business

Mergers Might Be Getting Easier. Here Are the ‘Arb’ Stocks to Watch.

UnitedHealth Group
‘s

$13 billion acquisition of health-tech firm

Change Healthcare

is a go, after a federal judge ruled against the Justice Department’s antitrust challenge to the deal—and there are other merger deals that could get the green light in the months ahead.

Change stock (ticker: CHNG) jumped some 7% this past Tuesday and Wednesday, to $27.21. That’s a hair below the acquisition price of $27.75 per share in cash. The stock had traded largely between $20 and $24 since the deal was struck, reflecting investors’ collective uncertainty about whether or not it would close. UnitedHealth (UNH) struck a deal with Change way back in January 2021 and the Biden administration sued to block the deal in February 2022.

Those who bought change stock betting on the deal eventually closing can soon pocket the difference. It’s an example of a strategy called merger arbitrage, which provides a yield opportunity that is not correlated with the direction of the stock market or interest rates.

Most M&A targets see their share price quickly converge with the buyer’s offer. For example, shares of insurance

Alleghany

(Y) were recently trading at around $842.85 per share, versus the all-cash acquisition price of $848.02 agreed with

Berkshire Hathaway

(BRK.A, BRK.B). That’s a discount of less than 1% to the transaction value.

But when there’s uncertainty surrounding a deal—possibly due to an antitrust challenge, concerns about financing, or major shareholder opposition—the target’s shares may trade at a meaningful discount to the agreed-upon price. It leaves an opportunity for investors willing to take the risk that the deal will close.

Not all those risks are worth taking. The most high-profile merger arbitrage opportunity these days is in

Twitter

(TWTR), which is fighting in court to compel Elon Musk to purchase the social-media company for $54.20 a share, or about $44 billion. Twitter stock was trading at $41.60 on Wednesday, 30% below the deal price.

That’s a tough one to handicap. Musk isn’t your average buyer, and the risk to the stock is substantial should the deal fall through. Since the

Tesla

(TSLA) co-founder publicly disclosed a 9.2% stake in Twitter on April 4, the shares are up 6%—versus a 20% loss for the Nasdaq Composite and declines of 35% and 70% for social media rivals.

Meta Platforms

(META) and

Snap

(SNAP). It’s fair to say that Twitter stock would be a lot lower today if not for Musk’s potential offer.

Target / Ticker Acquirer / Ticker Target Stock Price Deal Price Merger-Arb Yield Deal Value (bil) Deal Type Announcement Date
Spirit Airlines / SAVE JetBlue Airways / JBLU $22.40 $33.50 49.6% $3.8 Cash 7/28/2022
Twitter / TWTR Elon Musk $41.60 $54.20 30.3% $44.0 Cash 4/25/2022
Activision Blizzard / ATVI Microsoft / MSFT $75.04 $95.00 26.6% $68.7 Cash 1/18/2022
Black Knight / BKI Intercontinental Exchange / ICE $67.22 $81.76** 21.6% $13.1 Cash + Stock 5/4/2022
Tower Semiconductor / TSEM Intel / INTC $44.62 $53.00 18.8% $5.4 Cash 2/15/2022
VMWare / VMW Broadcom / AVGO $112.57 $133.37* 18.5% $61.0 Cash + Stock 5/26/2022
Rogers / ROG DuPont / DD $243.91 $277.00 13.6% $5.2 Cash 11/2/2021
Tegna / TGNA Standard General $21.89 $24.00 9.6% $5.4 Cash 2/22/2022
Tenneco / TEN Apollo / APO $18.65 $20.00 7.2% $7.1 Cash 2/23/2022
First Horizon / FHN TD Bank Group / TD $23.48 $25.00 6.5% $13.4 Cash 2/28/2022
PNM Resources / PNM Avangrid / AGR $47.50 $50.30 5.9% $8.3 Cash 10/21/2020
1Life Healthcare / ONEM Amazon / AMZN $17.15 $18.00 5.0% $3.9 Cash 7/21/2022
iRobot / IRBT Amazon / AMZN $58.50 $61.00 4.3% $1.7 Cash 8/5/2022

*Includes $71.25 in cash and 0.126 of a Broadcom share **Includes $68 in cash and 0.144 of an Intercontinental Exchange share

Source: Bloomberg, FactSet

But there are still plenty of targets to look at. Other stocks trading at meaningful discounts to their agreed-upon deal prices include

Tower Semiconductor

(TSEM), due to be acquired by Intel (INTC); Black Knight (BKI), due to be acquired by

Intercontinental Exchange

(ICE);

Tenneco

(TEN), due to be acquired by funds associated with

Apollo

(APO); Rogers (ROG), due to be acquired by

DuPont

(DD); Tegna (TGNA), due to be acquired by Standard General;

First Horizon

(FHN), due to be acquired by

TD Bank

(TD); and

PNM Resources

(PNM, due to be acquired by

Avangrid

(AGR).

Three look particularly interesting. The largest deal waiting for a thumbs up or down from regulators is

Microsoft
‘s

(MSFT) $68.7 billion bid for

Activision Blizzard

(ATVI), valued at $95 a share. That compares with Activision stock’s $75.04 on Wednesday, a discount of almost 27%.

US regulators are looking into the deal and it faces an antitrust probe in the UK Berkshire Hathaway’s Warren Buffett is among the investors betting that the videogame maker’s shares will close the gap. The conglomerate has increased its stake in Activision over the past year, to own some 68 million shares as of the end of the second quarter. Barron’srecommended buying Activision in July.

Other merger-arbitrage opportunities today could include shares of

VMware

(VMW), which has agreed to be acquired by

Broadcom

(AVGO) for about $61 billion. The deal includes both a cash and a stock component: VMware shareholders can elect to receive $142.50 per share in cash, or 0.252 of a Broadcom share—worth about $124.25 on Wednesday. The terms of the transaction specify that about half will be paid in stock and half in cash, meaning that shareholders may not get their preferred allocation, but instead receive a prorated payment.

A 50/50 split would value the deal at about $133.37 per VMware share, or 19% above its recent $112.50. That’s also a bet on Broadcom stock however—should the semiconductor firm’s stock fall more, the expected deal value will decline too.

Another deal that’s facing a potentially lengthy regulatory review is

JetBlue Airways

‘ (JBLU) $3.8 billion bid for a low-cost carrier

Spirit Airlines

(SAVE). That’s valued at $33.50 per share in cash—or almost 50% above Spirit stock’s $22.40. The market appears skeptical that the deal will close. JetBlue shares have also halved since the bidding began.

Others are worth avoiding.

Amazon

(AMZN) has announced a pair of acquisitions this summer: robot vacuum maker

iRobot

(IRBT) and

1Life Healthcare

(ONEM), the parent of healthcare provider One Medical. Big Tech companies in general have been under growing scrutiny from regulators and lawmakers, and the Federal Trade Commission has requested more information from Amazon regarding the One Medical deal. Nonetheless, both targets are trading within 5% of their offer prices.

Of course, investors don’t have to do it all themselves. A number of funds use merger-arbitrage strategies, including the


Arbitrage Fund

(ARBFX), which has fallen 1.3% in 2022, the


Merger Fund

(MERFX), which has advanced 0.2%, and the


BlackRock Event Driven Equity Fund

(BALPX), which has dipped 0.8%. There’s even an exchange-traded fund for that: The AltShares Merger Arbitrage ETF (ARB) which owns Alleghany, Twitter and Activision, has returned 2.8% in 2022.

Those might not be the most scintillating returns, but in a market like this, they don’t have to be.

Write to Nicholas Jasinski at nicholas.jasinski@barrons.com

.

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