But what few seemed to appreciate was the potential upside in the form of a $90.7 million outstanding tax claim – the proceeds of which would be distributed to shareholders if the courts ruled against the Tax Office.
An independent valuer had only assessed this to be worth up to 10¢ a share but a month after the bid, Centrebet’s competitors had a favourable ruling. That all but assured investors would get the full $1 per share in the form of quarterly distributions.
“I am still receiving payments today, and will likely to continue to do so for a few years yet,” Cummings says.
But the more valuable dividend for Cummings was a taste of merger arbitrage, a well-honed hedge fund strategy that seeks to profit from opportunities that arise from announced deals.
That proved to the genesis of Harvest Lane Asset Management, which Cummings founded in 2013. It now has $70 million of assets under management.
Cummings is the chief investment officer and has two partners, Andrew Salvestrin and Rod Harper.
Merger arbitrage has been a favourite; returns aren’t correlated at all to the direction of the market but the extent to which announced deals are consummated.
And in a year when markets were whipsawed, Harvest Lane delivered a solid 13.3 per cent return, after fees. (The fund only charges a performance fees.)
The fund is delivering on its long-term target return of 10 per cent per annum, with a beta (or correlation) to the market return of “almost exactly nothing”.
Simplistically, the essence of merger arbitrage is to buy shares of targets on the expectation that a deal will complete, earning the difference between the trading price and the offer price.
The spreads are often thin, but can add up to offer attractive annualised returns.
Merger arbitrage has traditionally been the domain of proprietary trading desks of the investment banks and Asian hedge funds.
But Cummings says the volume and complexity of deals in Australia, across small, mid and large caps, means he is not short of lucrative opportunities.
Last year there were 60 M&A deals, of which Harvest Lane participated in 40. That is about average for the fund (the most deals they’ve ever participated in in a year is 48 and the least is 32).
“Every other week, a deal is taking place, and most of them aren’t getting picked up in The Australian Financial Review,” Cummings explained. In fact, it is the deals that get no coverage where the best opportunities present themselves.
For instance, in May 2018 ASX listed tech company called Mitula Group became the target of an almost entirely scrip bid that valued at 0.85¢ per share, from LIFULL, a Tokyo listed real estate portal.
In addition to the fact that investors would receive shares in a Japanese company, terms such as “price protection mechanism” that would ensure the implied 0.85¢ per share valuation remained in place, made the transaction highly complicated.
Cummings said the deal was “one of the most complex transactions we have seen” which led the market “to throw it in the too-hard basket”.
Harvest Lane took a position but hedged itself by shorting LIFULL and hedging the currency. LIFULL’s share price collapsed however after an earnings downgrade, threatening the deal.
But in October, the share price recovered after a strong full-year result and the deal was back on.
This time, LIFULL offered to pay Mitula shareholders partly in cash if its share price fell again.
They didn’t need to as LIFULL shares held up, and the deal closed. Cummings said the fund took advantage of spreads in the mid-teens, to make an annualised return of around 60 per cent.
The small market cap, and the fact that shareholders would have been able to receive foreign stock, meant the deal was not on many managers’ radar.
“For that reason, along with the complex nature of the deal, a large discount to the deal terms persisted in market for an extended period of time.”
Cummings says the key to their strategy is following their process by covering off on all the things that could scupper a deal. So they have a checklist to understand the bidder, its connections and the terms of the offer.
He says he hates deals with are subject to “due diligence”, or “funding”.
While betting on deals that are likely to close underpins the merger arbitrage strategy, sometimes it’s the “embedded call option” that gives these traders a healthy boost.
That is the reward that comes about when an offer sparks a takeover war that forces the share price ever higher.
In fact, once Harvest Lane benefited from a bidding war that ignited among the nation’s billionaire mining magnates for a company that been largely forgotten by the market.
In April 2018, Mineral Resources launched an all scrip deal for Atlas Iron, whose shares had been trading at less than 2¢.
The all scrip, 1 for 570 share offer represented a near 60 per cent premium to that price.
But that bid soon lured both Andrew Forrest’s Fortescue Metals and Gina Rinehart’s Hancock Prospecting to the table given the strategic importance of their berth allocations at Port Hedland.
By September, a complex battle was ended when Hancock upped it’s over price to 4.6¢, 140 per cent higher than the initial price.
It is those sorts of deals that allowed Harvest Lane to deliver a solid return while market madness was ensuing around them.
And he is confident there will be more deals coming, even if market confidence wanes.
“Sellers are going to be more realistic and the buyers may feel they are getting a better price.”