Mergers can mean major risks for investors

Feb 6, 2024

By: Philip MacKellar

Do you think there is enough competition in the economy, or are big businesses using their weight to squash the competition and hurt consumers? This is certainly a question on both sides of the border. Here in Canada, the Shaw-Rogers merger a year ago, the recent RBC acquisition of HSBC Canada and the feud between the Competition Bureau and national grocery chains highlight this point. Meanwhile, in the United States, the Biden Administration is trying to push back against big business.

Federal Trade Commission (FTC) president Lina Khan and assistant Attorney-General for Antitrust Jonathan Kanter have taken an aggressive approach to enforcing antitrust law. Last month, the FTC blocked JetBlue’s US$3.8-billion acquisition of Spirit Airlines, and late last year the FTC won a case in federal court against biotech Illumina for its US$7.1-billion acquisition of Grail. As a result of this FTC action, Illumina will divest its ownership stake in Grail.

Blocking pending proposals like the JetBlue offer for Spirit Airlines is one thing, but convincing a federal court to unwind a transaction that has already closed is entirely different and exemplifies how aggressive the Biden administration is willing to be to preserve competition.

In addition to taking companies to court over their proposed and completed mergers, the Justice Department and FTC are tightening the rules. In December, they published 11 new guidelines that will make future mergers and acquisitions more difficult.

Shortly after the FTC notched these wins against JetBlue and Illumina, Amazon AMZN-Q -0.68%decrease announced it was dropping its bid to buy vacuum maker iRobot. According to Reuters, FTC staff had told Amazon employees in private meetings that they would block the iRobot tie-up. The fact that Amazon, with all its financial resources, legal expertise and lobbying clout, backed down is nearly as remarkable as the unwinding of the Illumina deal for Grail.

This regulatory scrutiny has major implications for corporate management teams, long-term shareholders, and merger-arbitrage investors. For those new to the term, a merger-arbitrage (or risk-arbitrage) investor is someone who attempts to profit from M&A by buying the stock of the acquiree and – in the case of stock-for-stock deals – shorting the stock of the acquirer.

Owners in Spirit Airlines and iRobot have seen their shares tank. Spirit Airlines is now looking into refinancing its debt and there is speculation it may file for Chapter 11 bankruptcy. For its part, iRobot has announced a restructuring plan that includes a leadership transition and laying off 31 per cent of their staff. The road ahead for both these companies appears tough.

The FTC may be far from done. With their new guidelines in place and a handful of big wins at their back, it is possible they might become even more aggressive. There are many mergers out there that they will be looking at closely. Grocery giant Kroger Co. is attempting to buy Albertsons in a purchase worth US$24.6-billion, Alaska Air is trying to buy Hawaiian Airlines for US$1.9-billion, and amusement park operator Six Flags has proposed merging with Cedar Fair in a deal that has an enterprise value of approximately US$8-billion. While these transactions may close, as Microsoft was able to complete its purchase of Activision Blizzard despite FTC opposition, the odds are stacked against them.

Microsoft is again under scrutiny by the FTC, which is looking into whether investments made by the tech giant, Amazon, and Google in startups such as OpenAI and Anthropic risk stifling innovation, concentrating power in Big Tech, and undermining competition. It is hard to determine if the FTC will be successful here. Blocking a merger on anti-competitive grounds is a well-established practice, but cracking down on companies for their partnerships seems like new territory. Regardless of the outcome, this is yet more evidence supporting the view that the Justice Department and FTC are clamping down on potential anti-competitive actions.

Regulators can and do make mistakes, though. Blocking a deal on anti-competitive grounds can backfire if the entity that would have been acquired then scales back from certain markets, downsizes or goes bankrupt. When this happens, competition suffers, consumers end up with fewer options, and the efforts of regulators start to look questionable.

In 2015, for example, Walgreens Boots Alliance attempted to purchase Rite Aid, but was thwarted by the FTC. In the aftermath of the failed deal, Rite Aid downsized, and never regained its footing. The pandemic took a toll on their operations and they faced a wall of litigation related to the opioid crisis. Ultimately, Rite Aid filed for Chapter 11 bankruptcy last year.

Again in 2015, the FTC blocked an attempted merger between Staples and Office Depot. The agency argued that the combination would have created a monopoly in the business-to-business office supplies market. Industry observers, however, argued the FTC was underestimating the impact of Amazon on the office product market. Indeed, in the years that followed, Amazon muscled in on the sector without a strong peer to stand against them. Office Depot eventually rebranded to ODP Corporation after pivoting away from an exclusive focus on office products, and Staples languished before being acquired by private equity. Time will tell if the FTC and Justice Department under the Biden administration are making this error again.

As we head into the U.S. election season, it is possible Donald Trump and Joe Biden spar over the FTC’s recent actions, and over the state of competition within the economy in general. Mr. Biden’s pro-consumer bias and Mr. Trump’s pro-business stance are at odds and present voters with a sharp contrast. It is worth noting, however, that while Mr. Biden’s administration has filed more complaints and blocked more deals, the Trump administration launched more investigations during his time in office.

Regardless of how politicians spin the debate during an election year, the implications for investors are clear. Buy-and-hold investors who are fortunate enough to have an acquisition offer on the table may wish to adjust their strategy and sell or trim their stake before the close. Otherwise, they may be left holding the bag. Moreover, those engaged in risk-arbitrage may need to sharpen their analysis and accept that, in addition to all the regular issues that can thwart a takeover offer, they must now contend with an aggressive FTC and Justice Department, which are keen to block deals. Under Mr. Biden, big business combinations are in the crosshairs and the term risk-arbitrage is living up to its name.