Best Idea in the Universe: Mobileye
Current Favorite: Mobileye N.V. (MBLY)
ArbitrOption’s investable universe includes risk arbitrage and special situation opportunities with three basic characteristics:
- a pending corporate event must be disclosed by the company’s management or Board of Directors (no “rumortrage”)
- the pending corporate event must have a calculable terminal value and timeline
- the company must have exchange-listed options with suitable expiration dates and strike prices
At the time of our initial trade, our option spread on Mobileye was expected to produce returns 300% better than ArbitrOption’s equity-trading peers.
ArbitrOption’s investment process can be broken down to five stages:
- Idea Generation
- Investment Research
- Portfolio Management
- Idea Generation: Hitching a Ride with Self-Driving Car Tech
On March 13, 2017, Israeli self-driving car technology maker Mobileye N.V. (MBLY) announced an agreement to be acquired by American tech giant Intel (INTC) for $63.54 cash per share, a 34% premium to its previous closing price. The transaction offers INTC a bolt-on acquisition that will dramatically expand its role in autonomous driving, by all accounts a growth area for the coming decades.
As you can see in the chart of MBLY’s stock price below, the stock jumped following the acquisition announcement and has been rising towards the per-share acquisition price.
Mobileye N.V.: Share price from 3/1/17 to 6/22/17
- Investment Research: Risk-Taking Techies Overly Conservative on Timing Estimates
Before we can identify the right trade on a deal, we need to forecast terminal values and a completion date. Per usual, we first confirm deal terms in the press release issued by INTC and MBLY: A subsidiary of Intel (INTL) will acquire all shares of Mobileye (MBLY) for $63.54 per share in cash. The acquisition requires approval by antitrust authorities and two rulings from the Israeli Tax Authority (ITA). It also requires approval by MBLY shareholders and has a minimum tender condition. The merger agreement is not conditioned on financing; it even includes the strongest possible language that absence of financing is not grounds to terminate the transaction, to wit:
Section 4.06 Availability of Funds. At the Closing, Parent and Buyer will have available to them all funds necessary to enable Buyer to consummate the Offer and the other Transactions pursuant to the terms of this Agreement and to satisfy all of Buyer’s obligations under this Agreement, including to pay the aggregate Offer Consideration and to pay all amounts required to consummate the Transactions.
MBLY and INTC initially indicated an expected closing date at the end of 2017, a conservative nine-month timeline.
Conditions of the Deal: Closing Date May Be Closer Than It Appears
The deal’s conditions, confirmed in the merger agreement, are straightforward and likely to be simpler than the conservative timeline suggests. Now that we’re three months into the deal process, many of the milestones have already been completed or are at least underway.
U.S. and Foreign Antitrust Approval
The acquisition is subject to approval by U.S. and foreign antitrust authorities. Let’s review the key factors: a) INTC has tremendous market power in all things technological and b) MBLY does not have many direct competitors (realistically limited to Google’s Waymo unit, Tesla, and Uber). Still, it’s hard to see how combining MBLY with INTC will increase prices or decrease the quality of service for MBLY’s customers. In fact, INTC and MBLY are already working together on a collaborative project with BMW. To us, this acquisition doesn’t change the competitive landscape and there’s nothing for a regulator to find objectionable.
The tender offer, published on April 5th, specified that in addition to U.S. antitrust approval, the deal is subject to review by Israel, Germany, and South Korea. One positive for the deal is that it is not subject to Chinese approval, which tends to take longer.
Tax Authority Rulings
The transaction has two distinct Israeli tax rulings, neither of which can block the transaction from being completed. First, MBLY and INTC sought and received a ruling from the Israeli Tax Authority that exempts most shareholders from withholding tax. Second, shortly after the deal was announced, Mobileye and Intel filed an application for a ruling that exempts various underlying transactions (called the “Pre-Wired Asset Sale”) from Israeli tax.
MBLY is incorporated in the Netherlands, creating some concern that Dutch Withholding Tax could apply to non-tendering shareholders (and option holders, who effectively receive the same consideration as non-tendering shareholders, see RNA). However, the merger agreement and tender offer both confirmed that MBLY is a tax resident of Israel. The ITA has ruled that non-Israeli shareholders who control less than 5% of MBLY shares are exempt from withholding taxes.
Shareholder Approval and Tender Offer
This deal has both a tender offer and a shareholder approval at an Extraordinary General Meeting. All acquisitions of Dutch companies are structured that way. In this deal, the tender condition applies to of 95% of outstanding shares. The minimum tender condition falls to 80% if INTC receives an asset sale ruling from the ITA and 67% if shareholders then approve the transaction. For detail, it’s worth noting that more than 50% of shares must vote, and more than 2/3 of the votes cast must be in favor.
All recent Dutch transactions have exceeded the minimum tender. The substantial premium that INTC is paying relative to MBLY’s pre-deal price should be sufficient to meet shareholders’ requirements.
Estimating the Timeline: Tender Offer Will Likely Encounter a Detour
Company managements first indicated a nine-month timeline for the deal, which is very conservative. This implies they believe the regulatory approval process, either antitrust, tax, or shareholder, could somehow be delayed. We don’t see it.
Antitrust Approval: One Surprise, but Forward Progress
On 5/9/17, MBLY disclosed that it had thought some more about its regulatory regime and concluded that Austria, also, would have to clear the deal before it could be completed.
The website for Austria’s antitrust authority was updated on 6/9/17 to show that MBLY and INTC filed for antitrust approval on 6/8/17. The Austrian review period is set to expire 7/6/17. If management already filed for Austria, we can reasonably believe that antitrust applications in the other jurisdictions (U.S., Israel, Germany, South Korea) had also been filed at this point.
Or so we thought. It turned out our reasonable belief was misplaced. The website for the German antitrust authority was updated on 6/16/17 to reveal that the filing was made in Germany on 6/12/17. Germany has a 30-day review period, so we can expect that the review will expire on 7/12/17.
We also know that MBLY and INTC announced that the acquisition cleared U.S. antitrust review on 6/12/17. One day later, on 6/13/17, Israeli antitrust was done. If the Israeli Tax Authority’s ruling is delivered before the tender offer’s expiration date, the minimum tender condition will be lowered from 95% to 67%.
Tax Authorities: One More (Not Mandatory, But Important) Ruling to Come
The merger agreement requires MBLY and INTC to seek two tax rulings from the Israeli Tax Authority, but those rulings are not requisite conditions for the merger. This deal can be completed even if the opinions have not yet been delivered. The value of the tax rulings is substantial, though, so we should be prepared for the possibility that INTC manipulates the process to delay completion until after it has the ITA’s blessing.
The Israeli Tax Authority (ITA) has already issued a ruling that most MBLY shareholders are exempt from Israeli Withholding Tax. The only outstanding ruling from the ITA is confirmation that INTC’s purchase of MBLY will be exempt from Israeli tax and that MBLY will retain its status as a Preferred Enterprise under Israel’s Law for the Encouragement of Capital Investment, 1959. The exact date of the companies’ application for a ruling has not been provided, but we’re using 4/14/17 as a rough estimate – 30 days from deal announcement should have been enough time to prepare and deliver the request. On average, previous transactions that required filings with the ITA were completed within 82 days of the deal’s announcement; the longest of these previous transactions was PBTH / OPK, which took 127 days from start to finish. If we applied that same time frame to MBLY, the transaction will be completed 7/18/17.
Shareholders and Tender Offer: Partially Done
The tender offer was launched on 4/5/17, soon after the deal announcement. The circular for the shareholder meeting was released on 5/12/17, and the meeting itself scheduled for 6/13/17. MBLY shareholders approved the deal as expected. No updates were provided regarding the dates on which antitrust applications were filed or the approval processes current status. The tender offer was set to expire on 6/21/17, but we anticipated it would be extended to accommodate antitrust reviews that have not been completed. On 6/22/17 MBLY and INTC announced that the tender offer had been extended; the new expiration date is 7/20/17.
Putting It All Together: Remaining To-Do Items
On 6/8/17, Dan Galves, MBLY’s Chief Communications Officer, made a presentation at the Baird Global Consumer, Technology and Services Conference. During his comments, Mr. Galves opined that meeting the minimum tender condition is the highest hurdle the transaction will face. As mentioned above, all recent Dutch transactions have faced and conquered the same high minimum tender threshold (95% of outstanding shares tendered).
Given the pace of the approvals and the structure of the transaction, it appears possible that the tender offer could expire before the Israeli Tax Authority issues a ruling on the pre-wired asset sale. The tender offer expiration, initially 6/21/17, has been extended once already to accommodate the pending German and Korean antitrust approvals. Although the ITA issued a ruling with respect to Israeli withholding tax obligations, we are still waiting on the ITA asset sale ruling and the tender offer completion. We feel strongly that Germany, Korea, the ITA, and the tender offer will not take five more months, until year-end, to resolve. Based on analogous past transactions, we estimate a deal closing in early August.
Applying the Research: Finding the Right Trade
MBLY’s expected stock price if the merger is completed by the end of August 2017 is $63.54, the acquisition price. The expected value if the acquisition fails is $46.85 – MBLY’s share price prior to the March 13 announcement, adjusted for recent changes in comparable companies’ stock prices.
Now we have an expected completion date and an expected terminal value. Based on current option prices, ArbitrOption believes the best investment is a bullish put spread, buying a January 2018 $57.50 put and selling a January 2018 $60 put. This position will achieve its maximum profit if MBLY is trading at or above $60 when the options expire. If the deal is completed before the options’ expiration, the options’ deliverables will be adjusted to cash and the options will expire early.
- Trading: The math behind the MBLY bullish put spread
In each trade, ArbitrOption aims for annualized return greater than 10% and a risk/reward ratio that is superior to that of the stock. In the MBLY trade, the minimum acceptable credit that ArbitrOption could receive from a January 2018 $57.50 / $60 bullish put spread would be $0.15. That price is found by taking the lesser of a) the minimum credit that would allow a 10% annualized return, or b) the credit that matches the current risk/reward ratio of the stock.
To generate a 10% annualized return, an event that lasts 142 days (the period between the March 13th announcement and estimated August 2nd close) would have to produce a 3.89% return. The minimum post-commission credit for this put spread that would still produce a 10% annualized return is $0.09.
10% / (365 / 142) = 3.89%
$2.50 option spread / (1 + 3.89%) = $2.41 maximum risk; minimum 0.09 credit to achieve 10% annualized return
At $62.50, with a success value of $63.54 and a failure value of $46.85, the risk/reward ratio in the stock is 16.69/1.04, or 16.05x. The minimum credit that could be received and still achieve a superior risk/reward ratio is $0.15 (we note that a lower multiple is superior because it represents less risk relative to greater return).
$2.35 risk / $0.15 reward = 16.05x
Since March 13, ArbitrOption has bought January ‘18 expiration $57.5 / $60 put spreads that risk 8.02% of the portfolio. The $57.5 / $60 put spreads were bought at prices that will produce a 12.93% return on investment if MBLY is worth $60 or more when the options expire. Assuming the transaction is completed on August 2nd, the annualized return will be 33.24%.
- Portfolio Management: Monitoring multiple approval processes
Given the outstanding process, the transaction could close as early as mid-July or as late as the end of 2017. We believe that closing by the end of August is most likely.
ArbitrOption is actively watching for new developments, and will increase the portfolio’s exposure to MBLY if circumstances allow us to add to the position at attractive prices relative to the risk.
- Exit: Upon deal closing, or options expiring
Barring changes in the expected outcome, ArbitrOption will exit its position as options expire or when the transaction closes, whichever comes first.
An investor who bought MBLY for $60.62 on March 13th would earn $2.92 if the transaction is completed at $63.54, or a return-on-investment of 4.82%. In contrast, an investor in the option spread described above takes on similar risks but earns a return-on-investment of 12.9%, almost 300% that of the stockholder.