Philippe Ferreira

Philippe Ferreira

Director, Senior Cross-Asset Strategist

Lyxor Asset Management

Merger Arbitrage recovers after hitting An Air Pocket

28 May 2018

Investment Partners

Widening deal spreads in March-April translated into an underperformance of Merger Arbitrage in early Q2. This is now largely behind us. The strategy recovered in May along with the tightening of deal spreads. Below we discuss the reasons why deal spreads widened and eventually reversed course as well as our outlook.

The reasons why deal spreads widened earlier in Q2 are mainly related to two exogeneous factors, which are now less of a concern.

- First, the rising probability that the U.S. and China would engage in a trade war raised concerns about potential retaliation measures from the Ministry of Commerce of China (“MOFCOM”) which is the anti-trust agency. Cross border mega deals which require a MOFCOM approval, such as the Qualcomm proposed acquisition of NXP, saw a substantial widening in deal spreads. MOFCOM delayed the merger earlier in Q2 but there is now more optimism on the likelihood to be approved.

- Second, there were concerns about how the U.S. Department of Justice might treat vertical mergers going forward. Over the recent decades, the DoJ approved hundreds of vertical mergers, which involve firms at different levels of the supply chain and that are not competitors. With the DoJ challenging the AT&T proposed merger with Time Warner, the broad spectrum of vertical deals saw a sizeable deal spread widening, such as Cigna vs. Express Scripts; Disney vs. Twenty-First Century Fox; and CVS Health vs. Aetna. The AT&T case vs. the DoJ is now more compelling and has a higher probability of prevailing. Vertical deal spreads tightened back as a result. 

Going forward, we maintain strong convictions on Merger Arbitrage, a low beta strategy perfectly fit for current market conditions. Coupled with easing concerns on the issues discussed above, the continuation of strong M&A volumes so far in Q2 and the large availability of cash in corporate balance sheets has improved sentiment. This should translate into an outperformance of merger arbitrage funds in the coming quarters.

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