You could think of it as a form of potential energy: money sitting on the sidelines, looking to be deployed in mergers and acquisitions (M&A).
As the New Year gets underway, special purpose acquisition companies (SPACs) may have as much as $300 billion to put to work over the next two years, according to Goldman Sachs (12/14/2020). There were five times as many SPAC IPOs last year (2020) as the year before, raising a total of about $60 billion. (Goldman arrives at the $300 billion number by assuming 5x leverage against that $60 billion.) Private equity (PE) firms remain flush with cash, too; by one estimate as much as $1.7 trillion in “dry powder” is available to fund deals.
Corporate management teams appear to be on board – a survey by the consulting firm PwC found that 53% of US executives plan to increase M&A investment in 2021. The firm also expects to see more megadeals, transactions valued at $5 billion or more, as interest rates stay low and capital remains widely available. Rising equity markets as we’ve seen recently are also supportive, positioning companies to initiate more stock-based transactions.
These are generally positive developments for investors pursuing a merger arbitrage strategy, suggesting that there will be plenty of deals. As a reminder, merger-arb seeks to take advantage of the price differential that often opens up between the announced price of a deal and the current trading price of the target company. That gap tends to close as deals move towards the completion date, allowing investors to capture the difference in price. Exchange-traded funds (ETFs) like the IQ Merger Arbitrage ETF (MNA) provide a way to get broad exposure to the strategy through a diversified portfolio of holdings.
Like nearly everything else, M&A activity was hit hard by the COVID crisis. Deal volume was down 80% in April 2020 compared to December 2019, according to BCG, but it did begin to bounce back in early summer as equity markets recovered (9/29/20). Some deals were driven by the demands of the new work-from-home environment, including the $27 billion acquisition of Slack by Salesforce. By October, the number of transactions was roughly on a par with what was seen in February, 1,236 compared to 1,108, according to data from Factset (November 2020). For the 12 months ending October 31, 2020 aggregate U.S. deal volume was $1.074 trillion compared to $1.524 trillion for the prior 12-month period, a decline of -29%, again using Factset data.
As always, bankers are optimistic about the deal landscape at the start of the New Year. Sometimes that optimism is justified, sometimes not. 2020 was a stark reminder that circumstances can change quickly. But the sheer volume of available capital, and the need to put that money to work, is one reason to be positive on the prospects for M&A in 2021. The growing influence of SPACs is another. Fortunately for us (and for MNA), we don’t need to see the number of deals grow to the sky; a steady stream of transactions that can be added to the index and to the fund as others roll off works fine for our purposes. The New Year appears poised to provide that.
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