December 30, 2020 – The desirable merger arbitrage yields offered during the pandemic bear market are now a thing of the past.
Since the spring, merger arbitrage spreads have largely normalized. The past ten announced mergers offer an average yield of just 2.2%, a small cry from the double-digit yields available nine months ago. Of the past ten deals announced, two are trading through the consideration, with arbitrageurs accepting negative returns for the chance of a higher bid.
Over the past month, 21 M&A transactions were announced for an aggregate value of $158.4 billion, nearly doubling last month’s $80.9 billion tally.
The large aggregate size of total deals over the past month was buoyed by four transactions above the $10 billion mark:
- S&P Global’s all-share $44 billion merger with IHS Markit at a 4.7% premium, which marked the largest deal of the year and the biggest since Abbvie’s $85.3 billion takeover of Allergan announced in June 2019
- AstraZeneca’s $39 billion acquisition of Alexion Pharmaceuticals at a 44.7% premium
- Salesforce’s $27.7 billion deal for Slack Technologies at a 59.0% premium
- Thoma Bravo’s $10.2 billion leveraged buyout of RealPage at a 30.8% premium, representing the second largest LBO of 2020
Nonetheless, the merger arbitrage risk premium has declined markedly since the spring. Back in the depths of the pandemic-led bear market, there was a point in time in which the market was pricing in that half of all outstanding mergers would break and the average yield reached nearly 25%. Since markets began to crater in early March, just 7 U.S. mergers were terminated due to the bear market, while 96 deals were completed successfully, representing a deal-break rate of approximately 7%. The 10-year average deal-break rate is 7%, and therefore we did not see an elevated number of legitimate transactions terminated as a result of the bear market. This statistic showcases the strength of definitive merger agreements, proving that it is nearly impossible for a buyer to wriggle out of a deal due to a market decline.
However, there were a high number of deals that got repriced downward over the past cycle. Since early March, approximately 4% of mergers were repriced downward, compared to just 1% over the past decade.
With two of the most high profile merger dramas coming to a close, including Simon’s acquisition of Taubman and LVMH’s takeover of Tiffany, much of the stress and volatility has left the merger market. Both Taubman and Simon settled with their suitors at lower prices prior to heading to deal litigation.
As for allocating to arbitrage opportunities in the current market environment, our comment from last month’s merger monitor highlights our unchanged view:
“The last ten announced merger deals offer an average merger yield of just 2%. On a relative basis, it is hard to allocate capital to these merger opportunities, which come with real and material downside risk, when we are forecasting returns as high as 10% for low-risk SPAC arbitrage. It is rational that, given this fact, the Accelerate Arbitrage Fund (TSX: ARB) now has 80% of its portfolio dedicated to SPAC arbitrage and only 20% in merger arbitrage. Arbitrageurs who haven’t adapted and devoted their portfolios to SPACs have underperformed markedly in 2020, while SPAC arbitrageurs enjoy low-risk and consistent double-digit returns this year.”
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.