August 25, 2021 — Three major themes have become top of mind for merger arbitrageurs: the U.S., China and meme stonks.
What concerns deal investors regarding the U.S. is their antitrust enforcers, the Department of Justice (DoJ) and the Federal Trade Commission (FTC). Specifically, two events have spooked arbitrageurs regarding the U.S. antitrust regulators. First, the FTC appointed Lina Khan, an inexperienced 32-year-old bulldog, as its commissioner. She has made it clear that she wants the FTC to get aggressive in trying to block industry consolidation (thus far, she has focused on big tech). Second, President Biden released an “Executive Order on Promoting Competition in the American Economy”, which included anti-deal rhetoric.
Thus far, it is too early to tell if this will materially affect deal completion probabilities on a go-forward basis. Yes, the DoJ did sue to block Aon’s merger with Willis Towers Watson last month. To be fair, this deal represented the consolidation of the number 2 and number 3 players in the industry, and the market was only pricing in a 50% odds of success. On the other hand, both Microsoft’s acquisition of Nuance and US Concrete’s merger with Vulcan Materials cleared their antitrust hurdles without any issue, a positive surprise for arbitrageurs. Our view is that U.S. antitrust agencies must continue to operate within the letter of the law and must ultimately win in court. The existence of law and precedents provides somewhat reasonable assurance to merger investors to prevent vexatious behaviour from the regulators.
The concern for merger players stemming from China relates to the State Administration for Market Supervision (SAMR), a puppet antitrust agency that largely operates at the political whims of Beijing. SAMR risk has caused much consternation amongst semiconductor mergers, given the strategic nature of the technology for the world’s superpowers. Many deals reliant on SAMR approval are trading at distressed levels. Unlike U.S. regulators, there is no rhyme or reason to how SAMR operates. Historically, it has generally approved deals as expected, however, it has made an erratic decision now and then. Nonetheless, SAMR’s recent approval of Maxim Integrated’s acquisition by Analog Devices, one of the handful of technology mergers under Chinese scrutiny, proves that they may not have a “block all deals” mentality.
Why would merger arbitrageurs be concerned regarding meme stonks, or those retail stock favourites that rocket higher for no reason?
Look no further than the Xilinx / AMD merger spread, which blew out recently when AMD became a meme stonk hot with retail speculators. Some arbs were blown out of the spread when it surged from $10.00 to $60.00 as AMD, the stock that deal arbs were short, skyrocketed.
This meme stonk risk affects deals with an all-stock merger consideration, representing only 33.0% of outstanding deals.
In the Accelerate Arbitrage Fund (TSX: ARB), we have taken a measured approach to a merger arbitrage allocation, keeping all three of the above concerns into account:
- Do not invest in mergers with high U.S. antitrust uncertainty. We are cognisant of the heightened antitrust scrutiny, so it is not the time to invest in deals with significant concentration issues.
- Do not invest in large-cap deals subject to SAMR approval. The SAMR regulatory regime is highly politicized and cloaked in secrecy and it is nearly impossible to gauge the odds of success with reasonable predictability.
- Exercise extreme caution while investing in all-share deals with meme stonk potential. Risk management is critical on short positions in the current environment.
Over the past month, 22 U.S mergers were announced, while 7 closed. There are currently a record 95 U.S. M&A deals outstanding, representing an aggregate value of $556.8 billion.
The below AlphaRank Merger Monitor represents Accelerate’s proprietary analytics database on all announced liquid U.S. mergers. The AlphaRank Merger Arbitrage Effective Yield represents the average annualized return of all outstanding merger arbitrage spreads and is typically viewed as an alternative to fixed income yield.
Each individual merger is assigned a risk rating:
- AA — a merger arbitrage rated ‘AA’ has the highest rating assigned by AlphaRank. The merger has the highest probability of closing.
- A — a merger arbitrage rated ‘A’ differs from the highest-rated mergers only by a small degree. The merger has a very high probability of closing.
- BBB — a merger arbitrage rated ‘BBB’ is of investment grade and has a high probability of closing.
- BB — a merger arbitrage rated ‘BB’ is somewhat speculative in nature and has a greater than 90% probability of closing.
- B — a merger arbitrage rated ‘B’ is speculative in nature and has a greater than 85% probability of closing.
- CCC — a merger arbitrage rated ‘CCC’ is very speculative in nature. The merger is subject to certain conditions that may not be satisfied.
- NR — a merger rated NR is trading either at a premium to the implied consideration or a discount to the unaffected price.
The AlphaRank merger analytics database is utilized in running the Accelerate Arbitrage Fund (TSX: ARB), which may have positions in some of the securities mentioned.
* AlphaRank is exclusively produced by Accelerate Financial Technologies Inc. (“Accelerate”). Visit AccelerateShares.com for more information. Disclaimer: This research does not constitute investment, legal or tax advice. Data provided in this research should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information in this research is based on current market conditions and may fluctuate and change in the future. No representation or warranty, expressed or implied, is made on behalf of Accelerate as to the accuracy or completeness of the information contained herein. Accelerate does not accept any liability for any direct, indirect or consequential loss or damage suffered by any person as a result of relying on all or any part of this research and any liability is expressly disclaimed. Accelerate may have positions in securities mentioned. Past performance is not indicative of future results.