TSEM - Microsoft-Activision Deal And 20 Other Opportunities In Merger Arbitrage Space

Summary

• Merger arbitrage spreads are wide.
• There are plenty of opportunities with spreads of up to 81%.
• This is a detailed review of the most interesting transactions in the space.

Merger arbitrage is an event-driven investment strategy of betting on a successful acquisition of a publicly-listed company. 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.

Overall, merger arbitrage situations are among my favorite special situation strategies given that they:

• have a short timeline, allowing for high annualized returns.
• are generally uncorrelated with the broader market, thus presenting a way to diversify an investor's portfolio, particularly in a worsening macroeconomic environment.
• have a binary outcome which allows to more easily quantify the odds of a favorable outcome.

Below I present 21 merger arbs with the widest spreads currently available on the market. The list includes my analysis on each situation and the reasons for the wide spread. Additionally, you will find a downloadable PDF of all these merger arbs.

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. 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 ATVI (29% spread) and SAVE (55%).

Activision Blizzard ( ATVI )

• Buyer: Microsoft ( MSFT )
• Consideration: $95/share
• Spread: 29%
• Exp. Closing: H1'23
• Main Risk: antitrust approval.

Microsoft is acquiring game developer Activision – its largest acquisition so far. Shareholder approval has already been received. The deal would turn the combined company into the world's third-largest game developer as well as allow Microsoft to expand into the mobile gaming segment. The spread mainly exists due to regulatory concerns that the merger will hurt the competition in the console gaming industry as Microsoft might start offering Activision Blizzard gaming franchises only to Xbox console owners – similarly to what it did after acquiring Bethesda in 2021. Last month, the FTC sued to block the transaction. UK and European antitrust watchdogs, among others, have also started their inquiries into the transaction. The EU Commission and UK's CMA have both extended their deadline for a ruling until Apr'23.

In response to antitrust claims, Microsoft has provided several counter-arguments:

• Microsoft remains a distant third player in the console market behind Sony (SONY) and Nintendo (NTDOY). Among the three console makers, Xbox has captured 16% of the market in 2021 (by units sold) compared to 50% for Nintendo and 34 for PlayStation. Microsoft has stated that Xbox has far fewer popular exclusive games than either of the two competitors.
• The buyer has also stated it currently has little presence in the mobile gaming segment. Xbox's share of global mobile gaming revenues stood at only 0.3% in 2021. Worth noting that the mobile gaming segment is currently the fastest-growing niche of the market.
• Finally, MSFT has suggested that any potential game exclusivity to Xbox would harm the company's revenues, thus fundamentally not making sense for the buyer, particularly considering potential reputational hit to Xbox.

To alleviate antitrust concerns, MSFT has offered 10-year game access deals to largest gaming console competitors Sony and Nintendo. While Nintendo has accepted MSFT's deal, Sony has remained skeptical of the transaction. Other concerns have revolved around potential labor issues. In Mar'22, several senators sent a letter to the FTC, arguing it would have an anticompetitive impact on labor. However, in mid-2022 a major labor union expressed its support for the merger after reaching an agreement with Microsoft.

Warren Buffett's Berkshire 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. Buffett doesn’t play merger arbitrage that often anymore and he is also very close friends with Bill Gates. Therefore, Berkshire’s involvement here is quite reassuring. The downside is also somewhat mitigated by a large break fee payable of $2.5bn by Microsoft - around 4% of ATVI's market cap. If the deal does not close by April 18, the break fee would increase to $3bn or 5% of ATVI's market cap.

Spirit Airlines ( SAVE )

• Buyers: JetBlue Airways ( JBLU )
• Consideration: $31/share
• Spread: 55%
• Exp. Closing: H1'24
• Main risk: regulatory approval.

Merger in the airline industry - JBLU is acquiring SAVE. The consideration is $31/share. Moreover, the acquisition involves a ticking fee of $0.10 per month starting from January 2023 till the transaction closes. This is expected to add an additional $1.20-$1.80 to the total consideration depending on when the merger closes.

The current spread is primarily due to antitrust concerns. The merger would create the fifth largest company in the airline industry which the Biden administration has distinguished as lacking competition. In September, Senator Elizabeth Warren sent a letter to the regulators, pushing for tight scrutiny of the merger. The regulator DOJ has issued a second request and is currently reviewing the transaction. While a prolonged and detailed regulatory probe is likely, there are several arguments in support of a regulatory approval:

• JBLU has claimed that increased scale would allow it to lower fares, leading to increased competition with the four largest carriers controlling more than 80% of the market. The combined company would have a 9% market share which compares to 23% for the largest industry player.
• The overlap between the companies is rather low at 11% for nonstop routes in 2021. Meanwhile, the combined JBLU-SAVE seat share would not exceed 40% in any of the largest metro areas - this contrasts with above 50% seat share (reaching as much as 91%) for the other four legacy carriers.

To help alleviate antitrust concerns, the buyer has proposed divestitures in overlapping areas, primarily in Northeastern airports.

Another DOJ concern relates to JBLU's Northeast Alliance partnership (referred to as NEA) with American Airlines. The partnership agreement involved coordinating schedules (not airfares) as well as allowing companies to sell each other's flights and combine loyalty benefits. DOJ as well as several states have claimed that the partnership will cost consumers $700m per year due to higher fares. In October, a motion to dismiss the DOJ case against NEA was denied. Now the decision comes down to the judge's reading of antitrust law which could significantly delay the decision. Hence, SAVE-JBLU merger outcome might also depend on the outcome of NEA trial.

Interesting Smaller-Cap Merger Arbs

Given higher market efficiency in larger-cap merger arbs, my primary focus is on smaller-size setups. Some of the more attractive smaller-cap transactions currently available include YI with 24% spread, GSMG with 21% and OIIM with 10%.

111 ( YI )

• Buyer: Management
• Consideration: $3.61/share
• Spread: 24%
• Exp. Closing: TBD
• Main Risk: Non-binding 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 higher chances of closing. If the privatization fails YI might have problems in meeting its redemption liabilities. Special committee is still reviewing the offer. In December, the spread temporarily closed - likely driven by China relaxing its COVID-zero policies - before widening above 20% again.

Glory Star New Media Group ( GSMG )

• Buyer: Management
• Consideration: $1.55/share
• Spread: 21%
• Exp. Closing: Q1'23
• Main Risk: Chinese company and material downside.

US-listed Chinese company privatization by the management. The spread hovered at less than 5% since shareholder approval in Sep'22 only to widen to as much as 21% recently. The spread increase might be explained by the market getting increasingly anxious due to lack of any disclosures and updates from the company as the previously stated closing deadline has passed. However, such price swings in Chinese US-listed privatizations are not that uncommon even shortly before transactions are completed. Major shareholder US hedge fund Shah Capital is rolling its 11% stake. The downside, nonetheless, is very material at over 30%.

O2Micro International ( OIIM )

• Buyer: Forebright Capital Management
• Consideration: $4.93/share
• Spread: 10%
• Exp. Closing: Q1'23
• Main Risk: Chinese privatization.

This is a US-listed 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 - that increases the chances of a successful closing. Another reason for the spread might be potential CFIUS review. However, this is unlikely to be an issue given that the regulatory body has been silent so far whereas OIIM has almost zero revenues in the US, with majority of the staff in China and Taiwan.

Other Merger Arbs With Wide Spreads

Digital Media Solutions ( DMS )

• Buyer: Management
• Consideration: $2.50/share
• Spread: 81%
• 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. The market, however, remains skeptical of buyers' intentions and the spread has been gradually widening from 13% to over 80%. This increase seems to be driven by limited updates since the announcement. The offer by the management is a result of a year-long strategic review, which doesn't add credibility either (management was unable to sell the business).

Silicon Motion Technology ( SIMO )

• Buyer: MaxLinear ( MXL )
• Consideration: $93.54 + 0.388 MXL stock
• Spread: 65%
• 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. This month 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. The buyer's management has recently reiterated confidence in successful transaction closing by mid-2023.

Columbia Care ( CCHWF )

• Buyer: Cresco Labs ( OTCQX:CRLBF )
• Consideration: 0.5579 CRLBF stock
• Spread: 46%
• Exp. Closing: Q1'23
• Main Risk: potential dilution to the consideration due to certain earn-out provisions and the buyer walking away.

Consolidation of two major US cannabis companies. The merger has received 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. This has raised the risk of total proceeds from divestitures not reaching the targeted $300m. The market seems to think that both sides will be unable to complete the divestitures. 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 0.5202 and reduce the spread to 29%.

Black Knight ( BKI )

• Buyer: Intercontinental Exchange ( ICE )
• Consideration: $68 + 0.144 ICE stock
• Spread: 43%
• 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 mortgage origination/servicing software. Shareholders have already approved the merger. However, Community Home Lenders Association has called regulators to block the transaction over antitrust concerns saying that the combined company will have too much pricing power in the small/mid mortgage banking sector. The companies each hold dominant market shares in specific US mortgage software segments - servicing ( BKI ) and origination ( ICE ) - suggesting the merger will lead to substantial vertical integration. In November, ICE agreed to an extended FTC review while reiterating confidence in successful closing. Since then, however, a congresswoman came out, urging the FTC to tightly scrutinize the transaction.

iRobot Corporation ( IRBT )

• Buyer: Amazon.com ( AMZN )
• Consideration: $61/share
• Spread: 31%
• Exp. Closing: 2023
• Main Risk: regulatory approval.

Amazon is scooping up robot vacuum cleaner maker iRobot. The spread has widened from minimal levels upon announcement to over 20% as market started pricing in higher likelihood of regulatory hurdles. The companies have received second requests from the FTC. Moreover, several senators have been pushing the antitrust regulator to block the transaction. A non-profit watchdog has also suggested the UK's CMA should launch an investigation into the transaction. Opposition's concerns revolve around potential privacy infringements and Amazon's history of anti-competitive acquisitions. IRBT is currently trading below pre-announcement levels, displaying the market's skepticism.

Albertsons Companies ( ACI )

• Buyers: The Kroger Co. ( KR )
• Consideration: $27.25/share;
• Spread: 30%
• Exp. Closing: Q1'24
• Main risk: regulatory approval.

Merger of two grocery retailers coming after ACI announced strategic alternatives in 2022. The acquisition is expected to significantly increase scale, and reduce costs. The transaction is also synergistic from a 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. 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. Moreover, as part of the merger agreement, ACI agreed to pay a $6.85/share special dividend to its shareholders. The dividend, however, will be distributed only to ACI shareholders as of October 24, 2022.

Tower Semiconductor ( TSEM )

• Buyer: Intel ( INTC )
• Consideration: $53/share
• Spread: 22%
• Exp. Closing: 2023
• 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 been increasing 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.

TEGNA ( TGNA )

• Buyer: Standard General
• Consideration: $24/share + $0.15/share
• Spread: 21%
• Exp. Closing: Q1'23
• 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. To appease the regulators, TGNA has recently offered to waive certain contractual rights, allowing cable companies to negotiate retransmission consent agreements. Last week, however, a prominent senator came out, arguing that the concessions are not sufficient and the FTC should block the merger given its potential impact on competition. Having said that, analysis of TGNA and Cox Media's US household coverage suggests that the combined company would still be within the limits of FCC ownership rules, whereas the merger will not affect competition. Another positive here is that telecom regulators noted they have no objections to the merger. Both FCC and DOJ reviews are ongoing. Merger end date has been extended till Feb'23.

F-star Therapeutics ( FSTX )

• Buyer: Sino Biopharmaceutical ( OTCPK:SBMFF )
• Consideration: $7.12/share
• Spread: 19%
• Exp. Closing: Q1'23
• Main Risk: regulatory approval and large downside.

This is a small biopharma acquisition by a large Chinese pharmaceutical conglomerate. The merger has faced regulatory scrutiny from the US regulator CFIUS. Last month, the US watchdog issued an interim order to block the transaction. The regulator's decision is intended to give it more time to investigate the merger. Such regulatory concerns are quite unusual given this is a tiny acquisition of an oncology treatment developer with a very early-stage pipeline. Both parties have thus far seemed determined to pursue the transaction, with several extensions of the termination date. The deadline is now set for January 31. Downside to pre-announcement prices is very steep, which also partially explains the spread.

ForgeRock ( FORG )

• Buyer: Thoma Bravo
• Consideration: $23.25/share
• Spread: 17%
• Exp. Closing: H1'23
• Main Risk: regulatory approval.

FORG is getting acquired by PE firm Thoma Bravo. Target's shareholders have already approved the transaction. The main risk is regulatory approval due to increasing market concentration in the identity access management (IAM) software space. The transaction follows Thoma Bravo acquiring two other players in the IAM software industry, including one of FORG's direct peers. In December, both sides received a second request from the DOJ. Interestingly, after agreeing to a deal with Thoma Bravo, FORG was approached by a potential strategic suitor, suggesting the downside might potentially be limited in case of a deal break.

VMware ( VMW )

• Buyer: Broadcom ( AVGO )
• Consideration: $71.25 + 0.126 AVGO stock
• Spread: 15%
• Exp. Closing: Oct'23
• Main Risk: long timeline/regulatory review.

This is a mammoth $61bn deal, giving Broadcom a push into the software industry. In December, the European Commission launched a detailed probe into the merger, with the deadline set for May'23. Among the main sticking points is reduced competition for particular hardware components used with WMV's software. The FTC is likewise scrutinizing the merger. Broadcom's CEO has noted that regulatory filings have so far seen good progress in numerous other geographies. The buyer's management expects the deal to close by Oct'23.

IAA ( IAA )

• Buyer: Ritchie Bros. Auctioneers ( RBA )
• Consideration: $10/share + 0.5804 RBA stock
• Spread: 12%
• Exp. Closing: H1'23
• Main Risk: shareholder approval.

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