When the Pentagon lacks affection for a corporate acquisition, the parties should rethink the deal. On Sunday, the US defence contractor Lockheed Martin terminated its $4.4bn acquisition of Aerojet Rocketdyne, one of the few remaining independent missile components makers.
Last month, the US Federal Trade Commission sued to block the transaction. The FTC noted that the US Department of Defence had assisted with the FTC investigation. No surprise that Aerojet is one of several listed targets whose stock price has wallowed well below their respective offer prices.
Unlike Aerojet, though, the others have yet to receive any clear regulatory objections. Just the threat from activist watchdogs in Washington and around the world makes a difference. Merger arbitrage spreads have widened often beyond 10 per cent, presenting an opportunity to hedge funds for a tidy return — only if they can predict which combinations will not offend antitrust regulators.
The last great merger arb opportunity occurred in March 2020. During the market collapse early in the pandemic, shareholders feared that acquiring companies would ditch signed merger agreements or aim to reduce the deal price. In fact, nearly all of those deals would close on original terms. Today, the watchdogs again have the upper hand.
Consider Microsoft’s recently announced acquisition of Activision. The latter trades at a wide 14 per cent discount to the offer. The deal may not close until next year. With interest rates rising, the time value of money suggests that the $95 per share deal price will be worth less by then.
But the real worry is that the US government will disapprove of Microsoft’s growing heft — it is already a $2tn plus company. Other deals with large arb spreads at the moment include Frontier Group’s acquisition of Spirit Airlines; a combination between agriculture companies Cargill and Sanderson Farms; and a purchase of Change Healthcare by UnitedHealth.
Not that buyers have no legal recourse. If Uncle Sam challenges a deal, companies can go to court to plead their case. It took years, but AT&T did eventually win a legal battle to complete its deal for Time Warner. Currently, biotech company Illumina is scrapping with US regulators over its acquisition of privately held Grail.
This points to the fact that hedge funds which trade on deal catalysts also bet on how much chief executives feel up to the battle. Sometimes it means going up against the Pentagon.