To The Moon

Its a sea of red everywhere currently, lucky for us, understanding how merger arbitrage works will help us realize why this strategy doesn't really care about the current unfavorable market.

The Merger

On April 25, $Twitter(TWTR)$announced that it had agreed to sell itself to Elon Musk for USD54.20 per share. Yet, the stock is currently trading at ~USD47.20, why the big gap? Wouldn’t it mean that buying the stock here is a no-brainer?

The merger agreement will lay out terms about the final price for $Twitter(TWTR)$, when the deal is potentially expected to close, information about any other bidders if there were any (without any names named), the kind of regulatory approvals the deal will require, approvals from other countries that Twitter does business in, termination fees payable if the deal does not go through and a whole lot more. These can often run into 100 pages+++

What is Merger Arbitrage?

Merger arbitrage is also known as risk arbitrage and as the name implies, arbitrageurs are willing to take the risk that the deal might not close and the stock might drop back to levels before the deal was announced or before the unsolicited bid for $Twitter(TWTR)$by Elon Musk.

In return, they expect to capture the difference between the current market price and the price at which the company is going to be acquired. This difference is referred to as the “Arbitrage Spread” on the deal.

Example of other ongoing merger arbitrage

In some cases, spreads can be large, such as the case with Microsoft’s current acquisition of Activision Blizzard, where Microsoft is paying USD95 per share in cash for it but Activision Blizzard is currently trading at ~USD77. The spread or the return on this investment is nearly 23%.

The spread on this deal is large because there are perceived regulatory risks to this deal and there is a chance that the Federal Trade Commission (FTC) might attempt to block the Activision Blizzard deal for anti-competitive reasons.

Sony and Electronic Arts are probably not too thrilled with the prospect of Microsoft owning Activision Blizzard's franchises like Call of Duty, Starcraft, World of Warcraft, Diablo, etc.

The Risk

In theory, the closer we get to the closing deal date, the arbitrage spread will get closer to 0%. BUT, we have to accept the fact that there are chance where the merger & acquisition fail to close.

Arbitrage spread components consist of timing risk, deal risk, regulatory, shareholder votes, financing, other approval or consents amongst many others.

Why invest in Merger Arbitrage?

The rate of return is NOT correlated with the market. For example, if we take a look at Twitter and S&P500 after the M&A announcement from Elon, there is no correlation whatsoever.

BOLD So, will Twitter deal go through the moon and star beyond just like @TigerStars? :p Let's hope so! Do let @Daily_Discussionknow your opinion of Twitter deal [Smile]