Shaw Communications is being acquired by Rogers Communications in a blockbuster $26-billion deal or $40.50 a share. Closing has been delayed amid boardroom battles at Rogers and regulatory scrutiny.Adrian Wyld/The Canadian Press
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Booming merger-and-acquisition (M&A) activity and bargains among special-purpose acquisition companies (SPACs) are fuelling profitable, low-risk arbitrage plays for investment funds focused on this space.
Global M&A, led by technology deals, surged to a record high of US$5.9-trillion last year. And the flurry of mergers continued with US$741-billion in deal volume in the first two months of this year, according to financial data provider Refinitiv.
“It’s an absolutely strong backdrop for merger arbitrage,” says Amar Pandya, portfolio manager with PenderFund Capital Management Ltd in Vancouver. “The environment for SPAC arbitrage is also very attractive.”
Merger arbitrage seeks to profit from the spread or yield from buying a stock at discount to the takeover price in an announced corporate transaction. SPAC arbitrage involves buying a security at a discount to its trust value.
These strategies were once available only to accredited investors in Canada. Now, they have found more homes in alternative mutual funds and exchange-traded funds (ETFs) thanks to regulatory changes in 2019. In the past, Warren Buffett’s Berkshire Hathaway Inc. has even engaged in merger arbitrage instead of holding short-term cash equivalents.
Funds focused on the arbitrage space, however, can differ in approach. For instance, Mr. Pandya’s Pender Alternative Arbitrage Fund is focused 70 per cent on merger arbitrage and 30 per cent on SPAC arbitrage opportunities.
Merger activity has been hot because of pent-up demand from the COVID-19 pandemic with companies looking to acquire firms to gain access to certain capabilities, he says.
“Corporate balance sheets are stronger today … and trillions of dollars in private equity firms are being deployed in M&A deals,” Mr. Pandya adds.
Spreads have widened significantly amid a high volume of deal activity and concerns about the tough anti-trust environment in the U.S. that could block large or mega-cap mergers, he says.
Microsoft Corp.’s MSFT-Q US$69.7-billion deal to buy video-game maker Activision Blizzard Inc. ATVI-Q is now under regulatory scrutiny.
Only one of 115 merger plays since Mr. Pandya’s fund launch last fall failed to close. Sportsman’s Warehouse Holdings Inc.’s SPWH-Q takeover by Group Outdoors LLC, owner of Bass Pro Shops, was halted when regulators wouldn’t bless the deal.
To avoid the regulatory risk, Mr. Pandya’s fund concentrates more on business combinations among small to mid-cap companies. He also tries to leverage PenderFund’s research that’s used in its traditional equity funds.
His fund owns Intertape Polymer Group Inc. ITP-T, a maker of packaging products that’s being acquired by Clearlake Capital Group LP. Intertape was a holding in a PenderFund small-cap fund, which sold its position.
“We’re confident the deal will close earlier than management’s suggested date of Sept. 30,” he says.
‘Attractive SPAC arbitrage spreads’
SPAC arbitrage focuses on shell companies created to raise capital through an initial public offering (IPO) and a partial warrant, and merge with private companies to take them public in two years. The IPO price is typically US$10 per unit with that money put into a trust account earning interest from U.S. Treasury bills.
The boom in SPACs in 2000 and early 2021, however, has cooled amid rising interest rates with many unable to find a target to do a deal. Under the rules, its investors can redeem the trust value, which is the IPO price plus interest, once those SPACs hit the two-year deadline.
Among the more than 700 North American SPACs – with the bulk listed in the U.S. – most of them now trade at a discount to their trust values. That means that arbitrageurs can effectively buy T-bills at a discounted price.
“We’re seeing attractive SPAC arbitrage spreads,” says Travis Dowle, president and fund manager at Maxam Capital Management Ltd. in Vancouver. “We are deploying capital at about 3.5 per cent annualized yields, excluding leverage.”
Mr. Dowle oversees Maxam Arbitrage Fund, which has more than 60 per cent in SPAC arbitrage versus a roughly 50-50 split with merger plays in the recent past.
Arbitrage offers a unique, low-risk way to diversify and protect an investment portfolio over the long term, says Mr. Dowle, who has run merger-arbitrage strategies for more than a dozen years at his firm. “Bonds have historically offered similar characteristics, but they arguably don’t today.”
“The strategy is characterized by low volatility with low correlation to equities and fixed income,” he says. “We expect arbitrage returns to be mid-single digits to potentially high-single digits, year in and year out, when including leverage.”
The key is that the investment returns are generated by a specific and definitive corporate event, he says.
“With merger arbitrage, it’s the closure of a transaction. With SPAC arbitrage, it’s the redemption at trust value plus interest,” he adds.
Among his smaller-cap merger arbitrage plays, his fund owns junior miner Noront Resources Ltd. NOT-X, which is being acquired by Australia-based Wyloo Metals Pty Ltd. at $1.10 a share.
“We were recently acquiring Noront shares at a 3- to 4-per-cent discount to the deal price, which makes for a very nice, annualized return,” Mr. Dowle says.
His fund also owns Canadian large-caps, such as Shaw Communications Inc. SJR-B-T, which is being acquired by Rogers Communications Inc. RCI-B-T in a blockbuster $26-billion deal, or $40.50 a share. Closing has been delayed amid boardroom battles at Rogers and regulatory scrutiny.
“Rogers today has the financing in place and Shaw has begun a process to divest its wireless business to meet Canadian regulator and competition concerns,” Mr. Dowle says . “We expect this deal to close in the first half of 2022.”
Merger arbitrage returns higher but more risk
Julian Klymochko, chief executive officer and chief investment officer at Accelerate Financial Technologies Inc. in Calgary, also owns Shaw Communications in his Accelerate Arbitrage Fund ARB-T. “We are bullish on the closing,” he says.
His ETF’s merger plays also include Anaplan Inc. PLAN-N, a U.S. enterprise software company being bought for US$10.7-billion, or US$66 a share, by Thoma Bravo LP. The private equity firm has never failed to close a deal, he notes.
Still, merger arbitrage currently makes up about 25 per cent of his ETF versus 75 per cent in SPAC arbitrage.
“Returns from merger arbitrage are higher, but come with additional risk,” while SPACs are virtually riskless, Mr. Klymochko says.
During the boom period, SPAC arbitrage was a lot more lucrative. Retail investors often bid up SPACs above trust value after a deal was announced, and that “would allow arbitrageurs to exit at a significant premium to net asset value,” he says.
“This strategy went from 3-per-cent expected returns to north of 20-per-cent expected returns.”
But enthusiasm among retail investors has fallen dramatically and fewer SPACs are listing. This type of arbitrage has become “more of a buy-to-redeem strategy” for arbitrageurs, he says. “About 98 per cent of U.S.-listed SPACs trade below their net asset value versus zero about a year ago.”
Still, the opportunity is that “there’s more than US$4.3-billion of arbitrage profit available for those willing to capture it,” he says. “That represents the aggregate discount to trust value of all the discounted SPACs.”
Among SPACs that he likes now is Screaming Eagle Acquisition Corp. SCRM-Q. It’s one of the lowest-priced ones trading at just over US$9.71 a unit, he says. Its sponsor is Eagle Equity Partners LLC, which is led by Harry Sloan, Jeff Sagansky and Eli Baker, who did the deal to take sports-betting company DraftKings Inc. public, and have a track record of success, Mr. Klymochko says.
The arbitrage space is very compelling now given that the market value for North American public mergers outstanding is more than US$450-billion and US$200-billion in SPACs, he says. “We are seeing phenomenal opportunities.”
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