The Picton Mahoney Fortified Arbitrage Alternative Fund Cl F returned 0.27%, and Picton Mahoney Fortified Arbitrage Plus Alternative Fund Cl F returned -0.27% in the second quarter of 2023.
There was unprecedented volatility in the merger arb market in the last quarter with a cluster of regulatory deal breaks. We have been commenting for over a year on the heightened regulatory risk for U.S. mergers. When Joe Biden appointed Lina Khan to head the Federal Trade Commission (FTC) in 2021, it marked a sea change in the FTC’s willingness to challenge mergers, even with weak arguments. A similar change occurred at the Department of Justice (DOJ), which also enforces antitrust law in U.S. mergers. This energetic prosecuting has not led to regulators winning in court, with the DOJ and FTC going a combined 1 for 6 in court challenges in 2022. Cleary Gottlieb calls this “the worst government merger litigation record in modern history"1.
Activision Blizzard Inc./Microsoft Corp.
The Competition and Markets Authority (CMA) of UK blocked this deal in late April resulting in a 15bps loss to the fund (unlevered). This was always a risk spread with an annualized return of more than 30%, so not a very surprising result. The companies are appealing and we still have a smaller position with some downside protection from puts. The EU recently approved the deal and in fact found it was pro-competitive in cloud gaming, a 180-degree opposite conclusion to the CMA! At the time of writing, FTC has lost a court challenge seeking to block the merger from closing and await a potential resolution in the UK.
First Horizon Corporation (FHN)/ The Toronto-Dominion Bank (TD)
This was a painful one as it appeared to be a straightforward path to closing until TD become the subject of concerns by the Office of the Comptroller of the Currency (OCC) – its primary US regulator, around its anti-money laundering practices. The first inkling of an issue cropped up in March but it wasn’t until May that TD and FHN mutually terminated. From Mar to May, the position cost about 75bps (unlevered) although risk management saved us another 75bps. The backdrop of a US regional banking crisis didn’t help with downside going lower in the period. We have now fully exited the position.
Horizon Therapeutics/Amgen Inc.
In May the FTC announced that it is suing to block Amgen from acquiring Horizon Therapeutics. There is no horizontal (competing drugs) or vertical (supplier) issues in the complaint. In fact, the complaint is one of the weakest we have seen and focuses on a nebulous concept of bundled products hurting potential future competition from drugs that don’t exist yet. This cost us about 50bps (unlevered) including some contagion to other biotech deals. We are adding to positions here.
Our Outlook
It feels like tempting fate to say that “everything that could go wrong has gone wrong” since there are always more things that can go wrong. When going through the remainder of the portfolio; however, it is largely composed of smaller (US$5-20BN market deals) with more straightforward paths. The wide arbitrage spreads that we’ve been saying are “wide for a reason” are even wider. We expect them to stay wide as there is no indication that the DOJ/FTC are being chastened by their court losses (although a Republican Presidential victory in 2024 would likely be good for the arbitrage strategy). We do generally view these wide arbitrage spreads as adequate compensation for arbitrage risk, as evidenced by the fact that our portfolios have not suffered significant losses despite the slew of negative events, i.e. we managed to profit elsewhere.
The Special Purpose Acquisition Company (SPAC) market continues to shrink and common yields are hovering around 6% as of June month end. New issue pricing in the quarter remains attractive (8-9% yields) although there were only 6 new SPACs launched in the quarter. That said, we have noted some successful regular IPOs in the market (e.g. CAVA group doubling from its IPO price). In general, when regular IPOs are doing well we can expect higher SPAC issuance and return potential.
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