Thursday 2nd February 2023
I recently wrote up a buy thesis on Activision Blizzard highlighting the reasons why I thought Microsoft would likely close its acquisition of it by September.
Microsoft (the acquirer) has said they would buy out all shares in Activision Blizzard (the target) using cash for $68.7bn, or $95 per share. I have bought shares in Activision Blizzard betting the deal will go through causing my shares to rise from the $75 price I paid to the $95 Microsoft will pay to take them off me.
As a part of my research process I read through two great books on investing in special situations: “You can be a stock market genius” and “Fortunes in special situations in the stock market“.
Here are the key merger-arb related risks I learnt about, and evaluated, through my research process:
Why the deal might not go through
- Regulatory risk: Is the regulator likely to try block the deal? This might be because they believe the deal will reduce competition in the industry.
- Management risk: What is the risk the CEO of the acquiring company changes their mind on the terms they are offering the target company? Say they had promised the target company’s CEO that they would play a large role in the combined firm, is the acquiring CEO the type of spontaneously change his mind?
- Union risk: Are any of the firms unionised, such that the unions could block the deal?
- Due diligence risk: This is a big one. What’s the risk the acquirer finds something wrong in the target company in the due diligence process? If this happens, not only will the deal break, but shares in the target company will likely fall below the pre-announcement level.
- Financing risk: Does the acquirer have the money to buy the target company? What’s the likelihood the financing they’re relying on does not come through?
- Shareholder approval risk: Are a quorum of shareholders likely to vote in favour of the deal?
Why the deal might not go through at the initial value
- In some instances, an acquirer may offer to buy out a target using their own shares. For example, Large_Co may offer Small_Co shareholders half a Large_Co share for every one of their Small_Co shares. If the price of Large_Co shares goes down, then the amount each Small_Co shareholder gets when the deal closes is lower.
This risk can be addressed by simultaneously shorting Large_Co shares while buying Small_Co shares to bet on the deal closing while locking in the current value. But this still requires the deal to close, otherwise prices will likely revert back to their pre-announcement level creating a loss for the merger-arb investor.
The Equity Analyst 