry about is the remaining timeline. In Ireland, this can be remarkably short if there are no hiccups/objections – my estimate of about 40 days proved to be right, for a gross IRR of 256%. However, timelines can be a lot longer, or more dramatic (see Germany!), in some countries…

AGI’s been a pretty good example for my v detailed walk-through of all aspects of a Risk Arb deal (if you’re still reading, I hope your patience has been rewarded?!). But it’s shame it wasn’t a deal where I could have been more aggressive… At an extreme, presuming necessary due diligence on dates and the exact legal status of each deal condition/stage, I might have potentially invested 20%+ of my portfolio in the deal! Wow, I’m not sure I’ve ever said that before! But remember, at earlier stages of a deal you’re usually just debating an increase in your stake based on still (somewhat) uncertain facts..

But later on, depending on circumstances, you may actually be faced with 3 distinct deals on offer:  Acceptance by the first Offer deadline, acceptance during the Offer Extension, and then the sale of shares in a Compulsory Acquisition. Depending on terms & dates, you can have a scenario where you’re definitely receiving proceeds and can start re-building a fresh position based on the next stage of the deal. That’s exactly why I presented my purchases in 3 separate snapshots above! In fact, on occasion, you can literally fund the next stage of a deal with the proceeds from the prior stage..!

OK, we’re done, I hope this has been helpful! Apologies, it would have been great to write this up contemporaneously – but I can assure you the deal worked out pretty much just as precisely as I’d anticipated, or could have wished for! Hopefully, I’ll get to write about some other risk arb/event-driven situations I invest in, particularly if they’re different/unusual. In general, however, these opportunities are somewhat problematic to write about responsibly as the status/the price/the risk of these deals can change so rapidly.

 

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