Merger Arbitrage

The offer tabled to Raven Mount shareholders consists of 0.525 units in Raven Russia, comprising one preference share and one warrant, per each Raven Mount share. The preference shares have a par value of 100p and come with a hefty 12 per cent yield, payable quarterly in arrears on 31 March, 30 June, 30 September and 31 December. The warrants have an exercise price of 25p per Raven Russia ordinary share and expire in April 2019. So with shares in Raven Russia (TIDM: RUS) currently trading in the market at 17.5p, the warrants (TIDM: RUSW) only have time value and no intrinsic value, reflecting the fact that they have 10 years to run. Nevertheless market makers have put a price of 6.5p on each warrant, albeit on a horrible 3p to 10p bid-offer spread. The preference shares (TIDM: RUSP) trade at their 100p offer price and have a much tighter spread of 98p to 102p.

In other words, an owner of one unit in Raven Russia (comprising one preference share and one warrant) would currently receive 101p selling in the market, so a seller of 0.525 units will receive 53p. This latter figure is highly relevant because Raven Mount shares are trading at 36p to 42p on a bid-offer spread, meaning that the market price of Raven Mount has yet to adjust to the value of the offer on the table. And it's not as if the offer isn't going to proceed, since the takeover document states that:

"Raven Mount's four largest shareholders, comprising Anton Bilton, Bim Sandhu (who are both directors of Raven Mount), Schroder Investment Management and Laxey Partners, who in aggregate have an interest in 74.8 per cent of Raven Mount's existing issued ordinary share capital, are also all major shareholders in Raven Russia, owning in aggregate 17.8 per cent of Raven Russia's existing issued ordinary share capital. They are all supportive of the possible offer and together, Raven Russia has received an irrevocable commitment and letters of intent to accept the possible offer, representing approximately 64.1 per cent of the existing issued Raven Mount share capital."

Moreover, it's not as if the preference shares lack liquidity in the secondary market since Raven Russia raised £76.2m in a placing (at 100p per unit) last month with asset management group Invesco subscribing for £75m of this amount. It's worth noting that Invesco has heavily backed Raven Russia in the past and holds around 99m shares in Raven Russia, or just under 20 per cent of the ordinary share capital. The funds from the placing together with the £20.8m net cash on Raven Mount's balance sheet will provide Raven Russia with almost £100m of additional working capital and funds to take advantage of opportunities arising from distressed players offloading property.

True, there are more risk averse property investments than Russian warehouses, but it's not as if this is not already reflected in the valuation of the underlying business Raven Mount shareholders are buying into. On the contrary, shares in Raven Russia are trading way below the last reported adjusted net asset value of 101p as of 31 December 2008. And although the preference shares carry a high coupon, this partly reflects the fact that the initial yields are in the order of 12 to 12.5 per cent in Moscow and 13 to 13.5 per cent in other cities, including St Petersberg. This compares to Raven Russia's average cost of debt of 8.3 per cent on its $475m (£323m) interest bearing loans in 2008.

This looks to me like a clear cut arbitrage opportunity whereby we can buy Raven Mount shares now at 42p, accept Raven Russia's offer of 0.525 units per Raven Mount share and then sell both Raven Russia's preference shares and warrants in the market. With an 11p difference between the offer price of Raven Mount shares and the bid price of the preference and warrants, this equates to 26 per cent upside potential from this trade. And the best part is that this profit can be realised in pretty quick time, since Raven Mount's offer already has over 64 per cent acceptances, so it could conceivably go unconditional in less than three weeks time.

To play this takeover arbitrage I am allocating £12,600 of my portfolio to buy 30,000 Raven Mount shares at 42p (TIDM: RAV) with the intention of offloading the preference shares and warrants for a combined £15,900 as soon as the takeover completes.

* My 2009 Bargain Share Portfolio is going great guns with the six shares I advised buying two months ago rising on average by 17.8 per cent against a market down by 5.5 per cent (Bargain Shares, 6 February 2009). M&A activity has boosted this performance with cash shell GNE succumbing to a 190p a share cash offer, albeit this was on the low side considering the company's cash pile of 255p a share. Still, this represents a 26 per cent profit on the 150p advised buy in price in little over five weeks.

Bargain Portfolio Update 2009