limited ticket size creates arbitrage opportunity

Earlier this week, ASX listed Mitula Group (ASX:MUA) announced that the board had received (and was unanimously recommending) a takeover offer from TSE listed group, LIFULL Co (TSE:2120). Mitula is a logical acquisition for LIFULL given they acquired its main competitor, Trovit, in 2014. Combining the groups will create one of the largest online classifieds firms with over 170 million visits per month.

What caught my attention at first was the juicy spread between the takeover price of AUD$0.85 and Mitual’s current share price of ~AUD$0.72 (and 18% merger spread is almost unheard of these days unless a potential regulatory or competition hurdle exists – which I don’t believe should be the case here).

So the obvious question that follows is, why does such a seemingly lucrative opportunity exist?

For starters, it’s a complex deal structure that will involve Aussie investors receiving stock in a TSE listed security. The AUD$0.85 takeover price is comprised of 0.0753 LIFULL shares for every one they hold in MUA – there is a “share exchange ratio adjustment mechanism” that protects the downside for MUA shareholder up to 10.7%, however, you will essentially be “long” LIFULL stock for the duration of the trade. I can’t find any options over LIFULL’s stock and given it is a relatively small company (~AUD$1bn market cap) it would likely be difficult finding stock to borrow and go short.

So, why am I still interested?

Well, another quirk of this deal is that shareholders can elect to receive AUD$0.80 in cash for their first 20,000 shares. This unique feature is a key reason why I think the opportunity to make a low risk 11% exists – institutional investors cannot bid the arbitrage away. From the point of view of an Australia institutional investor, or any shareholder with greater than 20k shares, they can either:

a) wait around and see if the takeover goes ahead, taking on currency and price risk in the interim, to then be stuck holding a position in a foreign listed investment – which many mandates will prevent and many private investors won’t want to deal with (to obtain the TSE listed shares one needs to open a securities account in accordance with the book-entry transfer system in Japan)

b) sell down their holding to 20k and wait for the deal to close and receive their $0.80 per share – which is equal to “2 fifths of stuff all” for an institutional investor who is likely managing tens, if not hundreds of millions of dollars.

Therefore, retail investors have an opportunity to take advantage of forced selling and should be able to extract AUD$1,600 (per account) from the market in exchange for very little risk.

Odd lot arbitrage

These “odd lot” arbitrage opportunities (obvious spreads in tenders/M&A deals that are limited in size) are why I maintain multiple brokerage accounts – i.e. a family account, a personal account, an account in my brothers name etc. They occur more frequently than you might think and provide an excellent opportunity for retail investors to make low risk profits. For example, earlier this year Virgin Australia (ASX:VAH) bought out all shareholders with 1,666 shares or less at a price of $0.30 when the prevailing market price was $0.25 – offering a risk free $80 per account (sure it’s not much in the grand scheme of things, but multiplied across a few accounts and it provides beer money for the next few weeks/months!)

Investment situations like this highlight the advantage that small investors can have over the professionals if they’re willing to invest a little time and effort digging around in the corners of the marketplace.

Sure there is a risk that the takeover does not pass the shareholder vote (unlikely given both companies are tightly held by insiders) or meets some anti-competition barrier (not sure who would oppose it given they’re global companies operating in a relatively niche space), but I believe the reward outweighs the risk involved. Even if the transaction did not occur, I don’t believe MUA is overvalued at current prices and as this event highlights the attractive nature of the underlying assets, I think it is unlikely to fall to pre-bid levels which were more likely a symptom of last years downgraded earnings and the Australian markets myopic focus on near term results.

The expected implementation date is late August (or potentially September) indicating a holding period of less than 5 months and implying an IRR in excess of 25%.

Sometimes all you have to do is walk over and pick the $20 note off the ground.

Note: I think their may be a way to receive the full AUD$0.85 per share, without opening a Japanese securities account, however, it still does not get around the interim currency and price risk

“The number of the Company common shares that can be received as consideration by the Stock-receiving Mitula Shareholders who do not notify the Company of their securities account information or their intention to hold the shares in the Pooled Account A within the prescribed period will continue to be kept in the Pooled Account B after the Settlement Completion Date. In such a case, if any valid notifications will not additionally be made to the Company within the prescribed period in the prescribed way, these shares in the Pooled Account B will be sold in accordance with the sales policy prescribed in the Scheme Booklet and then the sales proceeds will be paid to such shareholders in cash after deducting costs”

5 thoughts on “limited ticket size creates arbitrage opportunity

  1. Thanks for posting this.
    I was pleased by the takeover as I had bought a small position last year in response to what I thought was an overreaction.
    Your post has got me thinking about the merger arbitrage which I generally tend to avoid as I’ve stung in the past 😦
    What do you think the chance is it might get blocked as Trvovit already operates in Spain ?
    I note the break fee is pretty small.
    I also think there might be some more selling if some people prefer to cash in now and avoid the Tokyo listing.

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    1. Handicapping the probability of an individual deal failing is fairly difficult in my opinion. Instead, I really on base rates – since 1992 public market takeovers have failed around 10% of the time. Therefore, when calculating an expected return I use a 90% chance of receiving the takeover price (the upside) and a 10% chance of taking the expected loss (which as I said, I don’t think will be too large given MUA’s current valuation. Even using the downside price of $0.45 (price prior to announcement which was a very cheap valuation) still gives an expected return of >6% (upside of 8c multiplied by 90% less downside of 32c multiplied by 10%)

      Funnily enough, I think this could be the opposite to a typical merger where a failed deal could swing the supply/demand equation towards more buyers than sellers as there is unlikely to be a large % of “merger arb” guys in the stock given the liquidity, complexity etc. But a lot of the former investors who sold out due to not wanting to hold a TSE listed stock could buy back into it as they believe in the long term MUA story. Just thinking out loud…

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  2. Really interesting article, there is the risk that Lifull don’t get approval to issue shares for the takeover though. Even though the CEO of Lifull controls 35% of the company the 10%+ drop in their share price on announcement might suggest some risk there. The company still needs 15/65ths of the vote. Do you think there will be any issues with the vote on Lifull’s side? I know nothing about investing culture in Japan and how passive/active shareholders tend to be.

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  3. I can only envisage downward pressure on the share price based on the facts you present. There will be a limited number of individuals who can afford to buy 20,000 shares (or multiples thereof through varying accounts), but a large number of holders needing to offload a significant number of shares. Presents as a great opportunity if takeover proceeds. Thank you for your insights on a fantastic blog.

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