Last week, Abbott Laboratories (ABT) - Get Report and Alza (AZA) abandoned their merger because of governmental antitrust objections. That same day, Royal Ahold's acquisition of supermarket operator Pathmark was scuttled for the same reason, underscoring a pernicious recent trend in risk arbitrage: Antitrust enforcement has taken a nasty and dangerous turn for the worse.
The effect of this can easily be seen in the stock prices of pending merger deals, where spreads for certain deals likely to face regulatory scrutiny have doubled or even tripled in the past few months. Needless to say, understanding the likely regulatory hurdles before considering any of these deals is the key to not losing your proverbial shirt. In that spirit, a little background is in order.
Of all the risks an arb must bear, perhaps the hardest to handicap is the risk that government antitrust regulators will approve a pending deal. If you were to line up all pending mergers in terms of expected annualized return (assuming successful and timely completion), those with the widest spread -- and therefore highest return -- would be those deals that present some degree of antitrust risk.
In the U.S., the
Federal Trade Commission
share antitrust authority. Either one or the other will conduct an investigation of every pending merger under the guidelines established by the
Hart-Scott-Rodino Antitrust Improvements Act
. This is the law that establishes the parameters of the data that companies must disclose to the government, the standards to which the regulators will hold the prospective merger and the time frame in which the review must be completed.
The government's interest is simply to ensure a proposed merger isn't likely to harm consumers. This could be the result of a monopoly (where there is only one seller in a market) or a monopsony (where there exists only one buyer). Typically, companies whose merger is a close call on antitrust grounds will negotiate a settlement with the government that will allow the merger to proceed -- provided they agree to divest sufficient assets to eliminate any ability to unduly influence prices. This settlement is called a consent decree and is a fairly common occurrence.
What used to be an
occurrence was the government suing to block a deal entirely. Winning in court is so difficult and time-consuming that companies seldom litigate; they usually quietly terminate the merger agreement and move on. Sometimes the government sues to block a deal after negotiations over divestitures have failed. Other times the regulators are so offended by the prospect of a particular merger that no amount of divestitures will satisfy them, so there's nothing to discuss.
This was the case when
tried to purchase
a few years ago. The combination of Microsoft money and Intuit's Quicken was a nonstarter.
failed acquisition by
presented a similar case, as the
was unwilling to see nuclear-powered ship construction concentrated in one player's hands.
This year has already seen a decade's worth of blocked deals. Just last week alone, three deals cratered: In addition to Royal Ahold-Pathmark and Abbott Labs-Alza (although I think blaming the antitrust authorities is disingenuous here -- the problems in this merger ran much deeper), there emerged terminal antitrust problems with
Delta and Pine Land
, which was just abandoned.
Last month, the FTC sued to block
acquisition of tiny
, and both
are trading at spreads that imply the market expects those deals to be blocked as well.
Check back tomorrow for Riskier Business, Part 2, where David Brail tells what the aggressive new attitude at the Justice Department, and the FTC, means for tomorrow's deals.
David Brail is the president and portfolio manager of Palestra Capital, a Manhattan-based hedge fund that focuses on risk arbitrage, and has been an investor in risk arbitrage and bankruptcy securities since 1987. At the time of publication, Palestra Capital was long Alza, Arco, Viasoft and Delta and Pine Land, and short Abbott Laboratories and British Petroleum although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Brail appreciates your feedback at