Regular readers of The Squeeze will be familiar with the months-long saga of Elon Musk’s various attempts to buy, and then not to buy, Twitter (US: TWTR). Ever since his initial hostile takeover bid for $54.20 a share in April, the Tesla founder has taken markets on a rollercoaster ride with his antics aimed at backing out - or allegedly securing a lower price - for the deal. However, the to-ing and fro-ing will come to an end with a showdown trial in October, a Delaware court ruled this week. For all his protestations about Twitter’s problems with bots and fake accounts, Musk could end up being forced to complete his purchase of the blue bird app.
It’s not only Musk - and his lenders at Morgan Stanley - that have money riding on this. High-profile takeovers often catch the eye of merger arbitrage investors, who aim to make a return by correctly predicting the outcome of a deal. This is because the stock prices of takeover targets typically swing wildly after a bid is announced, and can remain volatile right up until the takeover is completed - meaning that traders can profit from the difference or ‘spread’ between the share price and the takeover price.
In the case of Twitter, shares jumped by 28 per cent to nearly $50 in one day, when it was revealed that Musk had bought a 9 per cent stake in the company. By the time his formal takeover bid was accepted by the board, shares had risen again to $51.70. And since then? The price has drifted back down to below $40.
Volatility is profitability for hedge funds. An investor that buys shares in Twitter now could stand to make a 36 per cent gain if the deal completes at the agreed price - which would be a big win, especially in a year when stock markets have fallen precipitously. This is a much higher potential reward than the average deal, though, and reflects the real risk that the deal will not complete at the agreed price. Large buyouts (worth $5 billion or more) usually have a spread of between 2 per cent and 4 per cent, 30 days after the announcement is made, according to research from PitchBook.
Takeover speculation is rife in British markets at the moment, and investors might be tempted to buy in for fear of missing out. As the share prices of companies like Ted Baker and The Hut Group sink to new lows, private equity investors are rumoured to be circling, with the potential to offer a good return to the investors that buy these shares at depressed levels.
There are reasons to remain cautious of takeover hype, though.
One is that investing in rumoured takeover targets is very risky. This is especially true in the case of a hostile takeover, where fewer than 40 per cent of bids succeed, according to research from the Journal of Financial Economics. On the other hand, open bidding processes can also be disappointing, even when the company at hand is looking for a buyer. For example, Ted Baker’s share price crashed by 18 per cent in one day in June after its chosen suitor walked away without tabling an offer for the fashion brand.
Once a bidder is found, there is the risk that the buyout may not end up following the original agreement. Louis Vuitton Moet-Hennessy tried to back out of its offer to buy luxury jeweller Tiffany & Co in 2019, and though it was forced in court to go through with the deal, it managed to argue the price down by $425mn from its original offer.
Even in cases where both parties agree on a price, many deals fall at the final hurdle of regulatory approval. Microsoft’s $69bn takeover of video game publisher Activision Blizzard is currently being weighed up by competition and anti-trust authorities in the US and UK, who could bar the acquisition on the basis that it would harm the gaming industry.
For all that risk, the gains from a takeover are usually not distributed equally. A Harvard study has shown that even before any news of a takeover breaks publicly, there is usually a run-up in the share price that incorporates around a third of the overall takeover premium. This means retail investors will often miss out on a large chunk of the potential returns.
So, Twitter v Musk will undoubtedly make for a dramatic showdown, but it’s probably not one to bet your pennies on. A more traditional takeover story can likewise offer a few percentage points of upside but, for retail investors, it is usually not worth the large downside risk.
This content is published weekly in The Squeeze newsletter, which is a fresh, new take on investment news giving less experienced investors the what and why of the latest pressing stories. Delivered every Friday.
Click here to sign up to receive The Squeeze newsletter every week.
