How Will Arbitrage Professionals Impact the Lexmark Transaction?
Lexmark Gets a Buyer after a Long Sales Process
Arbitrageurs will probably want to have some of this deal in their portfolios
This deal is a combination of a private equity spread and strategic logic. Generally speaking, private equity deals have wide spreads, but little to no strategic logic. In other words, it’s all about cheap financing and faith that the private equity firm can run the company better than it has traditionally been run. On the other hand, strategic deals will have commercial logic. However, the profit potential tends to be small unless there are regulatory issues with the transaction. In this case, you’re getting the best of both worlds.
So why is the spread so wide?
As a general rule, a 21% annualized return and a 5:1 risk-to-reward ratio would be associated with a risky transaction. Given the fact that Lexmark probably doesn’t have any national security issues and there doesn’t appear to be antitrust risk, regulatory approval should be pro forma. So, why is the spread wide?
The most likely reason is that there’s a lot of pain with arbitrageurs lately. The Baker Hughes-Halliburton deal was blocked in the US. The Pfizer- Allergan merger scuttled over new tax laws in the US. The Staples-Office Depot merger was also blocked. There was a story in the press that said Anbang pulled its offer due to instruction from Chinese regulators. Could another situation happen here where Chinese regulators decide that they don’t want Apex to buy Lexmark? If the financial situation in China gets worse, will financing disappear?
That said, a 21% annualized return and a 5:1 risk-to-reward ratio is probably fair compensation for taking those risks.
Merger arbitrage resources
Other important merger spreads include the deal between Cigna (CI) and Anthem (ANTM) and KLA-Tencor (KLAC) and Lam Research (LRCX). For a primer on risk arbitrage investing, read Merger Arbitrage Must-Knows: A Key Guide for Investors.
Investors who are interested in trading in the tech sector can look at the iShares Global Technology ETF (IXN).
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