Merger Arbitrage

Continuing the momentum from the final months of 2020, U.S. M&A volumes hit an all-time first quarter high, increasing 100% year-over-year. U.S. M&A regained its dominance, representing 54% of global volume, but the strength was widespread, as global M&A also hit an all-time first quarter high. Driven by the Federal Reserve’s easy monetary policies, trillion-dollar government spending bills, and states reopening, economies are quickly rebounding, and confidence has returned to the C-suite and boardrooms. In a recent PwC survey, 53% of U.S. CEOs said they plan to increase M&A spending in 2021. Following the 2008 global financial crisis, companies that were proactive and focused on long-term value creation through strategic M&A saw their stock prices rewarded. It appears the same playbook is being used this time around, but with more companies participating.

Merger arbitrage investors had a solid start to the year, posting a 2.3% gain for the quarter, as measured by the HFRX Merger Arbitrage Index. At quarter-end, the deal universe had an average annualized spread of 13%, aggregate deal value grew from $330 billion to $420 billion, and the total arbitrage profit pool expanded from $14.5 billion to $22 billion. The quarter’s headline deal announcement was Canadian Pacific’s $25 billion acquisition of Kansas City Southern, which hopes to be the first Class 1 rail transaction completed in over 20 years. Despite a robust equity market and a benign credit market, the deal universe saw the average annualized spread widen during the quarter. Competing bids, bumps, and shareholder opposition were all at record highs in the first quarter, causing spreads for impacted deals to trade negative and fall out of the average data set. Additionally, the explosion of SPACs caused a portion of investors’ time and money to shift away from merger arbitrage, which helped keep gross spreads steady while annualized returns widened.

U.S.-China relations have been a major theme in M&A over the past few years. The Alaska summit seemed to be an inauspicious start to the Biden-Xi era, but in late March, Marvel received Chinese regulatory approval for its acquisition of Inphi Corporation months ahead of schedule. Investors and companies will be watching to see if this marks the end of Chinese delay tactics employed during the Trump era.

All the pieces are in place for a robust year of M&A. Most companies believe the worst is behind them and can now focus on deploying capital to accelerate growth, increase scale, and—most importantly—digitize their businesses. As companies seek to get ahead of changes in how people work, shop, and receive services such as healthcare, M&A will play a pivotal role. Furthermore, we expect visibility and predictability will increase in industries hit hardest by COVID-19, allowing M&A to occur out of strength or necessity.