October 28, 2021 – Investors are navigating through the merger arbitrage landscape as they would in a haunted house – cautiously and somewhat frightened.
Much of the market’s fear, reflected in wide arbitrage spreads and high arbitrage yields, stems from concerns regarding the regulatory landscape in both the U.S. and China.
Accordingly, any deal subject to review by the U.S. regulators, the Federal Trade Commission or Department of Justice, and/or the Chinese State Administration for Market Regulation is approached warily by arbitrageurs.
These heightened regulatory concerns have translated to a current 8.6% average merger arbitrage yield and a 2021 average of 8.2%, approximately 300 basis points higher than the pre-Covid average yield. In addition, arbitrage yields in 2021 have expanded significantly despite interest rates falling, indicating that the risk premium has increased.
While merger approval delays and anti-deal rhetoric have buoyed market concerns, there has not been a commensurate increase in deal terminations due to regulatory interventions.
Over the past month, three mergers were terminated. However, two of these terminations were the result of “good” news.
For example, Magna International terminated its friendly acquisition of Veoneer when the much-larger Qualcomm submitted a superior proposal that was 18.4% higher. Arbitrageurs enjoyed the benefit of higher consideration.
Zoom Video Communications walked from its merger with Five9 after the target shareholders rejected the deal, given Zoom’s stock had fallen so far. Nonetheless, merger arbitrageurs made money off the deal as Five9 traded higher than the Zoom consideration after the transaction broke.
On the negative side, Kidedu Holdings exited from its takeover of Chinese education company Tarena International, claiming a breach of the merger agreement. This deal break came as no surprise, given that the Chinese government had effectively killed the for-profit education industry in China months before (but after the deal announcement).
Although some deals have been delayed on antitrust waffling, an abnormal quantity has not been blocked, despite the market pricing increasing terminations. Currently, the market is pricing in an 84% average odds of successful deal closing across the merger landscape. Historically, 92% of deals have closed successfully.
Clearly, higher yields without a commensurate increase in risk benefits investors, given the prospect of higher risk-adjusted returns.
In addition to the higher-than-average expected returns, deal flow remains robust. Over the past month, 13 U.S. mergers worth $52.8 billion and 6 Canadian mergers worth $7.6 billion were announced.
The total North American merger arbitrage opportunity set currently sits at 102 deals outstanding, representing an aggregate value of $500 billion. With an opportunity set so large, one can afford to be selective, as we have in the Accelerate Arbitrage Fund (TSX: ARB), where we currently hold a dozen merger arbitrage investments.
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.