22 Opportunities In Merger Arbitrage Space

Below you will find a downloadable PDF as well as full descriptions of each merger arbitrage play.

Merger_Arb_Spreads_SA_Nov_29.pdf

Merger arbitrage is one of my favorite event-driven strategies for its proposition of straightforward binary outcome (easier to weigh the odds), relatively short timeline, and, at least in my experience, frequent examples of market inefficiency. Moreover, with merger arbs the outcome of the bet is often little dependent on the general market movements/outlook, which also offers uncorrelated returns.

However, when the market is turbulent, investors get scared and merger arbitrage spreads often widen significantly, despite no real change in transaction risks. Such times create interesting opportunities to enter and play on overblown spreads, e.g. as it happened earlier this year during the market fall in June/July.

The market turbulence is still highly elevated and there are plenty of interesting merger arb opportunities available. Below you will find a list of 23 transactions with the widest spreads currently on the market with my quick takes on each situation and the reasons for the spread.

Which of these transactions do I find to be the most attractive from the risk/reward perspective? Well, a big part of the list below are large-cap mergers of well-followed companies, so it’s more likely that the outstanding spread fairly reflects the risks of transactions failing for one reason or another. In other words, there is no free lunch on most of the larger cap stuff. Having said that, it is still very important to regularly review the heavyweight space as some interesting merger arbitrage plays might pop in there as well, e.g. (ATVI) with a 27% spread, (TGNA) with 24% or (IRBT) with an 18% potential upside.

Nonetheless, I always prefer smaller-cap event-driven situations as in this area it is easier to find the edge and see why the market might be wrong. From the list some smaller names appear to be quite interesting including:

• (LOTZ) with 14%
• (OIIM) with 12%
• (FCRD) with 8%
• (GSMG) with 6%

Silicon Motion Technology (SIMO)

• Buyer: MaxLinear (MXL)
• Consideration: $93.54 + 0.388 MXL stock
• Spread: 75%
• Exp. Closing: H2’23
• Main Risk: Chinese regulatory approval.

International merger in the semiconductor industry. Silicon Motion Technology, a supplier of NAND flash controllers for SSDs, is getting acquired by its US peer MaxLinear. The acquisition is complementary to MaxLinear’s Broadband, Connectivity, and Infrastructure markets and would roughly double the buyer’s total addressable market to $15b. Shareholders have already approved the merger, however, approval from China’s regulators remains outstanding and is the main hurdle here. The buyer is based in the U.S., while the target is a US-listed Taiwanese company with China being its largest market. Both parties had previously filed under the simplified procedures. Recently, the companies converted to filing under a normal procedure as advised by Chinese regulators. This month the documents have been accepted and regulatory review is underway. Management reiterated the expected closing date to be in mid-late 2023. If the deal fails, the downside could be material as the merger was announced during a boom in the semiconductor industry. Whereas, right now the industry is facing fairly strong headwinds from weaker demand/client inventory oversupply.

Digital Media Solutions (DMS)

• Buyer: Management
• Consideration: $2.50/share
• Spread: 63%
• Exp. Closing: TBD
• Main Risk: Non-binding agreement, buyers might walk away.

Digital Media Solutions, a digital advertising solutions provider, received a non-binding takeover offer from its CEO and COO at $2.50/share. The buyers have indicated that certain affiliates/major shareholders are likely to join the bid as well – this would raise the combined ownership of the buyers to over 73%. The board has been reviewing the offer for several months now. However, the market remains highly skeptical of buyers’ intentions. The spread has been gradually widening from 13% to nearly 63% at the moment. This increase seems to be driven by limited updates since the announcement as well as accelerated new share registrations (which started as soon as the share price jumped after offer announcement). The offer is a result of a year-long strategic review, which doesn’t add credibility either (management was unable to sell the business). Another risk is the substantial downside – the $2.50/share offer came at over 2x premium to pre-announcement levels. DMS is a failed SPAC, which de-SPAC’ed in early 2020. Since then, its share price has fallen by nearly 90%. Financial reports provide limited details on the business.

Spirit Airlines (SAVE)

• Buyers: JetBlue Airways (JBLU)
• Consideration: JBLU: $31/share;
• Spread: 47%
• Exp. Closing: H1’24
• Main risk: regulatory approval.

This is an interesting saga in the U.S. airline industry. After an intense bidding war between (ULCC) and JetBlue, SAVE’s shareholders chose and have already approved the merger with JBLU. The current spread is mainly due to antitrust concerns. The DOJ has recently issued a second request and is currently reviewing the merger. Note that the acquisition involves a ticking fee of $0.10 per month starting from January 2023 till the merger closes. This is expected to add an additional $1.20-$1.80 to the total consideration depending on when the merger closes in H1’24.

On the positive side the merger will introduce the 5th largest airline and improve competition with the so-called “big 4” players who dominate the market right now – Delta Air Lines (DAL), American Airlines (AAL), United Airlines (UAL), and Southwest Airlines (LUV). JBLU has also proposed divestitures in areas where SAVE/JBLU together have an overwhelming presence in certain airports.

However, the major regulatory hurdle is the impact on US low-cost carrier segment (where SAVE operates). Senators have raised concerns that if SAVE were to be acquired, this would likely lead to an increase in low-cost airline ticket prices. Another DOJ concern relates to JBLU’s Northeast Alliance partnership (NEA) with American Airlines. The partnership agreement involved coordinating schedules (not airfares), also allowing companies to sell each other’s flights and combine loyalty benefits. Recently, a motion to dismiss the DOJ case against NEA has been denied. Now the decision comes down to the judge’s reading of antitrust law which could significantly delay the decision. Hence, the SAVE-JBLU merger outcome might also depend on the outcome of the NEA trial.

Black Knight (BKI)

• Buyer: Intercontinental Exchange (ICE)
• Consideration: $68 + 0.144 ICE stock
• Spread: 36%
• Exp. Closing: H1’23
• Main Risk: Regulatory approval.

Mortgage tech provider Black Knight is getting acquired by financial exchange and clearing house giant, Intercontinental Exchange. The merger is synergistic as both companies provide similar mortgage software services. Shareholders have already approved the merger. However, Community Home Lenders Association has called regulators to block the merger over antitrust concerns saying that the combined company will have too much pricing power in the small/mid-mortgage banking sector. Horizontal overlap is minimal with BKI being the third largest mortgage origination software player with 10% exposure (ICE controls nearly 50%). In the mortgage servicing segment, BKI has a 56% market share (ICE has 0% as it offers no competing product). Hence, the main concern here is vertical integration as each company holds a dominant market share in specific US mortgage software segments – servicing and origination. As a result, small banks might get trapped as they don’t have enough scale to justify developing proprietary software. However, there are indications that these risks might be overblown. BKI mostly serves large mortgage providers and has little exposure to smaller players suggesting BKI will not provide ICE a significant market power in the small/mid-mortgage servicing segment. Both companies seem confident that regulatory approvals will eventually be received. Both companies also hired third-party experts to evaluate the deal from a regulatory point of view. Limited overlap was found. Recently, ICE agreed to an extended FTC review while reiterating its expectation of merger completion by H1’23.

F-star Therapeutics (FSTX)

• Buyer: Sino Biopharmaceutical (OTCPK:SBMFF) (1177.HK)
• Consideration: $7.12/share
• Spread: 32%
• Exp. Closing: H2’22
• Main Risk: regulatory approval and large downside.

A small biopharma acquisition by a large Chinese pharma conglomerate. The market seems to be concerned that the merger might get blocked by CFIUS due to the buyer being a Chinese firm. Such regulatory concerns are quite unusual given this is a tiny acquisition of an oncology treatment developer with a very early-stage pipeline. However, a couple of weeks ago, parties had to withdraw and refile the merger documents to CFIUS. As a result of this, the transaction end date was extended till the 19th of Dec. Downside to pre-announcement prices is very steep, which also partially explains the spread.

Albertsons Companies (ACI)

• Buyers: The Kroger Co. (KR)
• Consideration: $27.25/share;
• Spread: 31%
• Exp. Closing: Q1’24
• Main risk: regulatory approval.

A merger of two food and drugstore companies. The merger comes after ACI announced strategic alternatives earlier this year. The acquisition is expected to significantly increase scale, and reduce costs. The merger is also synergistic from the geographical perspective – management states that ACI operates in several parts of the country with very few or no Kroger stores. ACI looks cheap and is also estimated to have around half of its EV in real estate value suggesting the buyer is unlikely to walk away. The main risk is regulatory approvals as US senators have raised anticompetitive concerns to the FTC. To satisfy potential regulatory hurdles ACI and KR proposed divesting a large number of stores. Also, as part of the merger agreement, ACI was supposed to pay a $6.85/share special dividend to its shareholders (the record date has already passed). However, several states filed a lawsuit to block the payment arguing it would weaken the company’s ability to compete as the antitrust reviews proceed. The court’s hearing on the special dividend issue has now been delayed till the 9th of December. Overall, management remains confident that divestments will be enough to satisfy potential regulatory concerns while also stating that a lawsuit related to dividend payments is groundless and should get resolved in court.

Activision Blizzard

• Buyer: Microsoft (MSFT)
• Consideration: $95/share
• Spread: 27%
• Exp. Closing: H1’23
• Main Risk: antitrust consent.

Microsoft is acquiring game developer Activision – its largest acquisition so far. Shareholder approval has already been received. The spread mainly exists due to regulatory concerns over MSFT’s potential abuse of power and potential restriction of ATVI games solely to Xbox consoles. If the merger closes, Microsoft would become the world’s third-largest gaming company by revenue, behind Tencent and Sony. In addition to acquiring icon gaming franchisees, MSFT would gain more control in global eSports activities through Major League Gaming. UK and European antitrust watchdogs, among others, have started their inquiries into the transaction. The EU Commission has extended its deadline for a decision to Apr’23. This month, Chinese regulators rejected a simplified filing request for the deal. Recent rumors also suggest that the FTC plans to block the merger. On a positive note, Warren Buffett’s Berkshire (owns 9.5% stake) is also participating in this merger arb play providing some confidence in the successful outcome and/or a well-protected downside on ATVI standalone basis.

111 (YI)

• Buyer: Management
• Consideration: $3.61/share
• Spread: 26%
• Exp. Closing: TBD
• Main Risk: Non-binding offer.

Chinese non-binding privatization offers are inherently risky. Reputable management as well as the financing for the buyout by a government-controlled entity give confidence that this offer has a higher chance of closing. Management is also highly incentivized to proceed with the offer and re-list in the domestic Chinese markets. The special committee is currently reviewing the offer.

TEGNA

• Buyer: Standard General
• Consideration: $24/share + $0.15/share
• Spread: 24%
• Exp. Closing: Q1’23
• Main Risk: regulatory approval.

Broadcasting media company Tegna is getting acquired by a consortium of buyers (mostly PE firms). The buyer group is led by Standard General (SG) and includes Apollo Global Management (APO), and peer Cox Media (majority-owned by Apollo). The consideration is $24 per TGNA share plus a small ticking fee of $0.15/share. The merger received backlash from labor unions, public-interest groups, and one competing broadcaster. Petitions were filed that combined TGNA/Cox Media would control too much of the market share. Other concerns include potential staff reductions, lower local news coverage, and renegotiation of retransmission fees. Though regulatory approval is by no means guaranteed, it seems that there are some arguments in favor of this deal. After some divestments, the combined companies are expected to have <39% exposure to U.S TV households (FCC’s ownership rules threshold). FCC has historically allowed similar acquisitions in the past as long as these consolidations are within the ownership cap threshold and proposed divestitures are appropriate – all six broadcasting mergers so far were approved after divestitures. Layoffs are unlikely as both parties indicated they would not perform any staff reductions. Also, Standard General’s management seems to have a decent track record in expanding local news coverage reducing this potential regulatory concern. Recently, Telecom regulators noted they have no objections to the merger, which adds a bit of confidence here. The merger end date has been extended till Feb’23.

Tower Semiconductor (TSEM)

• Buyer: Intel (INTC)
• Consideration: $53/share
• Spread: 23%
• Exp. Closing: 2023
• Main Risk: regulatory approval.

The merger will require numerous antitrust and foreign investment approvals. Intel’s CEO has noted that regulatory clearance has already been received in several geographies. The transaction continues to be held up by Chinese regulators, which have been increasing scrutiny over the merger in a strategically important semiconductor space. For the same reason, there is uncertainty regarding Israel’s government approval. Israeli withholding taxes will apply in case of successful closing – to avoid these foreign investors will be required to provide some paperwork, which might delay the eventual payout of the merger consideration and might explain part of the spread.

iRobot Corporation

• Buyer: Amazon.com (AMZN)
• Consideration: $61/share
• Spread: 18%
• Exp. Closing: Q4’22
• Main Risk: regulatory approval.

The spread has widened from 5% to over 15% as the market started pricing in a higher likelihood of regulatory hurdles. Two months ago the parties received the second request from the FTC. Soon after, several senators began pushing the FTC to block the transaction. Concerns were raised regarding potential privacy infringements and Amazon’s history of anti-competitive acquisitions. FTC review is ongoing.

VMware (VMW)

• Buyer: Broadcom (AVGO)
• Consideration: $71.25 + 0.126 AVGO stock
• Spread: 14%
• Exp. Closing: Oct’23
• Main Risk: long timeline/regulatory review.

This is a mammoth $61bn deal, giving Broadcom a push into the software industry. A long and detailed probe from EU regulators is expected. Broadcom’s CEO has noted that regulatory filings have so far seen good progress in numerous geographies. The merger could take more than a year to complete.

CarLotz

• Buyer: Shift Technologies (SFT)
• Consideration: 0.69 SFT stock
• Spread: 14%
• Exp. Closing: H2’22
• Main Risk: expensive hedging.

The merger is basically an equity raise for the buyer, however, the combination will also allow SFT to enter East Coast markets. Shareholder approvals shouldn’t be a problem as two major shareholders of LOTZ (25% ownership) are in support. The main issue is hedging – borrow fees are volatile and quite high at nearly 15%. There is also a minimum net cash condition, but it shouldn’t be a problem if the merger closes with no delays.

• Buyer: Ritchie Bros. Auctioneers (RBA)
• Consideration: $10/share + 0.5804 RBA stock
• Spread: 13%
• Exp. Closing: Q2’23
• Main Risk: shareholder approval.

The current spread largely reflects the risk of IAA shareholder approval (meeting date TBD). Recently, reputable activist Ancora (4% stake) voiced its opposition to the merger, arguing that it undervalues the company. Given the strong strategic rationale and relatively low transaction multiple, there is a decent chance for an improved offer. Both parties seem confident that regulatory approvals will pass.

HV Bancorp (HVBC)

• Buyer: Citizens Financial Services (CZFS)
• Consideration: $6.10/share + 0.32 CZFS stock
• Spread: 13%
• Exp. Closing: Q2’23
• Main Risk: high borrow fees.

The key reason for the spread is high borrow fees, currently standing at 13%. The merger is expected to close successfully by H1’23. Both shareholder and regulatory approval are likely to pass given the large premium over the historical TBV as well as the small size of the combined enterprise.

O2Micro International

• Buyer: Forebright Capital Management
• Consideration: $4.93/share
• Spread: 12%
• Exp. Closing: Q1’23
• Main Risk: Chinese privatization.

The spread exists mainly due to the market’s skepticism towards anything China-related. Privatization is led by a reputable PE firm that has carried out similar transactions in the past. Moreover, management is also participating in the buyout – which increases the chances of a successful closing.

Shaw Communications (SJR)

• Buyer: Rogers Communications (RCI)
• Consideration: $30.37/share
• Spread: 11%
• Exp. Closing: H2’22 – H1’23
• Main Risk: regulatory approval.

Regulators have blocked the transaction saying it will significantly dampen competition in Canada (where telecom rates are already among the highest in the world). To alleviate antitrust concerns, the companies have in turn agreed to divest RCI’s wireless service division. However, Canada’s Competition Committee recently stated that the proposed divestment is not an effective remedy. Anticipated settlement during the attempted mediation has failed. This month, the hearing started in a competition Tribunal. Both parties expect to receive regulatory clearance sometime in 2023.

First Eagle Alternative Capital BDC

• Buyer: Crescent Capital BDC (CCAP)
• Consideration: $1.89/share + 0.2063 CCAP stock
• Spread: 8%
• Exp. Closing: Q1’23
• Main Risk: NAV volatility.

This is essentially a NAV for NAV merger with an additional cash portion from the buyer’s external manager. Final consideration will be determined at the time of closing, which is expected in Q1’23. The spread likely exists due to small capitalization, somewhat confusing consideration calculations, and unknown, but predictable transaction expenses. The main risk is NAV volatility, however, due to the short timeline NAV changes are likely to be minimal.

1Life Healthcare (ONEM)

• Buyer: Amazon.com
• Consideration: $18/share
• Spread: 7%
• Exp. Closing: Q4’22
• Main Risk: regulatory approval.

Amazon is expanding into the healthcare space by acquiring primary care provider 1Life Healthcare. The merger requires ONEM shareholder and regulatory antitrust approvals. Shareholder approval is likely given the large offer premium and ONEM’s weak historical performance. The main risk is regulatory approvals. Several senators have issued letters expressing concerns about Amazon potentially dominating the primary care market as well as acquiring vast amounts of personal health data. FTC has already requested additional information from the parties. However, Amazon’s limited presence in the primary care market and the highly fragmented nature of the industry suggest the merger might be approved. Similar industry transactions also suggest that antitrust pushback is unlikely.

ForgeRock (FORG)

• Buyer: Thoma Bravo
• Consideration: $23.25/share
• Spread: 7%
• Exp. Closing: H1’23
• Main Risk: regulatory approval.

FORG is getting acquired by PE firm Thoma Bravo. The main risk is regulatory approval due to increased market concentration. Just this year Thoma Bravo has already acquired two players in the IAM space – one of which is a direct peer to FORG. Recently, reports came out that Thoma Bravo plans to pull and refile its merger docs with the DOJ. The merger is expected to close in the first half of 2023.

Signify Health, Inc. (SGFY)

• Buyer: CVS Health (CVS)
• Consideration: $30.50/share
• Spread: 6%
• Exp. Closing: Q2’23
• Main Risk: regulatory approval.

Acquisition of healthcare platform company. The reason for the small spread is still pending regulatory approval. Recently, FTC requested additional information due to anti-competitive concerns of the proposed merger. CVS’s management suggests the deal will pass as both companies provide different products and services. The merger is expected to close in H1’23. This is a strategic acquisition for CVS, and it fits well with CVS’s strategy of transformation into an integrated, and diverse healthcare platform.

Glory Star New Media Group

• Buyer: Management
• Consideration: $1.55/share
• Spread: 6%
• Exp. Closing: Q4’22-Q1’23
• Main Risk: Chinese company and material downside.

The price was already raised once from the initial $1.27/share, which was rejected by the special committee. An improved offer was approved and a definitive agreement is now in place. Major shareholder US hedge fund Shah Capital is rolling its 11% stake. Shareholder approval has been granted. Downside is very material, which coupled with GSMG being a Chinese company, probably explains the current spread.