Weekend thoughts: are deal downsides blowing out?

A quicky thought from this weekend.

In merger arb, you generally estimate the downside of a deal by using a stock’s unaffected price (i.e. the price before the merger was announced). So, for example, CPRI was trading for ~$35/share before they announced a deal to get taken over by TPR last August; if you were estimating the downside in a break, you’d generally plug $35 into your model for CPRI’s downside (i.e. if the stock was trading for $46, you’d say the market was ~50/50 for the deal to go through. $11 upside to $57 deal price; $11 downside to $35 pre-deal / assumed break price). But CPRI’s results have gotten much worse since the deal was announced, and most investors are generally viewing CPRI’s downside as ~$25/share. Sure enough, the stock has been hovering around $35/share since the FTC challenged CPRI’s merger (using a $25 downside, the market would be pricing the deal at ~38% to go through right now, though you could quibble with both downside and some tail odds that the deal price is cut).

CPRI’s downside blowing out continues a recent trend we’ve seen where antitrust challenges a deal, and the downside turns out to be way lower than the previous standalone price. Both SAVE and IRBT got challenged (and blocked) by regulators, and both are now on the verge of distress / bankruptcy. SAVE is a particularly interesting case; the stock was trading for ~$20/share in early 2022 before they had a freaking bidding war between ULCC and JBLU (with JBLU winning with a price >$30/share, including the dividend); today, the stock is <$4. Just look at the stock chart below; I know the stock is not the business and things can change over time, but isn’t it crazy to look at the stock plummeting and think “over this time, Spirit was the subject of a fierce bidding war and an antitrust effort that argued they were so uniquely successful in lowering prices for consumers that no reasonable regulator would allow any competitor to buy them?”

source: YCharts (YAVB readers can get a free trial by signing up here)

Or consider TWTR; that case / delay wasn’t antitrust, but TWTR’s value did melt down between signing the deal and Elon being forced to close (observers widely agreed that the company was worth ~half (or less) what Elon ultimately paid when he took it private)).

So here’s my question / what’s floating around my head: why are so many deal targets seeing their standalone value crash during their deal pendency? I can’t remember it happening this often / this frequently before. Perhaps my memory is lacking and this is a normal occurrence. Perhaps it’s a result of this administration (which is probably the most aggressive on antitrust enforcement in history, and I don’t think it’s particularly close). Or perhaps there’s something else going on; I personally think business is moving a lot faster than it did even a few years ago (let’s call it pre-covid), and firms don’t have a lot of ability (or incentive!) to respond rapidly to shifts in the environment while under a merger contract (the merger contract legally limits what a seller can do while waiting on the deal to close, and what manager is going to work overtime to respond to a shifting marketplace when it will be someone else’s problem when the deal closes in a few months?).

It could be any of those reasons, it could be a combination of them, or it could be something else entirely! I don’t know… but I do know that as a special situations and (occasional) arbitrage investor, it’s something that’s top of mind / that makes me a little nervous in looking at or putting on new positions / I’m adding some extra room on the downside to account for how many of these deals / businesses seem to deteriorate while events are playing out.