Wednesday, July 19, 2017 1 comments ++[ CLICK TO COMMENT ]++

Purchase: Cabela's (CAB) - Risk Arbitrage Position

Cabela's (CAB) is being bought out by Bass Pro Shops (private) in a cash deal and I took a position in Cabela's. Deal is expected to close by end of Q3. The spread is around 4% and my expected return (based on my probabilities and downside) is about 2%. Not that great but if the deal closes within 3 months, then return is ok.

This deal is a bit risky since it is a buyout of a retailer that has seen declining revenue and profits in the last few quarters. The whole retail industry is getting clobbered--the street blames Amazon and emergence of online retailing but I think the core problem is a likely decline in consumer spending (consumers have too much debt and have been living outside their means for a decade or more and we may be seeing an adjustment--and Cabela's is no exception. It has been so bad that the buyout price was revised down--goes to show the risk in these arbitrage situations; good thing I didn't take a position earlier--so things are definitely not good. Offsetting the poor performance is the fact that their business is somewhat unique (outdoor/hunting/etc) compared to most retailers. In any case, this is not a company that I would like to own if the deal fails.

Since the spread is so small, this deal is not worth it for you if your holdings are in a different currency and you don't hedge; or have a US$-denominated account. US$ has been weakening recently against C$ and currency fluctuations can wipe out any gains.

After purchasing the stock, I realized that I made a mistake with portfolio sizing (didn't realize some figures were in US$--I work with C$ and US$ and have to combine multiple accounts and it can be confusing--and came to the conclusion my position size is too big). I'm going to try unloading a portion of it if the price rises a little bit.

Purchase price (CAB): $59.25

Return Expectation

Takeover price: $61.50
Purchase price: $59.25


Probability of success (my estimate): 95%
Return on success: 4%
Probability of failure (my estimate): 5%
Return on failure (my estimate): -32% (assume it drops to $40 (sort of the low over the last 5 years--not absolute low)
  
Expected Return: 2.0%


Buffett's Four Key Questions 
 
(1) How likely is it that the promised event will indeed occur?  
Deal price was revised down on April 17 2017 from $65.50 to $61.50 due to poor earnings so I think deal will close.

 
(2) How long will your money be tied up? 
Companies expect deal to close by Q3 2017. The only delay risk I see has to do with Cabela's requirement to sell off its bank division (they have agreement with a bank but it needs to be completed).
 
 
(3) What chance is there that something still better will transpire - a competing takeover bid, for example?  
Low probability of anything better materializing. Cabela's is slightly better than other retailers (given its target market) but its business hasn't done too well recently so suitors likely to be limited.


 
(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?  
Trading at a really high P/E of 22. Will suffer maybe 30% loss if deal fails. Company revenue and income have declined in the last few quarters. In fact, the deal price was revised down due to its recent performance so things are definitely not good. However, this is a somewhat unique retailer (that caters to outdoor/hunting/country lifestyle) with less competition than other retail businesses.



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1 Response to Purchase: Cabela's (CAB) - Risk Arbitrage Position

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