If you’re not familiar with the concept of M&A arbitrage, here’s the quick version: Someone buys the stock of a company that’s in the process of being acquired because they anticipate higher offers. In other words, the investor is willing to bet money on another suitor entering the fray and driving up the price.
It’s a surprisingly popular gamble, but a dangerous one considering the risk you expose yourself to far outweighs the upside. In fact, if you look at a few recent examples, you’ll see that it makes more sense to just avoid M&A arbitrage at all costs.
After all, you don’t want to get burnt.
Clearwire (NASDAQ:CLWR) stock surged 71% on Oct. 11 on the news that Japanese mobile carrier Softbank would pay $20 billion for a 70% stake in Sprint (NYSE:S), which held its own 50.45% interest in CLWR. Investors (rightly) speculated that Sprint would then buy the remaining interest in Clearwire to bring its spectrum under one roof, which it ultimately offered to do Dec. 13 at $2.90 per share.
So, at the end of that fateful October day, Clearwire’s shares stood at $2.22. Those who owned its stock prior to Oct. 11 had a decision to make: Hold ‘em or fold ‘em. If you had bought Clearwire’s shares in July — when they were below $1 — it would have been awfully difficult not to cut and run despite the anticipated bid. But if you owned shares that were deeply in the red, opinions like those of Mount Kellett Capital Management — which said shares were worth $6.30 — might have led you to postpone selling so you could hope and pray for such a bid.
Unfortunately, that highly inflated bid never came. Sprint’s sweetened offer of $2.97 per share Dec. 17 — only 7 cents better than the one pitched Dec. 13 — was the best investors could hope for.
The worst fate was reserved for those who bought Clearwire stock Dec. 14 at prices as high as $3.40 per share, betting that an offer superior to $2.90/share would appear. Those speculators are now sitting on 15% losses.
Who was making those bets? And why? It was obvious to most observers that Sprint wasn’t going to open the vault to buy the remaining shares. For two years, Clearwire’s board entertained various strategic alternatives; Softbank was the best hope for both companies. Traders likely were pushing rumors of higher bids to drive demand for Clearwire’s shares, allowing them to profitably exit their positions beyond the original bid of $2.90 while John Q. Public was left holding the bag.
The fat cats win again.
Another recent example of M&A arbitrage is Schiff Nutrition International (NYSE:SHF), the Utah-based vitamin and supplement company that was successfully acquired by Britain’s Reckitt Benckiser (PINK:RBGPY) for $1.4 billion.
The adventure originally began back on Oct. 30. when Bayer (PINK:BAYRY) offered to buy Schiff for $1.1 billion or $34 per share — a 47% premium over its Oct. 26 closing price. Two weeks later, Reckitt offered $42 per share, and the bidding war was on.
Or was it?