Early this month, I published a piece on How to make 10% in 2 months , expecting that this merger would come to fruition on the expected 2 months period.
What I was not expecting is that the spread between the 2 stocks would not only close, but actually become negative in 3 weeks.
Here is what was supposed to happen:
As discussed in the previous article, there is an acquisition play of HBOR3 by HBRE3 structured as a share swap of 0.81553398 HBRE3 share to 1 HBOR3 share.
This would imply that either the shares of HBR should increase by $0.13, or Helbor shares would decrease by $0.11.
Which meant that everything constant, you would make 11 cents per share of Helbor sold when the deal closed.
Here is what happened:
Both stocks started trading higher recently, mainly following the local market stocks which traded higher later in the month.
But notice how HBRE3 climbed much more than HBOR3. I attribute this to two things:
The discount to the parity that this was trading to the merger terms, essentially closing the gap;
An overshoot by the market, which is inefficient on these small caps which led it to trade above the parity (!)
You can see the chart below how the pair is trading against the parity, and notice that right now it is not only trading around the parity, but about 4% over it, which means it would be profitable to reverse the trade!
How we’ve fared on this trade:
As the markets sometimes smile to us, this proved to be quite a profitable trade over the month, which led not only to us making about $11k per 100k shares on the way in, but also about another $9.5k on the way out.
This adds up to around $20.4k in only 21 days. As we posted only 30% of the short notional as margin for this trade, we actually made 37.43% return over these 21 days.
Above is not considering trading costs.
For those interested, we were able to borrow HBOR3 shares at 0.98% p.a. - basically a steal.
Also the brokerage costs on this were less than 200.00 for all the indicative trades above.
Final words
As I return to write about this trade, it reminds me about the beauty of the merger arbitrage world.
These kind of trades have a special flavor, as they are quite independent from the overall market, this same type of profits could have been achieved either on a down market or an up market, all that’s needed is for the specific set-up to work.
Usually these trades will close only when the merger actually goes through, but sometimes they will close much earlier because of unknown market forces or volatility as evidenced on the trade above, which increases even more your IRR.
I love to compose our portfolios with such strategies paired with other value investing strategies, meaning that you can achieve high returns, taking risks lower than the market.
On this specific trade, we will keep watching from the sidelines now, but perhaps it will give us more happiness until it closes.
As always, best of luck out there in the markets!
Wow! Good job!