December 28, 2023 – As we conclude 2023, the landscape of corporate merger and acquisition activity has been marked by a dynamic interplay of strategic consolidations and industry realignments.
Corporations maneuvered through a rising, then falling, interest rate environment, and a volatile but ultimately well-performing equity market. Periods of rapid merger activity, including October’s record-setting level of deal-making with $165 billion of M&A across 20 transactions, were followed by subdued periods such as November that featured just 6 U.S. public company mergers worth an aggregate of $18 billion. Subsequently, following a year-end Santa Claus rally in both stocks and bonds, increased corporate confidence led to a flurry of mergers and acquisitions in December, totalling $83 billion across 19 deals in the U.S.
The year witnessed many high-profile M&A deals, reflecting a strategic response to changing market conditions, technological shifts, and the pursuit of synergies. Companies across various sectors engaged in consolidation efforts to strengthen their market positions and adapt to evolving economic trends. Four major transactions closed in 2023 that exemplified two key themes in the merger market this year: Sector focus (tech and pharma dominated) and timing (many deals suffered from delayed closing timelines).
- Pfizer completed its $43 billion acquisition of global biotechnology company Seagen in a relatively brief 9-month deal cycle. The merger comfortably sailed through international and domestic antitrust regulatory reviews to close earlier than initially expected.
- Broadcom closed its $69 billion merger with cloud computing and virtualization technology company VMWare in the year’s largest transaction. They say that most deals “die on the vine” if they take too long, but the VMWare deal reached the finish line after an exhausting 18 months due to a grinding gauntlet of regulatory reviews worldwide and a last-minute delay in securing Chinese approval.
- In October, Amgen consummated its $28 billion deal for global biotechnology company Horizon Therapeutics. The transaction was expected to close in the first half of the year before attracting an unexpected (and dubious) lawsuit from the FTC seeking to block the deal. Given that the merger was not anticompetitive, the parties were able to prevail against the vexatious lawsuit and complete the merger, however, it took 10 months to close instead of the 5 months initially expected.
- In a candidate for “deal of the year”, Microsoft completed its hard-fought $69 billion acquisition of gaming company Activision Blizzard after a grueling 21 months (taking at least 4-6 months longer than expected). Kudos to Microsoft for successfully battling two overzealous antitrust regulators, including defeating the FTC in court and bending the U.K. CMA to its will, in a precedent-setting vertical merger.
First, U.S. public M&A transactions took longer to close on average. Whether it be a long SEC review process for proxy circulars, protracted reviews by antitrust bureaucrats, or geopolitical games played by international regulators, several of these hurdles in the merger process can delay transaction completion. This unexpected lengthening of timelines has the effect of compressing IRRs and lowering investment returns for arbitrageurs. For example, if a merger is expected to close in 6 months and the target trades at a 5% discount to the consideration, the expected arbitrage yield is 10% (annualizing the 5% expected return over half of a year). If this supposed transaction is delayed and takes 12 months to close instead of 6, then the annualized return, or arbitrage yield, compresses from 10% to 5%. Despite being completed successfully, the unexpected delay caused an attractive 10% yield to fall to an unattractive 5% yield.
Second, the frequency of deal outcomes affects overall merger arbitrage results. Historically, 6% of M&A transactions have terminated, while 94% have closed successfully. If a deal terminates then the arbitrageur likely loses money on the investment. Offsetting the terminated deals has been those that have resulted in a higher consideration, either through an interloper causing a bidding war or the initial acquiror being forced to pay a higher price. Historically, increased considerations have happened 5% of the time on average. These increased considerations can have a material positive effect on merger arbitrage results and typically offset the losses caused by deal terminations. This year, while the deal termination rate was in line with historical precedents at just under 6%, the rate of increased considerations was a paltry 1% (compared to 5% historically). There is no rhyme or reason for reduced bidding war activity and fewer increased considerations paid in definitive merger agreements lately. It is likely just (bad) luck of the draw.
Nonetheless, arbitrageurs are heading into 2024 with merger arbitrage yields above 10%, representing a 550bps premium to T-bills and a 330bps premium to junk bonds.
Gazing into a crystal ball and looking ahead to next year, the momentum in corporate merger activity is expected to continue. The business environment, characterized by rapid technological advancements across a myriad of sectors combined with economic challenges and opportunities, will likely drive companies to seek strategic partnerships for innovation, scale, and competitiveness. As industries navigate the complexities of a post-pandemic world, the strategic imperatives underlying mergers and acquisitions are poised to play a pivotal role in shaping the corporate landscape in the coming year.
Next year holds the potential for further transformative deals and collaborations as corporate executives and boards position themselves for growth and resilience in an ever-changing global economy. We expect several themes in the merger market to materialize, including:
- Continued activity in the biotech sector as large-cap pharmaceutical companies pursue growth via acquisition to refill declining drug pipelines.
- The re-emergence of private equity buyouts as lower financing costs, due to softening interest rates, combined with additional willing corporate sellers, given the recent stock market rally, allow more bid-ask spreads to converge which may facilitate higher leveraged buyout activity.
- Increased consolidation in the oil patch. Industry heavyweights Exxon Mobil and Chevron kicked off the consolidation trend with their $60 billion+ acquisitions of Pioneer Natural Resources and Hess, respectively. Look for increased M&A in the energy and natural resources segments next year. (Disclosure: the Accelerate Arbitrage Fund (TSX: ARB) is long both Pioneer and Hess and short both Exxon and Chevron).
Allocators enter 2024 with a prospective and generous opportunity set in North American arbitrage. The current merger arbitrage opportunity set consists of 78 public M&A deals totalling nearly $400 billion with an average yield of 10.9%, providing the potential for attractive risk-adjusted returns and a diversifying allocation for investor portfolios.
The AlphaRank.com Merger Monitor below represents Accelerate’s proprietary analytics database on all announced liquid U.S. mergers. The AlphaRank Merger Arbitrage Effective Yield represents the average annualized returns 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 Alpharank.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.
