As published in Conseiller on 19 June 2023.
While global M&A has slowed down considerably since last year due to investor jitters amid a steep rise in borrowing costs and market uncertainty, if you know where to look, there are still sectors where strong investor appetite and activity dominate: healthcare, industrials, and materials. These sectors are the beneficiaries of four powerful trends:
- Reshoring of supply chains driven by geopolitical tensions
- Electrification and the need for scarce material resources
- Greater global urbanization and the need for optimized energy and infrastructure
- Higher inflation and interest rates driving up debt management costs
The healthcare sector has seen a significant spike in activity this year with deal volumes surpassing last year’s levels by nearly 50%. The pharmaceuticals and biotech industry have seen dozens of deals announced in the past couple months providing a high-quality source of deal-flow for merger arbitrage investors. This spike in activity has been driven by a multitude of market and industry specific factors providing an ideal environment for M&A.
Taking a closer look at the biotech sector which has seen a surge of M&A activity, a biotech company is typically focused on a single drug or therapy. This necessitates raising millions of dollars in funding to research, develop and submit a drug for approval to the FDA where the ultimate timing and outcome is uncertain. Against this backdrop, investing in a biotech company is highly speculative. Hence, rising interest rates, increased market volatility and lower investor risk appetite for speculative investments, has left many biotech companies capital starved and trading at steep valuation discounts.
Large pharmaceutical companies with strong balance sheets and cash positions can acquire a drug developer with promising or proven clinical results. The acquirer can then leverage its own marketing, distribution channels and fixed overhead costs which could justify paying a steep premium to add a new drug to the portfolio. While Big Pharma and Big Insurance are increasingly targets for regulators, the new drugs and therapies developed in the biotech sector have less overlap with existing drugs and thus face fewer regulatory hurdles. As biotech acquisitions are typically financed with available liquidity and structured as a tuck-in to a larger pharmaceutical company, biotech acquisitions have a tendency to close in a shorter time providing attractive returns to arbitrage investors, especially when the deal is structured as a tender offer. A tender offer typically doesn’t require approval from the board of directors of or a shareholder vote to approve the proposal allowing for a substantially faster completion time than a merger.
An example of this type of deal was the acquisition of Provention Bio, Inc. (NASDAQ: PRVB) by Sanofi S.A. (EPA: SAN) with Sanfoi seeking to add Provention’s TZIELD , a first-in-class therapy in type 1 diabetes to their general medicines asset portfolio. On March 13, 2023 Sanofi announced an agreement to acquire Provention with the terms of the merger agreement stipulating that Sanofi would commence a cash tender offer to acquire all outstanding shares of Provention for $25 per share. The closing price of Provention’s shares on the day the acquisition offer was announced was $24.10 with the merger completing only 46 days on April 28, 2023. Buying that merger deal at the closing share price on the date of announcement and holding through completion would have provided a return a 3.7% and an annualized yield of over 33% highlighting the attractiveness of this type of deal structure.
The biotech sector has seen a surge of activity providing arbitrage investors with a plethora of high quality, low risk, and potentially, high yielding investment opportunities. In the Pender Alternative Arbitrage Fund, we have added several new positions recently including: Heska Corporation (NASDAQ: HSKA), Prometheus Biosciences Inc. (NASDAQ: RXDX), Satsuma Pharmaceuticals, Inc. (NASDAQ: STSA), BELLUS Health Inc. (NASDAQ: BLU), Spectrum Pharmaceuticals, Inc. (NASDAQ: SPPI) and IVERIC bio, Inc. (NASDAQ: ISEE).
Private equity firms continue to be active dealmakers in the public market representing a leading share of deal-flow and announcing the majority of the largest deals through the year.1 With nearly a trillion dollars of capital in PE firms needed to be deployed, attractive public vs. private valuations, a return of bank-led debt financing and general partner incentives to do deals, the environment is positive for an uptick in M&A going forward.
One benefit of the elevated volatility and regulatory risk witnessed in the market in March was a widening of arbitrage spreads as investors reprice deal risk and demand higher compensation in the form of risk and liquidity premiums. This leads to a greater dispersion in spreads or a greater mispricing of deal-risk which allows arbitrage investors to adjust exposure to various deals and optimize risk-adjusted returns.