After years of a giddy boom in mergers and acquisitions with ever sillier valuations (made possible by an endless flow of easy money from yield-starved investors and fee-hungry banks, under the eyes of regulators who’d conveniently fallen asleep)…the M&A bubble is now collapsing (US targeted new M&A volume has plunged 21% from a year ago) and many hedge funds that were into merger arbitrage got caught on the wrong side of the bet.
Written by Wolf Richter (wolfstreet.com)
Merger arbitrage is a bet that an announced acquisition gets completed. With the announcement, the share price of the target company shoots up to somewhere near the bid. If there’s hope that the bid will be raised, the share price might overshoot the bid. Once the target company agrees to be taken over, shares usually trade slightly below the acquisition price until the acquisition is completed. These price differentials can be exploited by merger arbitrage. These can be huge, leveraged bets on what are expected to be minor price differences. Risks are thought to be low – unless the merger collapses. That’s when these “arbs” can get their heads handed to them. This is now happening.
So far this year just in the US, about $400 billion in deals have collapsed. It already blew past the full-year total of last year’s withdrawn deals of $231 billion and the 5-year average full-year total of $243 billion, according the Dealogic. Even if no more deals are withdrawn this year, the current total would already set a new full-year record.
Pfizer – Allergen
This hangover from the multi-year merger bubble includes Pfizer’s $160 billion merger with Allergan, “the biggest withdrawn deal on record,” as Dealogic put it. It collapsed “two days after the US Treasury Department announced stricter rules for tax inversions.”
While the Treasury’s efforts to crack down on this tax avoidance scheme have been in the open for a while, the market didn’t think that it was the sole reason why Pfizer would buy Allergan, and that the merger would go through anyway. Turns out, the market was wrong. Tax avoidance was the only reason.
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