Merger Arb: Getting Your Stick to Where the Puck Will Be

hockeyThis spring and summer’s excitement over Valeant and Allergan, and the former’s desire to acquire the latter, fed a broader trend: the day of the merger arb is upon us in earnest.

You’ll remember that at least some of the dust in that dust-up had cleared by August 27th, when Valeant and its ally, Pershing Square[V/PS], won an important point in the Delaware Chancery. Allergan now says that it will hold a special meeting of its shareholders on December 18, 2014.

V/PS hopes to use such a meeting to work around the Allergan board’s resistance to the idea of the acquisition.

Also, in July of this year, Gregg Lemkau, co-head of Global Mergers and Acquisitions in the IB division at Goldman Sachs, said: “It feels like the long-awaited mergers and acquisitions recovery is finally upon us.” Indeed.

Seeing Them Before They’re Here

As any hockey player knows, the goal isn’t to go where the puck is, but to where the puck will be. That’s merger arb, too: and in that spirit, regular readers of AllAboutAlpha are of course familiar with Intralinks, the leading provider of virtual data rooms (VDRs) for merger-related due diligence.

Also, you’re no doubt familiar with Intralinks’ Deal Flow Indicator, because we’ve regularly kept you up to date on the DFI results, which employ Intralinks’ data about early-stage merger and acquisition activity to predict the timing (and the sectoral distribution) of the later stages.

Given the momentum of the alpha-pursuer’s puck, though, I wanted to go a little bit more deeply into how this works, so I spoke recently with Matt Porzio, Intralink’s VP of Strategy and Product Marketing.

The raw data behind DFI includes the quarter-by-quarter variations in the number of VDRs created or proposed to be created. This is critical because companies are generally quite serious about doing a deal by the time they get to the point of creating a VDR, the talk has gone well beyond the point of idle speculation.

The resulting DFI reports involve global numbers and a regional breakdown for North America, Latin America, Asia Pacific & Japan (APJ), Europe, Middle East & Africa (EMEA).

Statistically Reliable

To test the reliability of results, Intralinks has matched their DFI data against the Thomson Reuters deal data from two quarters later. They then retained an independent statistical analysis firm to review the results. The analysts’ regression analysis indicated more than 99% likelihood that DFI is a significantly significant indicator of announced deal data.

Porzio told me that the tightest correlations “are for M&A activity in Europe and North America, even Brazil. For some of the smaller emerging markets, the correlations are less tight.”

Recent reports have indicated increasing activity. Their report on first quarter activity this year indicated that North American activity in particular was up 17% from the same quarter a year before.

That raises the question: why? Are there fundamental reasons or is this a superficial QE-goosed stimulation?

Porzio’s comment on the upward jolt, “In the global economy there are consistent signs of growth and renewal, confirms for example by our sentiment survey.” Merger and acquisition activity “growing gangbusters as it was pre-financial crisis,” but it is growing again.

There is also a monetary factor: cash is plentiful.

There is also the aftermath of that pre-crisis deal making. Porzio said that “private equity operations still need to unwind deals they did in 2005 and ’06.”

Antitrust

We also spoke about antitrust policy. There was a line of thought when President Obama came into office that ran thus: “The new antitrust department will be tougher on mergers than were the Bushies. This will be good for merger arb fund managers, because it will increase the element of risk between the announcement of a deal and its approval, and thus the premium to be won.”

Such arguments may have some validity in the case of the high-end mergers, the ones that really do risk a nix from a political appointee. But, Porzio said: “Only a handful of proposed deals, 50 to 100, ever get beyond the first level of scrutiny [for challenge by antitrust authorities]. It is something that is very important for a few very large deals, but not for M&A activity in the mid-cap markets.”

Food for thought, even for busy traders.

 

 

 

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