Merger Arbitrage as an Alternative Investment Strategy

Merger arbitrage is an absolute return strategy of investing in companies involved in pending mergers, takeovers and other corporate reorganizations, with the aim of profiting from the completion of these transactions.

In the simplest form of a merger arbitrage opportunity, the buyer bids on the target stock, almost always at a premium to the market price, according to Virtus Investment Partners.

By buying the target company at a discount on the open market, the arbitrageur is positioning themselves to receive the difference between the bid price and the current stock price at the close of the trade, thereby earning a spread.

The size of this discount is influenced by general market conditions, as well as transaction-specific considerations that affect the timing of the transaction and the perceived probability of success, according to virtue.

The arbitrageur is likely to realize a potential return upon successful conclusion of the trade, whether the market rises or falls while waiting for the trade, because the value of the consideration to be received is a fixed dollar amount.

Investment returns depend primarily on the outcome of the specific transaction rather than the direction of the stock or bond markets.

When reviewing a deal, according to Virtus, merger arbitration managers should:

  • Analyze public information about the companies involved in the transaction and the markets in which they compete.
  • Estimate the likelihood of a government antitrust investigation and enforcement action and the likely outcome of such events.
  • Monitor government and private party litigation and assess the likelihood of antitrust and other regulatory actions.
  • Mitigate various potential risks such as transaction termination, transaction delay, material adverse changes to either party, shareholder disapproval, tax liabilities, and financing issues.
  • In hostile transactions, analyze the target company’s anti-takeover defenses.

the Merger fund (MERIX)managed by Westchester Capital Management, a subsidiary of Virtus, was the first mutual fund dedicated exclusively to merger arbitrage, offering access to an alternative strategy in a regulated, transparent and daily liquidity fund.

For more information, visit virtue.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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