February 27, 2021 – It was exactly one year ago when merger arbitrage spreads started getting hit by the rapidly spreading coronavirus.
In the last three days of February 2020, the average merger yield expanded from 5.3% to 7.1%. It would peak less than three weeks later at a stunning 22.9%.
Merger spreads did not fully normalize from the record-setting volatility until the fourth quarter of 2020, only to tick up recently due to the somewhat unrelated meme investing saga of early 2021.
We detailed the wide-ranging knock-on effects of Wallstreetbets meme stock surge, with its ripples affecting even the merger arbitrage market, in last month’s Merger Monitor. Given the increased volatility caused by the GameStop rally, some large hedge funds were forced to unwind positions, including merger arbitrage trades, to de-risk their portfolios and lower leverage. This has caused some attractive opportunities to emerge in the merger arbitrage space. The Accelerate Arbitrage Fund (TSX: ARB) has been selectively adding M&A investments to its portfolio for the first time in months.
The recent uptick in volatility has not reduced corporate risk-taking, as merger activity continues to increase. The merger arbitrage universe expanded from 59 deals outstanding last month to 69 currently. The market finally overcame the Covid-led deal drought, exceeding the pre-pandemic 66 deals outstanding last February. As the pandemic wore on, the transaction count fell -40% to just 39 deals outstanding as of June of 2020.
In February, 17 deals were announced, representing an aggregate deal value of $72.2 billion. This tally is up from the 11 M&A transactions worth $44.5 billion announced in January. Increased deal activity and an expansion of the opportunity set are beneficial for merger arbitrageurs.
Last year’s bear market put unsolicited takeovers on ice. However, given the market recovery and reinvigoration of animal spirits, unsolicited competing takeovers have reemerged. Specifically, two recent large unsolicited takeover bids are notable:
- II-VI’s $6.5 billion offer for Coherent at a 63.2% premium, which topped friendly bidder Lumentum Holdings’ current offer by 24.0%.
- CoStar Group’s $8.3 billion offer for CoreLogic at a stunning 80.9% premium, topping friendly acquiror Stone Point Capital’s $7.4 billion deal by 19.7%.
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.