The 10,000-foot view on merger arbitrage in mid-2024 is that it combines the highest historical absolute spreads, and the lowest deal break rates – and this is true of many plain vanilla deals. But the backdrop is very different for the hairier situations that TIG specializes in, including those with antitrust, regulatory, litigation, political and cross-border issues. 

Antitrust, politics and geopolitics

“The current political environment has been sympathetic to new labour market theories that challenge the status quo precedents and has used executive orders to stop mergers. The US Government has been more active in blocking or delaying deals for antitrust or political reasons. Some targets such as a luxury goods group, Capri, and a steelmaker, US Steel, have traded 30 or 40% or more below the offer price,” says portfolio manager, Drew Figdor. 

FTC Head Lina Kahn has increased antitrust uncertainty, and Biden is perceived to be delaying a steel deal for political reasons, because it is critical for the Democrats to win Pennsylvania, though in fact Trump also said he would block it. “All of this introduces some randomness into the M&A process, and also complicates cross border deals because sanctions on high technology and certain entities can lead China to respond,” says Figdor. This contributed to very wide spreads on a chip software deal being reviewed by China’s authorities – even though it is below China’s usual threshold for merger notifications. 

Nonetheless, TIG will regularly take a view and take a risk on Chinese approvals. “Though Chinese regulation is more of an unknown, we judged that a mainframe software deal did not include high technology AI-oriented semiconductors and had fairly small China revenue, so did not make sense for China to block. The spread was 20% and the deal closed,” says Figdor.

Germany’s refusal to approve the Taiwanese Global Wafers bid for Siltronic was also a surprise, very late in the process, which introduces more randomness to some individual European domiciles. “The irony is that the EU, which was once a renegade subscribing to conglomerate theory, is now the most logical and predictable of the large regulators,” observes Figdor.

The UK CMA delay to Microsoft’s Activision bid was a concern for several reasons: “The UK CMA does not have an appeal process, cannot be challenged by going to court, and will not accept behavioural conditions. In contrast the US Government can sue to block, but equally a bidder can go to court and the judge will hear evidence. That gives us more time and opportunity to capture alpha,” says Figdor.

In 2023 spreads on deals with regulatory risk blew out due to delays on Activision and Amgen/Horizon and therein Figdor scented opportunity. “When we got a trial date for Horizon, we increased exposure to other regulatory deals in anticipation that Horizon closing would be a defining event in the regulatory landscape that could affect spreads on other regulatory deals. We judged that spreads were so wide at 20% or more that the risk/reward was very asymmetric,” recalls Figdor.

Milestones not end games

Visibility is amongst the worst Figdor has seen in his over 30 years of merger arbitrage experience: “We estimate a historically low 60% hit rate of correctly predicting antitrust, regulatory or political outcomes. But we have a much higher success rate at predicting litigation outcomes around different milestones along the process. For instance, we have had much more success predicting trial outcomes than the Government’s desire to sue”.

This is important because TIG mainly focus on pinpointing events with a 0-30-day timeframe rather than holding deals until the end game. And regardless of the regulatory climate, Figdor always finds market-moving events within that window: “We could trade a lawsuit, a second request, a decision and pre-trial motions”. In some complex deals TIG takes a view on multiple events: more than one lawsuit outcome, contract renewals, and various broadcasting rights negotiations.

Idiosyncratic events

TIG are cautiously positioned with exposure below historical averages, but the opportunity set is still compelling. Gross exposure might well predict risk and return for a well-diversified merger arbitrage strategy mainly in plain vanilla deals, but for TIG, idiosyncratic, position-specific events are more important. Despite low gross exposure in December 2023, the strategy had one of its best ever months.

Spread volatility

“A focus on catalysts up to 30 days is more interesting than a traditional buy and hold approach. They are very agile in trading around spreads,” says Busquere. Figdor actively trades around the volatility of merger arbitrage spreads, which is increased by merger arbitrage pods subject to very tight risk controls in multi-strategy shops. TIG typically trades around 50-60% of a position rather than the whole position, so trading events over 30 days or less does not necessarily imply portfolio turnover of 12x or more.

Shorting deals

Sometimes TIG will even take the opposite side of a spread. In January the Fund shorted two deal breaks within a 30-day timeframe. One was an airline, and the other was a robotics firm being acquired by a tech giant. “Shorting deals is like investing in deals. It is based on assessing the market probability of success, and they may turn long again when the valuation is better,” points out Busquere.

Unusual jurisdictions

TIG is mainly in larger cap deals because they cannot deploy enough capital into the smallest deals to move the needle of returns, and in any case Figdor finds bigger spreads in larger deals but is prepared to go off the beaten track in jurisdictions. Wider spreads, as high as 5, 10 or 20%, have lured Figdor to deals in Saudi Arabia and Dubai, which have been researched with travel to the Gulf. “We try to research unique places and visited Abu Dhabi to investigate the regulatory approach. We do not see many merger arbitrage competitors in the region, because some firms do not want to spend two days travelling,” says Figdor.

The UK has arguably become an unusual jurisdiction less favoured by many equity investors, but Figdor finds value, and in contrast to CMA concerns, he has confidence in the Takeover Panel that prevented acquirers from reneging on bids in 2008. “There is plenty of opportunity for over-bids and bidding wars in the UK market. We look for firms with unique assets such as bakeries,” says Figdor.

Grassroots research

TIG draws on a wide network of expertise. “We use specialist brokers as well as legal experts in most countries as well as local brokers. The key is to find information quickly. Our primary focus is to find opportunities to meet face to face with the companies, competitors, regulators and other stakeholders,” says Figdor. These in-depth discussions can lead to occasional activism; TIG has sometimes sold some of their shares to a potential counterbidder to incentivize an additional bid. “TIG are good at predicting antitrust, litigation and regulatory risks. They attend lawsuits, do deep fundamental analysis and meet company managers,” says Busquere.

Portfolio and position level hedging

TIG can spend up to 0.65% per year on portfolio-level hedging, using put structures that produce the biggest payoff from an equity market selloff of 10-15% or more. For a smaller selloff, the puts just dampen volatility and increase the incentive to buy more. “Efficient tail risk hedges have limited losses to an acceptable level,” says Busquere.

Five deal categories – LBOs, hostile deals, stock swaps, cash deals and special research – help to gauge downside risk and inform the structure of hedges for the sensitivity analysis. For instance, historically hostile deals had a higher equity market correlation than LBOs or strategic deals. The analysis is fluid. “LBOs have become less risky since 2008 since reverse termination fees as high as 6% have to be paid by private equity bidders reneging on deals,” says Figdor.

The hedge is designed to protect against a global repricing of risk, though in practice Figdor “cannot envisage a scenario where every deal widens by a uniform 10% since they are not interconnected or correlated”.

At position level, TIG also often has puts sometimes protecting as much as 40-50% of a position. “Options and option structures are in their DNA to control risks and create asymmetric profiles,” says Busquere.

Risk management

Since inception of the strategy only eight deals have breached the target maximum 1.5% loss per deal and consequently risk policies were revised to reduce the chances of a recurrence. “Three were commodity deals and two of those commodity deals were in 2008. One adjustment we made was to assume commodity deals are 1.5x the actual position size to account for the extra volatility and not lose 1.5% as if it was a normal deal,” says Figdor.

“One was a hostile 3-way stock swap merger which is very hard to hedge correctly and easy for the target to argue stock of buyer not acceptable. The adjustment we made is to limit exposure to hostile stock swaps since you cannot know which security to hedge and the probability of the bidder winning is lower,” Figdor points out.

One deal breaching the loss target was just a freak event: an insurance deal that insured a Florida county that got wiped out in a hurricane and lost 80% of its market cap.

Shifting opportunity sets: SPACs

In 2021 TIG had as much as USD 1 billion in SPAC deals in the overall strategy but ceased in 2022. “It was very interesting for a while when markets were hot, and we are always looking for asymmetric deals. The ability to put back stock at cash value was the ultimate asymmetry.  Now that most shares have been tendered back, and SPACS never raised capital, investors have realized that the quality of many companies in SPACs was more like venture capital firms with no revenues than operating companies. However, if the IPO market gets hot again SPACs can be a cheap way to play it,” Figdor reflects.

Soft catalysts

The strategy is opportunistic but soft catalysts are off limits due to a double whammy risk. “If a stock rises 15% upon announcing a spinoff, and you buy, you face two risks. If the market drops 15%, you lose 15%, and since the probability of the event has also dropped, you might lose 30% in total,” argues Figdor, who would rather focus on hard catalysts. “Hard catalysts are very idiosyncratic whereas softer catalysts are harder to hedge due to the beta exposure,” adds Busquere.

Impact of interest rates

Higher interest rates have increased spreads on plain vanilla deals and made the risk/reward less skewed to the downside. When rates were near zero, a typical deal might have had a 1% gross spread, but 30% downside based on average bid premiums. Now there could be a 3% spread and 27% downside. Therefore, TIG can selectively do some plain vanilla deals but will not major on them. “We would rather seek independent alpha deals that can make 40-50% or lose 10%. We expect our short-term catalysts should be more uncorrelated than a safe strategic merger,” says Figdor.

The fastest ever rate hikes of 500 basis points in 2022 did delay deal flow as CEOs worried that rates might reach 6-7% and create a severe recession. By now markets have adjusted to the level of interest rates and do not expect a serious recession, so deal flow is coming back.

Politics outlook

“If Trump returns as US President, deal flow will increase hugely. He is likely to replace Lina Kahn and Jonathan Cantor with more traditional antitrust regulators,” expects Figdor. Nonetheless, TIG is not wagering on a Trump victory. Rather the reverse, a low VIX allows for relatively cheap hedging.

Asset raising

In 1999 Figdor’s strategy was one of the first on the Lyxor (now Amundi) platform. Says Figdor: “Amundi has been key to our success and great partners. They have a global footprint for their sales effort and are partners in the truest sense of the word. Their key markets have been the major European markets”.

Some share classes with higher minimum amounts (e.g. above USD 70 million) have much lower management fees.