| Guideline for investing in merger arbitrage Posted: 30 Sep 2020 08:39 AM PDT Merger arbitrage has become a popular investment strategy used both by professional capital allocators and retail investors alike. It constantly provides numerous attractive situations, but in order to find them, you need to know what to look for and how to spot the red flags as well. In essence, and this is crucial, opportunities to profit from merger arbitrage arise from investor's assessment that the market is overestimating/incorrectly pricing the risks of potential failure, and then betting on the successful closure of the merger (or from pure luck - by guessing correctly which mergers will close successfully). Therefore, the first question to be asked upon stumbling across a seemingly attractive merger arbitrage case is - why does this spread exist? There are numerous points one has to check before answering this question. Short summary checklist to use in the research process: - Why does the spread exist? What are the main risks and conditions (shareholder approval, regulatory consent, etc.)?
- Is the spread appropriate given the risks or this the market mispricing this opportunity?
- What is the downside if the transaction fails? How does the risk/reward look like? Collecting pennies in front of a steamroller might not be the best strategy for generating investment returns.
- What kind of offer is this? Non-binding and hostile offers are more uncertain, but in certain cases might offer a larger upside.
- What is the type of consideration offered? If this is an all-stock merger - are there enough shortable shares available for hedging? The payment of CVRs usually takes much longer than the closing of the merger itself.
- What is the strategic rationale behind the offer for both parties?
- Is the buyer credible? Will it be able to finance the transaction?
- What is the estimated timeline? What are the chances of it being delayed? International mergers are prone to delays. Large-cap mergers have a higher risk of this as well.
- Where there any other bidders? Is there a possibility of a bidding war? In case the current deal fails, how likely is it for another bidder to appear? Is there a go-shop period?
- Are there any activist shareholders involved? What are their intentions/agenda?
- How likely is the approval from shareholders? Does the offered price seem "fair" for both sides? What other aspects are present that could impact the decision of shareholders? Who are the major shareholders and how are they likely to vote?
- Are there any objecting shareholders?
- What regulatory approvals are required? What issues could regulators potentially find with the merger (competition, national security)? Regulatory risk is hard to handicap, however, small/micro-cap transactions usually get approvals easier.
- What is the termination fee? And does it offer any downside protection?
- Position sizing - can one stomach the downside the transaction fails, or add to the position if the spread increases?
- In what industry the merger takes place? It might be good to avoid overhyped industries.
- What are the chances one still missing something? For larger size transaction spreads almost always exist for a reason.
Source: https://specialsituationinvestments.com/2020/09/guide-to-merger-arbitrage/?utm_source=merger%20arb&utm_medium=reddit&utm_campaign=Merger%20arb submitted by /u/Special_Situations [link] [comments] |
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