Macro Tailwinds Provide a Catalyst for Merger Arbitrage

Jason Hill

Summary Points:

• By pursuing absolute returns that are largely uncorrelated to equity and fixed income markets, we believe CMRGX provides attractive long-term diversification benefits.
• The past several months have been an unusual period for merger arbitrage, and we anticipate fewer “broken deals” going forward.
• We believe continued economic growth and stabilizing interest rates will provide a hospitable environment for merger activity.
• We believe the current antitrust regulatory environment is unusually inhospitable, but likely transitory.

Throughout the period, we sought to capture arbitrage spreads in a variety of ways—through equities, convertible bonds and other fixed income securities, and liquid options. The choices we make are bottom up, based on the idiosyncratic characteristics of the companies involved, and draw upon Calamos’ legacy in comprehensive capital structure research. We believe the fund’s breadth of investment choices offers many advantages for striking attractive risk/reward. For example, our use of options and fixed income securities provide valuable levers for mitigating downside risks.

As of the close of the reporting period, CMRGX held securities associated with 31 deals or potential deals, in line with 33 at the start of the quarter. Equities made up 64% of the securities in the fund at the end of the quarter, versus 57% at the start. Convertible securities declined from 37% to 28%, and options rose from 6% to 8%.

CMRGX: Finding opportunities across targets’ capital structures

The portfolio is actively managed and subject to change daily without notice.

Navigating regulations and political crosscurrents is often the biggest challenge for companies involved in mergers, given the many entities that may want a say. Certainly, the companies involved in the mergers are the most vested in the outcome and devote considerable effort and expense to anticipate all possible hurdles before they enter a definitive deal. Even so, occasionally the regulatory and political obstacles prove insurmountable, resulting in a broken deal. January proved to be an outlier month, and three deals were broken; in one case, the companies walked away because of concerns raised by European regulators, and in another, a state government’s objections blocked the way. The third was squashed by an individual US district court judge. The overarching theme seemed to be one of “big is bad” or “bigger is worse.” While CMRGX had exposure to all three of these deals, we believe that our trade structures and use of options were key to limiting downside.

Although we were discouraged by these outcomes, we nevertheless believe the outlook for merger arbitrage is attractive from here. We see sustained economic growth and a more stable rate environment providing catalysts for companies to enter mergers. As we noted in our previous commentary (“Stabilizing Interest Rates Can Set the Stage for a Merger Surge”), we believe many companies are simply waiting for rates to stabilize to enter into merger agreements. We look forward to participating as this pent-up demand may produce future opportunities. In our view, these agencies are pursuing new theories of harm, which have less legal and philosophical precedent. We believe this is likely to be temporary, and that just as administrations themselves are transitory, regulation will swing back to focusing more on traditional antitrust theory and case law.