By Salvatore Bruno via Iris.xyz.

Given that merger arbitrage deals are the core component of a merger arbitrage strategy, what happens when merger & acquisition deal volume declines?

For several years, we’ve been in the midst of an M&A boom. According to Dealogic, in 2018, U.S.-targeted M&A volume reached a total of $1.74 trillion and 7,791 deals. Q1 2019 was busy, too, as U.S.-targeted M&A broke historical first quarter records, reaching a total volume of $537.6 billion and 2,158 deals. So, while it may seem a little early to worry about running out of transactions, M&A is highly cyclical and the day will come when volume declines.

Two of the key metrics that drive the performance of a merger arbitrage strategy are deal premiums and completion rates. We raised the question, are either, or both of these key performance drivers impacted by a decline in the number of deals?

Our research revealed two significant findings. First, there appears to be a positive relationship between S&P 500 Index returns and the subsequent change in the number of deals that are announced. The chart below shows an increase in deal flows following positive market returns.

Deals vs S&P 500 Index Returns
Second, there appears to be no statistical relationship between the changes in the S&P 500 Index and the merger premiums offered by acquiring companies.Deals vs S&P 500 Index Returns 2
Examining merger deal premiums grouped by calendar year shows the annual average ranges from 20% to 47%, with the historical average at 31.2%. The data suggests that while the pipeline of transactions may correlate with the market (as proxied by the S&P 500 Index), acquirers are still offering a consistent premium for target companies. Therefore, the S&P return and number of announced deals (above a bare minimum needed to execute the strategy) should have little or no impact on the potential return of a merger arbitrage strategy, in our opinion.
Read the full article at Iris.xyz.