Your financial advisor sends you an email with a merger companies list attached. Wanting to invest your money in a growth vehicle, you wonder why is merger arbitrage good? You sent back an inquiring email and here’s what your advisor tells you …
Why is Merger Arbitrage Good?
Merger arbitrage is good because it enhances shareholder value, promotes strategic expansion and effective capital allocation, drives market consolidation, expands economies of scale, and fosters strategic alignment. Check this out:
Shareholder Value Enhancement – Merger arbitrage seeks to combine corporate assets, managerial experience and expertise, and market share to streamline operations and capitalize on a synergistic strategy. These blended efficiencies enable higher profit generation and ultimately greater shareholder value.
Strategic Expansion – The creation of new revenue growth opportunities, strengthening industry position, and increased capital access are positive externalities of merger arbitrage. Expanding geographical presence results in new market entrances and goods and services diversification.
Effective Capital Allocation – Why is merger arbitrage good? A merger arbitrage’s goodness can be capsulized by strategic deployment of funds. Efficient capital allocation is the precursor to improved fiscal performance culminating in increased shareholder value. Merger arbitrage permits companies to more effectively allocate capital through streamlined operations, corporate duplicity elimination, and resource redirection into higher return pursuits.
Market Consolidation – Merger arbitrage is market consolidation. Consolidation increases barriers of entry, reduces industry players thus reducing competition. However, company stability is enhanced with the possibility of lower consumer pricing resulting from increased supplier purchasing power.
Economies of Scale – Why is merger arbitrage good? Mergers distribute fixed costs over a larger revenue base. The cost savings produce an increase in gross, operating, and net profit margins. As mentioned earlier, scale begets supplier purchasing power, begets potential lower consumer pricing.
Strategic Alignment – Mutual core business alignment is an advantage of merger arbitrage. The blended firm can utilize the newly streamlined entity to concentrate on high-growth initiatives, capitalize on market trends, and expand its industry footprint.
Why Might a Diversified Investor Want to Invest in Merger Arbitrage?
A diversified investor might want to invest in merger arbitrage because of steady returns, lower market risk, and a defined risk/reward profile.
Steady Return Potential – Merger arbitrage is dependent on transaction completion. Investors can calculate potential profit, assess risks, and extrapolate capital gain based on the probability of a successful deal closure.
Lower Market Risk – Merger arbitrage is less market-movement sensitive because transaction closure is based on defined merger agreement terms and conditions and not on price oscillations. Bear in mind, less market sensitivity is not market immunity.
Defined Risk/Reward Profile – The risk profile of an M&A transaction is defined in the merger’s public announcement. Investor profit potential is documented by the announced pricing spread and transaction challenges are identified in the press release.
What are the Risks of Merger Arbitrage?
The risks of merger arbitrage are transaction risk, regulatory risk, and financing risk.
Transaction Risk – Deal failure is the most realized risk in merger arbitrage. If the transaction is not completed, event driven investors may lose their invested capital.
Regulatory Risk – Delays, stringent requirements, and rejection of regulatory approval derail merger consummations, putting the arbitrageur’s capital at risk.
Financing Risk – Transaction financing can pose a risk to deal closure. If the acquirer, the firm proposing the purchase, encounters difficulties raising needed purchase capital, the transaction’s closure is jeopardized.
Why is merger arbitrage good? Merger arbitrage is good because it offers steady return potential, the benefits of diversification, lower systemic risk exposure, and a defined risk/reward profile.
Read next: What is the Minimum Investment in Arbitrage?
