Dear Unitholders,
“We expect a decline in rates to continue to drive higher M&A activity from both strategic and financial investors.”
The SPAC market continued its rebound in September with the market cap of outstanding SPACs increasing from the previous month. Several SPAC IPOs were announced throughout the month and new filings indicated that other sponsors intend to launch new SPACs in the near-term. While these SPACs tend to be backed by well-known sponsors with an established track record of sourcing and closing deals, we have yet to see this new vintage of SPACs announce a merger. It is likely that there are opportunities given the lack of IPO’s for nearly two years and higher funding costs impacting many early-stage companies. We continue to monitor new SPAC issuances but intend only to participate in those that offer the most favorable arbitrage return potential.
After several months of elevated deal activity, September was relatively slower with 10 new merger deals initiated in the Fund while six deals held within the Fund closed. Merger arbitrage spreads remain wide on both a relative and absolute basis as a recovery in M&A deal volumes, regulatory overhang and a pick-up of small cap M&A has kept spreads wide. We track potential merger deals or pre-deal M&A using a variety of screens, databases and services and it is notable that we are currently seeing the highest level of potential “deals in the works” for small and mid-cap North American companies since launching the Fund. This can include companies that have received an indication of interest, a non-definitive offer, a strategic review initiated after an expression of interest or a credible rumored deal. This does not imply that the majority of these deals in the works will result in a definitive merger agreement, but it is likely that many will become definitive, and it does indicate that markets are primed for more deals. In addition to robust M&A activity within our core small cap universe, there are several large cap deals trading at wide spreads due to elevated regulatory scrutiny that we are following closely including Albertsons Companies, Inc. (NYSE: ACI), Ansys, Inc. (NASDAQ: ANSS), Capri Holdings Limited (NYSE: CPRI) and Kellanova (NYSE: K). These mergers are likely to see catalysts materialize in the coming months blocking or supporting their acquisitions and could present compelling investment opportunities at some point. We are also continuing to find ample deal activity in our core small and mid-cap universe. The Fund continues to be fully invested given the volume of quality merger arbitrage and SPAC arbitrage opportunities. At the end of September 2024, the Fund had 36 investments in small cap deals under $2 billion, 26 of which were valued at under $1 billion.
Major stock market indices continued their march higher in September recovering from an initial fall early in the month. The S&P 500 rose 2.1% in September with the NASDAQ up 2.8% and the S&P/TSX up 2.8% while the Russell 2000 was up 0.7% in the month. The Fed delivered a jumbo 50bps rate cut during the month, cutting the Fed Fund rate for the first time since March 2020. In Canada the BOC cut rates a further 25bps noting that softening economic data and slowing inflation could drive a more aggressive pace of rate cuts through the year-end. We expect a decline in rates to continue to drive higher M&A activity from both strategic and financial investors. With short-duration fixed income investments facing a headwind of declining interest rates while merger arbitrage benefits from a tailwind of elevated activity and wide spreads, we are in an attractive environment for merger arbitrage investing. We continue to be optimistic about the forward outlook for M&A activity, merger arbitrage returns and small cap M&A in particular.
The upcoming US election could point to a turning point in M&A activity and merger arbitrage returns. The regulatory environment over the past few years has been challenging with the Federal Trade Commission Chair Lina Kahn and the US Department of Justice Antitrust Division assistant attorney general Jonathan Kanter taking a hostile approach to regulate merger deals. This has likely resulted in a decline in M&A activity as the uncertainty of closing a transaction prevented many deals from materializing. This hostile regulatory environment has also delayed the mergers of several large deals. With the potential for change in these key regulatory positions regardless of a Harris or Trump victory, the final quarter of the year appears catalyst rich for merger arbitrage. Many deals which are facing regulatory hurdles are in their final stages of approval yet still trade at wide spreads which in some cases we would consider mispriced. We will be assessing these deals carefully and believe there could be some attractive investment opportunities among them.
Amar Pandya, CFA
October 18 2024