Metromile (MILE) – Merger Arbitrage – 13% Upside

Current Price: $0.91

Offer Price: $1.03

Upside: 13%

Expected Closing Date: Early Q3 2022

 

Consolidation of two insure-tech companies. Home and pet insurance provider Lemonade ($1.2bn market cap) is buying car insurer Metromile. Consideration is 0.05263 LMND shares for each MILE share for a total value of c. $140m. Shareholder approval has been received back in Feb’22, while antitrust approval was received two weeks ago. Only customary conditions remain and in the latest press release MILE confirmed that the merger is expected to close in early Q3 2022. The buyer is unlikely to walk away. So this is basically a done deal that should get closed in a few weeks. However, the spread doesn’t reflect that and has actually widened from c. 2% in Q4’21 to over at 13% now.

The main reason behind such a large spread seems to be expensive LMND hedging at 17% annual rate. Although borrow is available at the moment, there is a risk of forced buy-in before the merger closes or even of a short squeeze. Short interest is high at 30% of free float. LMND used to be a popular stock among retail/Reddit investors and yet another pumping wave could certainly happen.

However, I think risk/reward is still favorable given:

  • Short remaining timeline;
  • Borrow rate seems to have stabilized over the last few months;
  • Low likelihood of buyer walking away;
  • Stable LMND short interest rate (20%-30%) pretty much right since its IPO in July’20. Aside from the early’21 craze, the trading has been relatively calm with no further spikes so far.
  • Many fresh retail speculators of last year that have been instrumental to ’20 and ’21 squeezes have been badly burned over the last half a year and the likelihood of hedged LMND position backfiring (i.e. forced buy-in due to a short squeeze) has significantly diminished.
  • Q2 financial results for both companies are expected to be released in mid-August, with the merger likely getting closed before that.

At current prices, the offer values MILE at 0.9x BV vs. 2.3x BV at the deal announcement. LMND is valued at 1.3x BV vs 3.8x back in Nov’21.

The downside in case the merger fails is difficult to assess. The deal was signed back in Nov’21 making pre-announcement prices kind of irrelevant. LMND offer came at a minimal premium to MILE prices at the time.

MILE/LMND traded at minimal spread till short interest spiked in Q1’22. Spread development is depicted below.

LMND’s historical borrow fee:

 

Merger/Company Background

LMND is primarily a homeowner and pet insurer. It is a high-growth AI/tech story stock that has been hyped up by retail investors in early 2021. At its peak, the stock reached a valuation of 16x BV. Not surprisingly, the story hasn’t held up very well – Lemonade turned out to be a hand grenade blowing up 86% of equity value since Jan’21 (currently at 1.3x BV).

LMND’s underwriting performance has been terrible so far (stable 90% loss ratio vs peers at 70-75%). However, the company is growing its gross written premiums (GWP) at 45-70% YoY with the most recent run-rate at $440m GWP/year.

MILE acquisition is intended to revitalize the story, at least for some time. The merger will diversify LMND operations into the car insurance space. LMND had actually started its own car insurance segment just weeks before announcing the acquisition and expects the deal to propel the segment from “a newcomer in the car insurance space to its vanguard”.

MILE offers auto insurance based on each customer’s miles driven (per month). It claims to have a sophisticated algorithm that tracks each customer’s driving habits (speeding, hard-braking, accelerating, cornering, etc.) and writes premiums based on that. The habits are tracked through the Metromile Pulse device, which is plugged into the car’s diagnostic port and transmits data to the company. MILE is one of Chamath’s SPACs, which he previously claimed to be the next Geico. Instead, it turned out to be one of the worst-performing SPACs so far. The underwriting performance is even worse than LMND’s, while growth is non-existent.

LMND claims that it sees significant operational, cross-selling synergies and strongly values/needs MILE’s database (allegedly “billions of miles” of data).

Given the strong need for LMND to keep the story going, I don’t think it will try to wiggle out of this all-stock deal just weeks before closing.

Published on: June 27, 2022  •  Published by:
Category: M&A  •  Quick Ideas

1 COMMENT

  1. Ilja

    Borrow fee rate spiked to 45%, so this risk was higher than expected. Luckily, the spread has narrowed to 4.5% over the last few days. No longer worth keeping this idea active. +8.5% gain in a week.

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