The allure of betting on mergers

BIG deals rarely happen without big personalities. If Elon Musk were an uninteresting tycoon with a low public profile and a puritanical approach to promises, then shares in Twitter, a social-media platform, would be trading within a whisker of his US$54.20 per share offer. The difference, or “spread”, between this offer and Twitter’s current trading price, of below US$40, is a reminder that he is not.

The wider the spread, the lower the chance investors assign to a deal completing. To Musk and Twitter’s management, the spread is a live opinion poll in a fractious situation. But to a group of specialised hedge-fund managers, it is their bread and butter.

Merger arbitrage, also known as risk arbitrage, involves purchasing the shares of a target firm during the risky interval between a deal’s announcement and its completion. The arbitrager first identifies a merger that the market is relatively gloomy about—ie, a spread that they believe overestimates the chance of a deal’s failure. Then they buy shares in the company, and wait until the deal closes and the acquirer pays the offered price per share. The amount of capital dedicated to this strategy has quadrupled during the past decade to more than US$100bn, despite some patchy returns. For several reasons, its star will continue to rise.