TCRR - Adaptimmune Shareholders Can Lock In A Big Merger Spread By Swapping To TCR2 Therapeutics

2023-04-21 14:24:33 ET

Summary

• ADAP is swapping 1.5117 of its shares for every TCRR share.
• There is a huge spread between the two values, so existing shareholders can lock in a big gain once the deal closes.
• The spread is available as an arbitrage (by shorting ADAP) with a few additional risks.

TCR2 Therapeutics ( TCRR ) is getting bought out by Adaptimmune Therapeutics ( ADAP ). Both companies are development stage biotech firms, and the combined company will be led by ADAP management and focused on developing ADAP's pipeline. They'll be using TCRR cash to do so, which is the primary attraction of the merger for ADAP - it's a back-door way for them to raise quite a bit of additional cash.

Cash

TCRR had $149 MM of cash and investments as of their most recent (year-end) financial statements, against $64 MM in liabilities. The vast majority of the liabilities are future lease payments, and there are some assets held for sale against those separately. It is also likely that whatever space ADAP doesn't take over they'll be able to sublet for at least some reduction in the headline lease liability number. Still, even if one assumed all those liabilities were at face value the TCRR market capitalization is under $70 MM, so buyers of TCRR at this price have a bit of a margin of safety, as if the deal falls through it is likely it could be liquidated for a return of roughly the current value.

For ADAP this is basically just a less dilutive way of raising cash. It is likely they would have to raise funds in the near term, and this is a more certain way of going about that. It extends their cash burn runway out for years, which reduces the risk of the markets not being open to an equity raise when they need one.

Spread

The benefit of putting on this trade as a merger arbitrage (shorting 1.5117 ADAP for every TCRR purchased) or as a switch (selling an existing ADAP position and buying an equivalent amount of TCRR) is the spread, which is quite significant. At present ADAP is trading at $1.45 and TCRR is trading at $1.76, so with a 1.5117 ratio every share of TCRR will receive $2.19 worth of ADAP at the time of the deal close. That is a 24% spread, very high for a merger arbitrage deal. For those who are already ADAP longs you could buy 1 TCRR for every 1.5 ADAP you already own and keep the extra cash, or buy the same dollar value of TCRR, and get a larger eventual position.

Risk

Of course, as with any potential investment there are certainly risks. In this case, the biggest set of risks are that the deal isn't completed for some reason - if it closes on the published terms the spread will be earned by those switching, while those who have the merger arbitrage trade will earn the spread less the cost of borrowing ADAP.

There are a few possible reasons the deal could fail. Regulatory risk is a big one for many mergers, especially with the current administration taking a relatively activist role blocking deals. However, given the firms involved here are both in the development stage and the deal is primarily for cash, I think regulatory involvement is very unlikely. Since the deal is for all shares, there is no financing condition, which is another thing that can sometimes cause mergers to fail.

However, since the deal is for shares both sets of shareholders need to approve it. That requires a vote by both parties. While I had originally estimated a close date for this deal of June 30th when I wrote it up for Microcap Review subscribers, since then they've announced shareholder votes for both sets of shareholders on May 30th. I would expect the deal to close relatively quickly thereafter, so I think mid June is probably a better estimate at this point, assuming both sets of shareholders approve.

I suspect TCRR shareholders should approve the deal - TCRR stock price is up materially since the announcement and would almost certainly drop if it fails. They are also mostly down to cash value, so the longer it takes to distribute that the more gets used up in the process, so motivation to get the deal done should push that through. ADAP is a bit more of a concern, but I think ultimately they should pass the deal as well.

The biggest reason I think the ADAP shareholders will approve is how concentrated they are. As you can see from the table below, slightly over 50% of the firm is held by four institutions. They are much less likely to try and scupper the deal for a near-term short squeeze or with the misguided opinion that the firm doesn't need the cash - even if a ADAP shares did bounce on a deal break as arbs unwound their positions it wouldn't be enough volume for even one of these holders to exit their position.

Source: Proxy

The final potential reason that the deal could fail that I'm going to discuss is the potential for a competing bid. A competing bid for TCRR isn't very likely, and would probably benefit this trade anyway. A bidder making a takeover attempt on ADAP, however, would potentially be bad for the trade. I think that's relatively unlikely, because presumably anyone who wanted to buy them would have made that move when the share price was much lower right after the announcement (for the entire month of March). Also, ADAP has had some news that also makes it less likely in my opinion that they receive an over-bid.

ADAP will be receiving a cash infusion from GSK ( GSK ) as a result of a collaboration agreement between the firms. However, the cash infusion is for GSK getting out of the deal with ADAP's intellectual property. Essentially, they've decided they don't want to continue the development, and are returning the IP to ADAP, along with some cash. The fact that GSK views it as being worthwhile to pay to hand back the IP versus continuing to develop it isn't a good sign. The cash infusion will be welcome, but the negative mark against their pipeline isn't.

Risks to Arbitrage

The above risks are common to those switching an ADAP position to a TCRR position and those undertaking a merger arb. But there are a few additional risks that are unique to the merger arbitrage version of this trade. Specifically, the cost of borrowing ADAP shares to short and the risk of losing the locate. On the day of writing, Interactive Brokers has 100,000 shares available to short at a cost of borrow of 10.8%. The number of shares available has varied slightly but seems to come back to this amount with regularity - I suspect as inventory declines one of the large holders replenishes it to capitalize on the fee. The cost however of 10.8% per year is not guaranteed, so it could go up. It is also not calculated on the value of the ADAP shares, but rather on $2.50. So for a one-year hold you'd expect to pay $0.27. Given the holding period here should be a month or two at most, that isn't a huge issue given the size of the spread. However, if the borrow disappears it almost always does that during a short-squeeze, which generally means buying back the shorted shares at a high price. So the risks of putting this on as a hedged merger arbitrage are different - while there is no exposure to the long term prospects of the firm there is the risk of losing the locate in the short term.

Conclusion

The spread here is very large, making it attractive to switch ADAP shares to TCRR or put this on as a hedged merger arbitrage trade. I think regulatory or overbid risks are minimal, and both sets of shareholders are likely to approve the deal. The biggest risk for the hedged version of the trade is the relatively thin amount of borrow available for the ADAP short side of the trade.

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