It creates what is called the Conglomerate Discount. This is clear from the general pattern of value destruction across all of the deals discussed here.

Investors in recent years have come to distrust and punish most corporate acquisitions. Some of the negative sentiment is of a general nature. Market, in their collective wisdom, at least the wisdom of the moment, really – but really – dislike this transaction. What this signifies, first of all, is that Mr. Value Destruction of the CRM/WORK Deal Chart by author Between 20, 94% of announced deals did in fact close. Lots of room for active investing to make a difference (although there are a few exchange traded funds – ETFs – that purport to package merger arbitrage strategies in a more passive vehicle.) This is the logical side of the merger arbitrage, and most merger arb investors play this angle. The deals vary widely and selectivity can improve the prospects for a savvy investor. Which of course also drove down the average spreads. The assets-under-management of merger arbitrage investment funds increased by a factor of more than 100 between 19. The size of the spread can also be interpreted as an implied probability that the deal will close – in this case, it was said to be 72% on the day after the announcement. The 12% spread translated to a 17.8% annualized gain for investors who stayed the course. It took 253 days to close – unusually long, due to an extended Dept of Justice review for possible antirust concerns. In fact, there was considerable uncertainty surrounding the Red Hat acquisition. Easy money - except that you had to be right in assuming the deal would close. The bet was simple: if you thought the deal would close at $190 a share, you bought all you could at $169 a share. Investors relying only on public information could have entered the position at that level. The Red Hat merger arb spread was 12% on the day after the deal was announced. IBM/Red Hat Merger Arbitrage Chart by author

But if all goes well, the spread closes as the deal approaches its conclusion. It exists because the deal will take several months (on average) to close, and there is some possibility that it may fall apart, for any number of reasons. Typically, however, the target company’s shares do not immediately reach the level of the offer, but hover somewhat below it.

Salesforce’s premium for Slack is in the same range (50-55%), though because it includes both cash and stock, the value of the offer fluctuates in sync with the value of Salesforce’s own shares. Microsoft’s offered a 50% premium for Linked In. IBM bid 60% above Red Hat’s previous share price. Even though it is only a bid (and not a done deal), the market price will rise in anticipation of its consummation. The offer price entails a significant premium over the current market price. First of all, the shares of the target rise promptly to somewhere near the offering price. The objective of the strategy is to capture the arbitrage spread-the difference between the acquisition price and the price at which the target’s stock trades before the consummation of the merger.”Ī bid by one company to acquire another company always has two effects. It may also involve shorting the shares of the acquiring company. “Merger arbitrage is an investment strategy that involves buying shares of a company that is being acquired.The first thing to say about all this is that it constitutes a nice illustration of a stereotypical market pattern, triggered by an acquisition event – which sets up an investment strategy known as merger arbitrage.

Salesforce & Slack Nov 25-Chart by author

Salesforce slack acquisition analysis