Commentary

- Liquid Alternative Fund/Plus -

Third Quarter Report, 2019

The third quarter was relatively straightforward for the arbitrage portfolio. One notable change is that, for the first time in several years, we have some significant positions in Canadian arbitrage opportunities. There were two large subscription receipts issued in the third quarter, by Northland Power and Intact Financial. Subscription receipts are a Made-in-Canada financing solution for companies that want to raise equity financing in order to make an acquisition. Because there isn’t 100% certainty that an acquisition will close, companies will issue a sub-receipt that converts to common shares if the acquisition closes but are redeemed for the issue price in the unlikely event that the acquisition falls apart. These sub-receipts often trade at a discount to the common share of the company, allowing us to capture a relatively low-risk arbitrage spread. While not risk-free, we view the returns of the Northland Power and Intact Financial sub receipts (mid to high single digits annualized) as very attractive.

Another Canadian arbitrage situation that emerged this quarter was the purchase of Dream Global REIT by Blackstone. Dream Global is a Canadian company that owns a portfolio of office and industrial real estate in Europe. This is a relatively straightforward all-cash deal: one share of Dream Global will be acquired for $16.79. We are able to buy shares at about a $0.25 discount to this price; if the deal closes on our expected timeline we would expect to earn about a 6% return on your capital.

In the US, we continue to have significant positions in two large Pharma deals: Allergan being acquired by AbbVie and Celgene being acquired by Bristol-Meyers. These deals are so large that there is not enough merger arbitrage capital in the world to keep spreads in line with where they should be based on the risks of each deal. Earning high-teens returns for these deals is a great risk/reward for the portfolio.

While buying IPOs is clearly not a strategy for the arbitrage funds, we have been paying close attention to recent IPOs (and direct listings) in the US. WeWork is a debacle that illustrates both the risks of investing in illiquid assets (too much capital chasing too few opportunities) and also some of the drawbacks of the IPO process. The IPO process is highly regulated and inflexible. Companies file a comprehensive prospectus but are unable to disclose anything outside of the prospectus. Institutional investors might get an hour meeting on a roadshow, have a quick read of the prospectus and then decide whether they want to buy the IPO in a price range set by the underwriting investment bank. The initial price set by Goldman Sachs for WeWork anticipated a $60 billion valuation; in the end they couldn’t even price at $20 billion.

In contrast to an IPO, going public via a SPAC offers a much greater degree of flexibility for both companies and institutional investors. While the regulatory disclosure requirements are the same, in a SPAC transaction investors are permitted to “come over the wall” by signing a Non-Disclosure Agreement. This allows companies and investors to spend weeks conducting rigorous due diligence and negotiating a price and structure that makes sense for everybody. This flexibility is a key differentiator for SPACs relative to traditional IPOs and why we continue to see successful SPAC acquisitions (or De-SPACings) even in the face of failing IPOs. As WeWork was coming off the rails, our investment in Social Capital Hedosophia was trading very well, despite being of a similar speculative nature (they are acquiring Richard Branson’s space exploration company Virgin Galactic). As a reminder, underpinning all our SPAC investments is the ability to redeem the common shares for their IPO price plus interest. With the IPO market broken, we expect to continue to see good de-SPACing deal flow in our portfolio.

Finally, we would be remiss not to mention the change of ownership occurring with the management of the Vertex Arbitrage funds. In August we announced that Picton Mahoney will be acquiring the investment fund management contracts for the Vertex Arbitrage funds. The Funds will continue to be managed by Craig Chilton and Tom Savage, the current portfolio managers of the Funds, who will be joining Picton Mahoney upon the closing of the proposed transaction. As a unitholder, you may be receiving a voting package as part of the transaction; we would be very grateful for your support in completing the forms and returning them.

As always, please feel free to reach out with any questions or concerns.

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