Summary
- iRobot is now trading at a lucrative discount to its agreed sale price with Amazon.
- Potential negative earnings surprises and recession in 2023, in addition to Amazon having the cash to complete the merger, makes the stock even more attractive now.
- A big risk is that regulatory scrutiny delays the close of the acquisition.
The spread of the Amazon (AMZN)-iRobot merger has increased significantly since the announcement of the merger, finally offering investors a lucrative opportunity to include iRobot Corporation ( IRBT ) in a merger arb portfolio. I've previously discussed why investors should avoid the stock , but at a spread of 20%, IRBT is finally worth a shot as part of a merger arb portfolio.
Why iRobot Was Initially A Bad Merger Arb
I argued at the previous article dated Sep. 26 that the spread of 5.5% on the deal was too small for investors to buy IRBT. I felt this was especially true since approval was likely to drag on, given regulators are likely to have a closer look on the impact of the deal on the robotic vacuums market.
I argued that the deal would likely take more than a year to close. The reasons were: 1) Amazon could restrict the sales of iRobot's Roomba, the market leader, on other platforms. 2) could hurt competitors by increasing demand from suppliers, indirectly raising prices of producing robotic vacuums. 3) Roomba gives Amazon new sets of consumer data that could prompt regulators to look into privacy concerns related to the deal. I used the acquisition of Fitbit by Alphabet Inc. ( GOOGL ) as a barometer of how long it would take for Amazon to close the deal and concluded that the 14 months it took to close the Fitbit deal could be a good estimate for the iRobot deal. At a 5.5% spread at the time, I felt the market offered better merger arbitrage alternatives .
Why iRobot is Now a Buy
Well, the most obvious change is the passage of time. It has been more than two months since I wrote the first article, and by definition it means the deal will take less time to close than in the previous article, improving the ARR.
Secondly, IRBT has essentially retraced the entire move it made following the announcement. IRBT closed at $49.99 on Aug. 4, before jumping to $59.54 a day later following the announcement. The company is now trading at $50.17, only 18 cents higher than the pre-announcement level. At an agreed price of $61 a share, iRobot now offers a return of 21.5%, a strong return regardless of market conditions. But it is even more attractive given fears over 2023 earnings and a weakening consumer . Merger Arbs are terrific vehicles for investors to park cash during difficult market environment. A reflection of this is the performance of IQ Merger Arbitrage ETF ( MNA ). The ETF, while trounced by the S&P 500 since inception in late 2009, has beaten the index on every 20%+ drawdown according to my calculation. This shows that merger arbs are a good place to hide away from volatility. IRBT in particular is one of the better opportunities given the combination of high return and credit worthiness of the acquirer.
The Risks That Remain with The Amazon-iRobot Merger
The FTC's decision to try and block Microsoft Inc. ( MSFT ) acquisition of Activision Blizzard Inc. ( ATVI ) should serve as a warning for investors that the regulatory environment is generally hostile when it comes to mergers and acquisitions. The Microsoft-Activision deal, as I wrote before , has less regulatory concerns compared to Amazon-iRobot. This makes it highly likely in my view that the iRobot merger receives some regulatory scrutiny. I still believe both the Activision and iRobot deals will close as the FTC will find it difficult to prove that Microsoft and Amazon have the means and motives to harm competition if they close those deals.
An interesting observation is that the FTC statement focused its case on the potential for Microsoft to engage in self-preferencing policies, rather than other regulatory concerns like the use of data for instance:
In a complaint issued today, the FTC pointed to Microsoft's record of acquiring and using valuable gaming content to suppress competition from rival consoles, including its acquisition of ZeniMax, parent company of Bethesda Softworks (a well-known game developer). Microsoft decided to make several of Bethesda's titles including Starfield and Redfall Microsoft exclusives despite assurances it had given to European antitrust authorities that it had no incentive to withhold games from rival consoles.
As I mentioned in the previous iRobot article, Amazon is particularly infamous for engaging in self-preferencing:
Given Amazon's history of self-preferencing, regulators will be looking closely to see how the merger will affect competition in the robotic vacuum market. I've mentioned the possibility of including iRobot as part of Prime subscription, regulators will want to see if such a possibility is an unfair advantage that iRobot gets as a result of the merger. They will also be looking to see if Amazon can use its position as an e-commerce behemoth to disadvantage competing products on its platform. Regulators could challenge the merger if they feel they can prove Amazon will disadvantage competitors if it merges with iRobot. Unfortunately for the latter, not only has Amazon engaged in self-preferencing practices, it is also criticizing laws that attempt to reign in those practices.
Even if I am right and the deal does close, the added regulatory scrutiny could extend the time it takes for the deal to close, lowering the ARR in the process.
Conclusion
While the regulatory concerns over the Amazon-iRobot remain (they might have even increased following the FTC's decision to block Microsoft's acquisition of Activision Blizzard), the spread on the deal have expanded enough to justify including it in a merger arb portfolio. The combination of a potential recession next year and the credit worthiness of Amazon makes IRBT an interesting opportunity for investors who want to earn a good return during a much-dreaded recession in 2023, or at least a place to avoid volatility during that time. There is a risk however that the deal drags on due to regulatory concerns, lowering the ARR in the process.
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iRobot Is Now A Compelling Buy