Merger Trading Will Get Easier
Also some bad FTX loans, a late greenwashing case and Fed chair precedents.
I guess there are two ways of thinking about merger arbitrage as a hedge fund strategy. One is: “Merger arbitrage is a bet on which mergers will close.” If you are a merger arbitrageur, your job is to look at merger deals that are announced, figure out how likely they are to actually close, and then bet money on the ones that the market underprices. Company X is trading at $35 per share, and then it announces that it has signed a merger agreement to be bought by Company Y for $50 per share. The stock trades up to $46. You look at the deal and think “this deal is ironclad, there are no regulatory problems, it will definitely close in six months, and I can make 8.7% in six months by buying today at $46 and selling at closing at $50.” You are playing a game of skill against other traders, trying to buy the deals that will close and avoid (or short) the deals that won’t. In reality nothing is certain, so you will try to pick the deals where you think the probability is good and the reward (the spread between the deal price and the current stock price) is worth the risk.
The other way to think about it is: “Merger arbitrage is a low-margin form of liquidity provision.” Company X is trading at $35 per share, and then it announces that it has signed a merger agreement to be bought by Company Y for $50 per share. Investors in Company X would like to turn their attention to something new: Their job is providing capital to interesting business ideas, not figuring out whether and when mergers will close. Merger arbitrageurs come in to provide a service: They go to all the Company X investors and say “hey instead of waiting an indefinite amount of time for this merger to close and pay you $50, just sell us your shares today for $46, and we’ll deal with all the hassles on the back end.” And this is a useful service for which the merger arbs charge, you know, $4. They are making markets somewhat more convenient and efficient for everyone else. They are offering a simplifying abstraction — “when a merger is announced, that merger will happen” — over the messy legal complexities of the market.