Mergers and acquisitions: decorrelated performance drivers?

“IBM buys Red Hat for $34 billion.” “China’s Mascot Bidco Oy buys Finland’s Amer Sports.” “LVMH buys US luxury hotel owner Belmond."

Despite the spike in market volatility, mergers and acquisitions - especially prevalent in the oil, healthcare and tech sectors - continue to make headlines as 2018 draws to a close. While most of these announcements have been located in the US and often involved mid-cap companies, they represent attractive first-half 2019 investment opportunities for any investor.

After all, the value of target companies often climbs substantially: once the bid is locked in, the target’s share price is no longer associated with the company’s fundamentals but instead with newsflow related to the deal in progress. And since, historically speaking, 93% of mergers that are announced end up going ahead, they offer an opportunity for investments with high probabilities of success. That’s the whole idea behind “Risk Arbitrage” strategies, in fact: assuming little exposure to the markets while selecting deals that are most likely to be carried out.

Let’s look at a concrete example. In the wake of Belgium’s victory in the Hockey World Cup, consider the country’s favourite drink - beer - and compare the change in SAB Miller’s share price with the trend in the Euro Stoxx 600 when the company was bought out by world leader AB InBev. As shown in the chart below, SAB Miller’s share price ranged from a floor price, i.e. its value at the official announcement date, and a high point, i.e. the bid price. Ultimately, the share offered a projected return of 12% in a market that shed nearly 9% over the same period.