Merger Arbitrage

Unsurprisingly, M&A volumes registered one of the worst quarters since the first quarter of 1998. Announced deal value declined almost 80% sequentially and 90% year-over-year. As countries around the world and states across the U.S. essentially shut down in response to the spread of COVID-19, CEOs shifted their focus to managing their companies and maintaining adequate liquidity instead of inorganic growth. Spreads narrowed during the first half of the quarter, as numerous deals closed and equity markets recovered. The closing of AbbVie’s acquisition of Allergan, NVIDIA’s purchase of Mellanox, and Raytheon’s merger with United Technologies helped continue the tightening of deal spreads from the end of the first quarter into the middle of the second quarter. However, beginning in mid- to late May – with economies closed longer than originally expected – several deals ran into headwinds, which caused spreads to temporarily widen before recovering and finishing the quarter with an average 10% annualized net spread.

In the short term, companies will primarily reassess what the post-pandemic world will look like and focus on paying down debt and rebuilding their balance sheets. However, there are reasons to believe that M&A will return in the second half of the year. Banks are better capitalized than they were during the global financial crisis, the Federal Reserve is providing enormous support to the credit markets, and progress on multiple COVID-19 vaccine candidates are just a few key factors. While uncertainty around earnings potential can lead to a valuation gap between an acquirer and target, the use of stock may become more prevalent in strategic deals to bridge that gap.