GSMG - Amazon-iRobot And 16 Other Opportunities In Merger Arbitrage Space

2023-04-03 16:41:21 ET

Summary

• Merger arbitrage spreads are wide.
• There are plenty of opportunities with spreads of up to 118%.
• This is a review of the most interesting transactions in the merger arbitrage space.

Merger arbitrage is an event-driven investment strategy of betting on a successful acquisition of a publicly-listed company. Generally, from the time a merger is announced until closing, there's some uncertainty whether the transaction will close successfully. The spread between the target company's trading price and the offer price is generally supposed to reflect the risk/uncertainty the market sees in the transaction. I find that quite often (especially in smaller cap deals) the market is mispricing those risks, which creates attractive investment opportunities.

Merger arbitrage is among my favorite investment strategies. Why? Well, merger arb attractiveness stems from the fact that they:

• Have a binary outcome and offer pre-defined return/downside. This allows to more easily quantify the odds a favorable outcome.
• Are uncorrelated with the general market, thus presenting a way for investors to diversify their portfolios.
• Have a relatively short timeline, allowing for high annualized returns.

Below I present 17 merger arbs with the widest spreads currently available on the market. The list includes my quick takes on each situation and reasons for the spreads. Additionally, you will find a downloadable PDF of all these merger arbs.

Which of these arbs do I find the most interesting? Generally, I am much more intrigued by smaller-cap M&A transactions given that they are significantly less followed/covered and offer a higher probability of finding an edge against the market. YI (37% spread) and TCRR (9%) - both of which were previously highlighted to Special Situation Investing subscribers - come to mind as some of the more interesting currently actionable small-cap merger arbs at the moment. 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, such as IRBT (42%).

iRobot Corporation (NASDAQ: IRBT )

• Buyer: Amazon.com (NASDAQ: AMZN )
• Consideration: $61/share
• Spread: 42%
• Exp. Closing: Aug’23
• Main Risk: Regulatory approval.

Amazon is scooping up robot vacuum cleaner maker iRobot for $1.7bn. IRBT’s equity holders have already approved the transaction. The merger would expand Amazon’s portfolio of smart home devices. Merger spread has widened from minimal levels upon the transaction announcement to over 40% in recent months due to regulatory hurdles and a potentially prolonged closing timeline. The companies have received second requests from the FTC. Several senators, including Elizabeth Warren, have been pushing the regulator to block the transaction. Recent media reports suggest that the antitrust regulator is likely to file a lawsuit against the transaction in the next few months. The deal has also raised antitrust concerns internationally. The European Commission is rumored to launch a formal probe into the merger shortly. Meanwhile, a non-profit tech watchdog group Foxglove Legal has also urged the UK's CMA should initiate an investigation into the transaction.

Opposition’s concerns have been revolving around potential privacy infringements given that Amazon already possesses vast amounts of consumer data through its IoT devices, such as Alexa and Ring. Moreover, the lawmakers have claimed the merger would allow Amazon to dominate the North American smart vacuum cleaner market where iRobot currently is the clear leader with a 75% market share. The opposition has highlighted Amazon’s history of anti-competitive acquisitions. For instance, after acquiring smart doorbell provider Ring in 2018, the tech giant has crushed its competitors in the smart doorbell industry, selling more than the four next largest competitors combined.

While this merger arb is risky, a couple of arguments suggest the transaction might have a higher chance of closing than implied by the current IRBT share price. Firstly, Amazon and iRobot have limited horizontal overlap as the tech giant currently has no presence in the smart vacuum cleaner market. In 2021, Amazon introduced its home robot Astro, however, the product does not offer a vacuum cleaning function, moreover, since the introduction Astro has only been shipped in very low quantities and has remained a niche product given its high price tag. This implies that the merger would not directly impact iRobot’s market share in the smart vacuum cleaner industry.

Secondly, the merger seems unlikely to be blocked on privacy infringement grounds given a lack of such precedent based on analysis of historical DOJ and FTC’s rulings. Moreover, iRobot’s devices have only basic sensor mapping and thus are unlikely to materially infringe any data privacy. Worth noting that Amazon’s recent acquisition of primary care provider One Medical, despite similar data privacy concerns , closed successfully.

Thirdly, eventual regulatory approval might be likely given other successfully closed transactions involving Big Tech acquirers. Google’s $2.1bn acquisition of Fitbit (announced in Nov’19 and completed in Jan’21) is perhaps the most comparable Big Tech merger to the Amazon-iRobot deal. While the transaction admittedly occurred in a more lenient regulatory environment, it allowed the search engine giant to get access to Fitbit’s user data. Amid a prolonged regulatory probe involving the EU and US regulators, the merger closed after Google came to terms on concessions with the European Commission. The transaction closed successfully despite concerns about Google’s history of data protection and privacy violations. While not as dominant as iRobot in the smart vacuum space, Fitbit was the second largest player in the North American wearable band market as of Q2’19, capturing a 24% share. Another recent merger involving a Big Tech acquirer was Meta’s acquisition of VR content maker Within Unlimited. In mid-2022, the FTC sued to block the merger due to its anti-competitive effects, however, the judge eventually ruled in favor of the transaction and the deal subsequently closed.

Vertical integration is likely to remain a sticking point in the eyes of the regulators. Amazon might potentially restrict iRobot’s sales to its own marketplace. Moreover, the e-commerce giant could strategically sell iRobot’s devices through Amazon Prime and/or integrate the devices with Alexa. However, so far the precedent of mergers blocked by the FTC on vertical integration grounds is limited to only a couple of transactions, including Lockheed Martin-Aerojet Rocketdyne and Nvidia-Arm. Worth highlighting that these transactions were larger and occurred in strategically much more sensitive defense and semiconductor industries.

IRBT is already trading significantly below pre-announcement levels, highlighting the market’s skepticism. Still, there might be further downside in case of a deal-break here given that IRBT has missed revenue/earnings estimates in the last two quarterly earnings releases. IRBT’s revenues declined 24% in full-year 2022 driven by lower orders from retailers and distributors in NA and EMEA as a result of post-COVID demand normalization. The business burned $286m in operating income or 24% of its market cap in 2022 (vs break-even in 2021 and $146m operating profit in 2020). However, in Feb’23, i.e. after the release of IRBT’s annual results, Amazon noted that it is in talks with the regulators, suggesting the tech giant is still pursuing the acquisition. In case of a deal-break, IRBT would receive a quite hefty $94m termination fee (8% of the current market cap).

Glory Star New Media Group ( GSMG )

• Buyer: Management
• Consideration: $1.55/share
• Spread: 118%
• Exp. Closing: TBD
• Main Risk: Privatization offer withdrawal.

US-listed Chinese company privatization by the management. Major shareholder US hedge fund Shah Capital is rolling its 11% stake. The spread hovered at less than 5% since shareholder approval in Sep'22 as the market expected a prompt merger closing. More than half a year later, the merger is still pending, meanwhile, management did not provide any explanation for why it is taking so long. This scared investors and the spread gradually widened to above 100%. With the recent annual results release, the company did not provide any updates on the transaction, noting that the privatization is “yet to be consummated”. The market clearly does not believe the merger will close as the stock currently trades below pre-announcement levels. While historically US-listed Chinese privatizations in definitive agreement stage have had a very high closing rate, such a prolonged lag indicates a strongly elevated merger break risk. The only two failed US-listed definitive-stage Chinese privatizations - SVA and CXDC - were canceled 13 and 11 months after the definitive agreement was signed.

Spirit Airlines ( SAVE )

• Buyers: JetBlue Airways ( JBLU )
• Consideration: $31/share + $0.1 per month
• Spread: 81%
• Exp. Closing: H1’24
• Main risk: Regulatory approval.

This is an airline merger with numerous complications on the regulatory front. The current spread exists mainly due to antitrust concerns. Last month, the DOJ filed a lawsuit against the merger, arguing it would be adverse to consumer prices and competition. Another DOJ concern relates to JBLU's Northeast Alliance partnership ((NEA)) with American Airlines where the litigation is currently ongoing and might impact the ongoing merger. In response, SAVE and JBLU have argued that the merger would increase competition to the four legacy carriers in the US and, to alleviate antitrust concerns, JBLU has proposed divestitures in overlapping areas. Moreover, both companies have recently reached agreements with pilots unions. So far, however, the offered concessions have clearly not appeased the regulators. The DOJ’s trial hearing date has been scheduled for October 16. The judge stated that he expects an expeditious trial, with a potential ruling by year-end - this should leave time for the merger parties to pursue an appeal against the potential unfavorable judicial ruling.

Columbia Care ( OTCQX:CCHWF )

• Buyer: Cresco Labs ( OTCQX:CRLBF )
• Consideration: 0.5579 CRLBF stock
• Spread: 62%
• Exp. Closing: Q2’23
• Main Risk: Merger termination.

Consolidation of two major US cannabis companies. The merger has received CCHWF’s shareholder approval. Some asset divestitures required by the regulators have already been announced. The spread, however, has recently widened given failed attempts to pass the federal marijuana banking legislation which has made a big negative impact on the sector's short-term outlook. The market seems to think that both sides will be unable to complete the required divestitures and reach the targeted $300m in proceeds. Both companies still seem to be interested in closing the merger as indicated by the recently extended outside date from Mar’23 to Jun’23. Also, the merger exchange ratio is subject to proration adjustment by the amount of Columbia Care shares issued as an earn-out for its historical acquisition from Dec’20. Information on the earn-out is limited but the maximum stated size is $58m in CCHW shares. At current prices, the maximum earn-out would lower the exchange rate to 0.5083 and reduce the spread to 48%.

Silicon Motion Technology ( SIMO )

• Buyer: MaxLinear ( MXL )
• Consideration: $93.54 + 0.388 MXL stock
• Spread: 62%
• Exp. Closing: Q2’23 - Q3’23
• 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. Approval from China's regulators is the main hurdle. 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, but have now re-filed under a normal procedure as advised by Chinese regulators. The documents have been accepted and regulatory review is underway. MXL has reportedly reached out to third parties to facilitate approval from the Chinese regulator. In Feb’23, the buyer's management reiterated optimism in successful transaction closing by mid-2023. Recently, one of SIMO's rivals hinted that the SIMO-MXL merger is close to receiving approval from the Chinese regulators.

Infinity Pharmaceuticals ( INFI )

• Buyer: MEI Pharma ( MEIP )
• Consideration: 1.0449 MEIP
• Spread: 60%
• Exp. Closing: mid-2023
• Main Risk: Buyer’s shareholder approval condition.

This is a tiny all-stock merger between two biopharmas. Merger spread used to stand at minimal levels before widening to 60% since early March. This seems to have been driven by the risk of MEIP’s shareholder opposition as the buyer seems to be getting the deal at quite unfavorable terms. This is also indicated by MEIP’s share price falling 20% upon the announcement. As part of the transaction, the buyer is required to keep $80m in net cash vs $4m for INFI while giving away a 42% ownership of the combined entity to INFI’s equity holders. MEIP would add INFI’s phase 2 drug candidate to its early-stage pipeline. If the buyer’s shareholders reject the deal, there could be a chance for a liquidation where the company might be worth materially above current share price levels.

TEGNA ( TGNA )

• Buyer: Standard General
• Consideration: $24/share + $0.15/share
• Spread: 44%
• Exp. Closing: Q2’23
• Main Risk: Regulatory approval.

Broadcasting media company TEGNA is getting acquired by a consortium of buyers which includes Standard General, Apollo and Cox Media. The consideration is $24 per TGNA share plus a small ticking fee of $0.15/share. Various industry players and unions have voiced their concerns that combined TGNA/Cox Media will control too much of the market share (39% of U.S. TV households). Other concerns include potential staff reductions, lower local news coverage and renegotiation of retransmission fees. Despite SG’s proposed concessions, the merger has recently received a significant blow from the FCC with the case now going to the administrative court. Standard General has harshly criticized the decision and in turn sued the regulator arguing the decision to halt the merger was unprecedented and illegal. However, based on the historical perspective, the risk of the deal getting killed has increased substantially. This is also reflected by the spread widening from teen levels to over 40%. Merger end date is set for May’23 after which either party can walk away from the deal without penalty.

First Horizon ( FHN )

• Buyer: Toronto-Dominion Bank ( TD )
• Consideration: $25/share
• Spread: 42%
• Exp. Closing: H1’23
• Main Risk: Regulatory approvals.

Largest Canadian bank is acquiring a US peer. The merger would make TD’s US franchise the sixth largest bank in the United States. Target's shareholder approval has already been received. The current spread is explained by the risks of regulatory approvals in the US and Canada as well as the potential downward merger consideration adjustment. In mid-2022, a prominent senator sent a letter to the regulator OCC, urging it to block the transaction over concerns about TD’s history of customer abuse. Despite the pushback, merger spread gradually narrowed to low-single-digit levels only to widen to 20% in March on the news that the parties will not be able to receive regulatory approvals by the outside date of May’23. The spread increased further to over 40% amid the subsequent SVB fallout. The current spread also reflects the risk of a downward price adjustment given that US bank indices are down significantly since the merger agreement was signed. The buyer’s management has mentioned that negotiations regarding a merger consideration adjustment are ongoing. TD has remained committed to closing the transaction and the parties are in discussions to extend the outside date.

111 ( YI )

• Buyer: Management
• Consideration: $3.61/share
• Spread: 37%
• Exp. Closing: TBD
• Main Risk: Privatization offer withdrawal.

Chinese pharmaceuticals distributor YI is getting taken private by management (92% voting power, 44% economic interest). Merger consideration is $3.61/share after deducting ADS fees. Special committee is still reviewing the offer. Chinese non-binding privatization offers are inherently risky. However, 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. The privatization seems to have a quite strong rationale behind it as YI is seeking a listing on the Shanghai STAR Market and delisting from the US seems like a necessary step toward this process. YI would be forced to redeem equity interests of post-IPO investor if the STAR listing is not achieved by Jun’23. The company has explicitly noted it may not have the needed liquidity if the redemptions are triggered. The spread has been widening in recent months, likely driven by investors’ increasing uncertainty on whether the privatization offer is still on the table as the deadline for achieving the Chinese listing approaches.

Black Knight ( BKI )

• Buyer: Intercontinental Exchange ( ICE )
• Consideration: $68 + 0.0682 ICE stock
• Spread: 32%
• 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. Both companies each hold dominant market shares in specific US mortgage software segments - servicing ( BKI ) and origination ( ICE ). The FTC recently filed a lawsuit to block the merger due to potentially lower competition in the loan origination software industry as well as in the pricing and eligibility engine (PPE) software market where BKI and ICE hold dominant positions. The regulatory pushback came despite the fact that merger parties recently agreed to divest BKI’s loan origination software business. The buyer has remained confident in a successful litigation outcome. Along with the recent entry into a divestiture agreement, the companies have agreed to revise down the stock part of the merger consideration from 0.144 ICE to 0.0682.

Albertsons Companies ( ACI )

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

Merger of two grocery store chains coming after ACI announced strategic alternatives in 2022. The transaction is synergistic from a geographical perspective - management states that ACI operates in several parts of the country with very few or no Kroger stores. The main risk is antitrust approvals as the merger would combine the two biggest supermarket companies in the country. US senators as well as a couple of farmer/consumer groups have raised anticompetitive concerns to the FTC. The buyer KR has already received a second request from the antitrust watchdog FTC. However, both sides are confident of circumventing the regulatory hurdles with proposed divestitures of a large number of stores. The companies have recently started to look for potential buyers of stores in overlapping areas.

T ower Semiconductor ( TSEM )

• Buyer: Intel ( INTC )
• Consideration: $53/share
• Spread: 25%
• Exp. Closing: H1’23
• Main Risk: Regulatory approval.

This is a cross-border acquisition in the semiconductor space - Intel is acquiring Tower Semiconductor. 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 the Chinese regulator SAMR, which has increased scrutiny over the merger in the strategically important semiconductor space. For the same reason, there is also 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. Recently, reports appeared that Intel expects the transaction to close in H1’23.

VMware ( VMW )

• Buyer: Broadcom ( AVGO )
• Consideration: $71.25 + 0.126 AVGO stock
• Spread: 21%
• Exp. Closing: Oct’23
• Main Risk: Long timeline/regulatory review.

This is a mammoth $61bn deal, giving Broadcom a push into the software industry. The European Commission has launched a probe into the deal and the merger parties are expected to receive an antitrust warning shortly. The FTC and the UK’s CMA have likewise started their inquiries into the transaction. Among the main sticking points is reduced competition for particular hardware components used with VMW's visualization software. The merger has already received regulatory clearance in a number of geographies, including Brazil, Canada and South Africa. The buyer's management expects the deal to close by Oct'23.

Seagen ( SGEN )

• Buyer: Pfizer ( PFE )
• Consideration: $229/share
• Spread: 13%
• Exp. Closing: 2023-2024
• Main Risk: Antitrust approval.

This is the largest merger so far this year. SGEN’s shareholder approval seems likely given a massive premium to pre-announcement levels. The current spread seems to exist due to the likely scrutiny from antitrust regulators and a prolonged closing timeline. The transaction would give Pfizer a leading position in cancer treatment space where the company already owns a sizable portfolio of drugs. This might increase the combined company’s power to negotiate with insurers. Industry analysts have noted that divestitures in some areas, such as bladder cancer treatment, might be needed. Pfizer’s CEO is confident of a successful transaction closing. The merger is expected to close in late 2023-early 2024.

ForgeRock ( FORG )

• Buyer: Thoma Bravo
• Consideration: $23.25/share
• Spread: 12%
• Exp. Closing: TBD
• Main Risk: Regulatory approval.

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