Merger arbitrage is an event driven investment strategy and a mainstay of the hedge fund industry, especially event driven hedge funds. A trader employing this strategy is known an arbitrageur. Arbitrageurs review the merger particulars after the announcement of a deal and calculate the probability of the merger closing successfully or unsuccessfully. Then they look to make an investment and open a position in the underlying target stock based upon this research. The strategy is also known as risk arbitrage.
Tracking merger arbitrage returns is a difficult process as many investment funds have a slightly different approach. Some of these strategies may not be replicable by the average trader and “average” funds returns may therefore be misleading. Investment in event driven ETF’s is possible, but even these products DO NOT stay true to the basic merger arbitrage strategy. Because of this, using a unique selection criteria Merger Arbitrage Limited created the T20 Index to track the 20 largest cash of merger arbitrage spreads. These returns, published weekly, provide traders and investors a benchmark figure as to how the strategy is performing. In addition to our general M&A news feed, the list also has its own curated news feed focussing on the index constituents.
There are various financing structures used in Mergers & Acquisitions. A simple cash deal is the most straightforward.Cash can come from existing reserves, or by arranging financing with a third party or syndication. However, in order to purchase the target company’s stock, the acquirer can also offer its own stock as payment known as a stock deal or stock swap. Occasionally, the acquirer will use a combination of stock and cash to finance the deal or include additional incentives such as Contingent Value Rights (CVR’s). The stock element adds another variable into the deal. The risk for which must also be considered by the trader as a short position in the acquirer stock must now be established according to the exchange ratio in order to lock-in the value of the spread.
Investing in Merger Arbitrage
Typically, the stock price of the target company trades at a slight discount to the acquisition price following the announcement of the deal. The discount, or spread, exists because of deal closing probability or uncertainty and market inefficiencies. Subsequently, the arbitrageur looks to purchase shares in the target having forecasted a successful conclusion to the merger. As the deal moves towards a successful close, the spread narrows and the arbitrageur makes a profit.
A trader can invest using a merger arbitrage strategy by trading the underlying stock but advanced strategies can also be constructed using options such as calls and puts. Despite liquidity often being a limiting factor in this strategy, additional profitability is possible for traders who understand and are willing to accept the risk. Debt instruments such as bond can also be used although this requires an even greater level of market knowledge.
Merger Arbitrage Limited provides data in many key deals with our merger factsheet pages. These list vital deal particulars such as expected completion data and offer price as well as a specialized news feed relating to the deal. There are separate page for pending, pre-offer, closed & failed mergers and acquisitions. For an example, see our Tiffany & Co. (TIF) factsheet regarding the takeover by LVMH.
Additional Merger Arbitrage Resources
A current list of pending merger arbitrage spreads is available on our merger arbitrage spread list page. We also provide weekly commentary and analysis. Use the menu bar above to explore our full range of services.
Additional services offered by Merger Arbitrage Limited include our extensive M&A focused investment Glossary and our investment and finance book list. For some high brow reading, we also have a uniquely curated list of academic works on merger arbitrage and M&A. Many papers are referenced throughout the site. For those who don’t have time for much reading, check out our movie list of the best finance films.
