February 25, 2023 – The mergers and acquisitions market is a constantly evolving and complex landscape comprising a cast of characters and companies that change with the market cycle.
Understanding the ever-changing dynamics and trends of the M&A market is crucial for investors, executives, and policymakers alike. It can provide insights into the current state and future direction of various industries and companies. In addition, merger and acquisition activity can have material effects on different segments of the capital markets, whether it is leveraged finance, equity capital markets, or special purpose acquisition companies.
Accordingly, we have been monitoring two interesting recent trends in the M&A market:
1. Creative financing structures for leveraged buyouts – Since Twitter’s buyout by Elon Musk closed, banks have stopped providing debt financing for leveraged buyouts. It is not difficult to see why. Recessionary conditions, a bear market, and a rapid rise in interest rates have caused loan values to drop precipitously. On the Twitter deal, it is estimated that the consortium of banks that provided debt financing lost $500 million. The loss on the Twitter financing came after lenders suffered an estimated $600 million loss funding Vista Equity Partners and Elliott Management’s leveraged buyout of Citrix Systems.
Fool me once, shame on you. Fool me twice, shame on me.
No more fooling the banks – at least for this cycle.
Historically, private equity firms have relied on either the junk bond market or the leveraged loan market for the debt needed to fund their buyouts. In recent years, leveraged loans provided by large Wall Street banks have been the most popular route of financing leveraged buyouts. However, with the significant recent losses on several headline deals over the past year, access to the leveraged financing provided by the banks has shut.
Private equity firms are in the leveraged buyout business. The products they sell are deals. Therefore, private equity firms must spend the capital that institutional investors allocated to them to provide the products that were paid for (buyouts).
As such, the lack of debt financing to complete a leveraged buyout is problematic for private equity firms’ manufacturing of their products. Accordingly, some innovative financing structures have been implemented to keep the deal manufacturing going.
For example, in the memo, “The Unleveraged Buyout“, we described the “LBO without the L”. Some private equity firms have announced buyouts with no debt financing – acquisitions funded with 100% equity.
Private lenders have stepped in to fill the void in the deals that still use leverage. Interestingly, in Thoma Bravo’s recently announced $1.8 billion acquisition of Magnet Forensics, the firm’s own credit fund stepped in to provide 100% of the debt financing. A private equity firm utilizing its own credit fund to provide all of the debt financing for its leveraged buyout is a novel structure that we have not seen before.
Creativity is never in short supply on Wall Street.
2. The new “big dog” in real estate – Over the past two years, Blackstone has been the 800-pound gorilla in the real estate market, taking private six publicly-listed REITs for an aggregate purchase price of more than $45 billion. Investors were piling into the firm’s private REIT offering, fueling its acquisition spree.
2022 was a challenging year for real estate as an asset class. The U.S. REIT index fell nearly -25%. In the recent memo, “Peekaboo, I See An Arbitrage“, we wrote about the significant problem created when a private REIT, whose investment performance was driven by the manager’s model and not the market, claimed positive performance when its public comparables were down more than -20% on average.
“This gulf between lofty and unrealistic private market valuations and the “real” mark-to-market prices of similar public assets has reached its breaking point. There are cracks in the façade of private funds and investors in these private strategies now face a major risk of write-downs.
The major risk for private fund non-redeemers is the payout to redeemers at over-inflated NAVs will reduce the remaining NAV for those who stayed in. This creates a “bank run” dynamic as investors rush to redeem before the private fund’s assets are depleted.”
As expected, investors have recognized this arbitrage opportunity to sell private REITs high and buy public REITs low. Accordingly, investors have been attempting to sell private REITs in droves. The selling pressure has become so great that many private REITs have gated redemptions and started liquidating assets.
Correspondingly, given its asset base is now shrinking, Blackstone REIT’s unprecedented acquisition spree has ended. The baton has been passed to a new “big dog” in real estate M&A.
Enter GIC.
The Government Investment Corporation (“GIC”) is a sovereign wealth fund that manages the foreign reserves of the Government of Singapore. It was established in 1981 to manage Singapore’s foreign reserves to preserve and enhance the long-term international purchasing power of these reserves.
As a sovereign wealth fund, GIC has a unique investment horizon that spans multiple generations, allowing it to take a long-term view on investments. This approach enables it to invest in a wide range of assets that may require a longer time horizon to generate significant returns.
GIC, with its nearly $700 billion of assets under management, has recently begun a real estate acquisition rampage.
First, in September, it announced the acquisition of real estate investment trust STORE Capital for $14 billion. Then, several weeks later it announced the $5.6 billion buyout of Summit Industrial Income REIT. Finally, a few days ago it teamed up with Centerbridge Partners to acquire industrial REIT INDUS Realty Trust for just under $1 billion. The Accelerate Arbitrage Fund (TSX: ARB) participated in all three merger arbitrage investments.
Outside of GIC’s real estate acquisition frenzy, the M&A market has remained steady.
In February, a dozen deals in the U.S. and Canada worth $24 billion were announced. Conversely, a dozen deals worth $40 billion closed during the month. No transactions were terminated.
Currently, there are 75 outstanding public North American M&A transactions with a total market value of more than $430 billion.
As the saying goes, with the consistent new deal activity and the large current opportunity set in mergers and acquisitions, “there’s always something to do” in merger arbitrage.
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.
