Description

Situation Overview:

Select merger arbitrage spreads are currently dislocated due to a few factors including Elizabeth Warren’s recent letter writing campaign against various transactions including Microsoft’s acquisition of Activision Blizzard,  Standard General’s purchase of Tegna Inc., L3Harris acquisition of Aerojet, Amazon’s purchase of iRobot Corp., and Horizon’s sale to Amgen. In addition, many deals are being more scrutinized by various regulatory bodies including the FTC, DOJ, EU, Mofcom.

Warren is currently writing letters against a variety of mergers, and just about every headline grabber, which likely pulls resources away from current regulatory and enforcement situations that need keen attention including FTX fraud / bankruptcy, Southwest Airlines and others. In addition, to more regulatory scrutiny in the US, Europe and geopolitical tensions with China, all of this is leading to wider merger arbitrage spreads as event-driven investor flows get re-allocated to spaces such as private credit and even to money market funds that yield ~4%.

Liz Letters:

https://www.warren.senate.gov/oversight/letters/ftc-chair-lina-khan-responding-to-sen-warrens-letter-on-microsofts-proposed-acquisition-of-activision-blizzard-redoubles-ftcs-commitment-to-scrutinize-mergers-impacts-on-workers

https://www.warren.senate.gov/imo/media/doc/2023.01.11%20Letter%20to%20FCC%20re%20Standard%20General%20-%20Tegna.pdf

https://www.warren.senate.gov/newsroom/press-releases/warren-to-fcc-promote-competition-in-media-industry-by-blocking-hedge-fund-standard-generals-acquisition-of-broadcaster-tegna

https://www.warren.senate.gov/newsroom/press-releases/warren-ftc-should-oppose-aerojet-l3harris-merger

https://www.warren.senate.gov/imo/media/doc/Letter%20to%20FTC%20on%20Amazon%20-%20iRobot%20Merger.pdf

https://www.reuters.com/markets/deals/warren-tells-ftc-she-is-particularly-concerned-about-amgen-indivior-deals-2023-01-26/

I believe this is a solid entry catalyst to put on a basket of merger arbitrage trades with ~7-60% IRRs to play for spread compression and even some deal closures/breaks.

I have used this ranking system in prior write ups (cut and paste with minor tweaks):

Ranking:

1. Safe(er) Deals “Tier 1”: Consider a safer transaction to exhibit the following characteristics- strong DMA , financing in place with reputable financial institutions; board unanimous (or hold out wanted go shop / higher offer); strategic merits are rationale for deal

2. More complex than Tier 1 ranking “Tier 2”: potential anti-trust issue, but solvable under conditions in the DMA and the presence of a credible buyer. Depending on size of spread, can be sized in tier 1

3. Hairy (potential tail risk is difficult to analyze) “Tier 3”: Financial buyer (even if using portfolio company); weak DMA, potential problems if financing market conditions tighten

**Spread calculations do not include transactions to hedge or increase exposure using other parts of the target or buyer capital structures. Can use credit in some merger situations including HZNP and TGNA.

Issue Spotting: The above rankings are impacted by a grid with the following criteria

·     Regulatory (sector and / or company specific)

·         Shareholder / other litigation (prior to deal)

·     Red flags: management incentives; buyer due diligence

·     Quant fund involvement

·     Strategic operational merits vs financial engineering

·     Financing

·     Ability to terminate / extend

·     Probability of competitive bidding situation

MSFT / ATVI Key Terms:

$95 all cash

Deal terms probability 40%

Gross spread: 18.50 per share / 24%

Tier 2 / Set-up: direction of fundamentals improving here so could size on further spread widening and have ammo ready in a deal break

Hedge structure consideration: put spread; call spread

*Dicey regulatory situation, main focus is sanity checking stand-alone deal break price; options market is implying 50% chance of deal close or termination by Jan 2024 and 35% outcome by June 2023

That prompted the FTC to file its case the same day to send a strong signal to EU Competition Commissioner Margrethe Vestager and her staff, the people said, even though technically the commission wouldn’t entertain remedy proposals from the companies until later in the process.

TGNA Key Terms:

$24 all cash

Deal terms probability 50%

Gross spread: 4.35 per share / 22%

Tier 2 / Set-up: DOJ likely to approve, but don’t see reasons why this should be tier 1 as we don't have a lot of buyer history with closing deals and break price of $13-$15 is below street of $17-$19 range

Hedge structure consideration: put spread albeit liquidity worsening; sizing

Can also play TGNA deal close via credit or set up long/short equity and credit trade

Aerojet Key Terms:

$58 all cash

Deal terms probability 55%

Gross spread: 2.24 per share / 4%

Tier 2 / Set-up: direction of fundamentals improving and other buyers likely emerge on a deal break (+break fee is net positive for balance sheet)

Hedge structure consideration: put spread / calendar put spreads

iRobot Key Terms:

$61 all cash

Deal terms probability 15%

Gross spread: 15.60 per share / 35%

Tier 3 / Set-up: fundamentals deteriorating, spread reflects likely deal break and termination

Hedge structure consideration: calls (can do vs small short stock too - borrow fee), call spread

HZNP / AMGN Key Terms:

$116.5 all cash

Deal terms probability 75%

Gross spread: ~6 per share / 5.5%

Tier 2 / Set-up: Warren letter surprised market even though pharma in spotlight. This could move to Tier 1.

Hedge structure consideration: put spread, outright puts

*Irish High Court Filing key approval, Warren merger investigation leads to delays

COUP / Thoma Bravo Key Terms:

$81 all cash

Deal terms probability 92%

Gross spread: ~1.25 per share / 1.5%

Tier 1 / Set-up: Normally LBO/PE would be Tier 3/2, but Thoma Bravo vs other PE firms is sound buyer and deal likely to close. High probability of close, but Tier 2 sizing

Hedge structure consideration: put spread (but eats into fair amount of spread)

 *Deal likely closes in next ~60 days and proceeds can be redeployed into other spreads

Albertson’s / Kroger Key Terms:

$27.25 all cash

Deal terms probability 75%

Gross spread: ~6.15 per share / 29%

Tier 3: this deal has a lot of risk and see no reason to deploy capital to this situation at this juncture even vs options (dead money for now)

Vmware / Broadcom Key Terms:

$142.5 cash and 0.252 stock

Deal terms probability 50%

Gross spread: ~21.05 per share / 17%

Tier 3: set the spread small

Hedge structure consideration: nm

Forgerock / Thoma Key Terms:

$23.25 all cash

Deal terms probability 50%

Gross spread: ~3.45 per share / 17.5%

Tier 3: potential regulatory issue; Thoma Bravo has portfolio companies that compete in niche space. Placeholder allocation vs hedge

Hedge structure consideration: put spread

Maxar Technologies / Advent:

$53 all cash

Deal terms probability 90%

Gross spread: ~1.75 per share / 3.4%

Tier 2: large premium, PE buyer

Hedge structure consideration: puts

*Looking at CFIUS a bit closer on this transaction; other approvals beyond HSR required includ DDTC/ITAR (mid Jan), CDSA / NISPOM, FCC, Land Remote Sensing Policy Act, Communications Laws, Foreign Direct Investment Laws; Proxy Jan 31)

Governing Law for financing is New York (not Delaware)

DCT / Vista: when go-shop expires, will take closer look at spread trade

AEL: pre deal. no trade

NATI: pre-deal. no trade

VLTA-SHEL: excluded spac transactions as it adds layer of complexity for time being

CNCE: excluded as with CVR it is not trading with attractive spread, but may take closer look as deal timeline progresses

MAGT_CN: excluded non US deals for now

VVNT / NRG: NRG holders not pleased with transaction announcement, will re-evaluate 

Catalyst

Spread compression

Transaction closing(s)