Throughout the first three quarters of 2024, Global M&A activity totaled $2.3 trillion. The technology sector led in activity with a total volume of $375 billion, accounting for 16% of overall value, followed by Energy & Power at 16%/$374 billion and Financials at 12%/$308 billion. Drivers of M&A have recently been mixed, according to Gabelli Partners. Portfolio Managers Ralph Rocco, Willis Brucker and Paolo Vicinelli point out that there have been some headwinds in recent years, namely a hawkish regulatory environment fostered by aggressive anti-trust regulators in the US, who were suing deals based upon novel antitrust theories. “This aggression likely led to some management sitting on the M&A sideline. For those companies pursuing M&A, the aggressive regulators dissuaded some managements from pursuing deals after the deal deadline, caused spreads on other deals to widen, and were successful in blocking a few deals”. Nevertheless, the team points out that some tailwinds have emerged lately, leading to increased deal volumes, and have generally been positive drivers of performance.
Rocco, Brucker and Vicinelli are the portfolio managers leading the GAMCO Merger Arbitrage strategy, which has been in place since its launch in 1985 and has a UCTIS version, the GAMCO International Sicav GAMCO Merger Arbitrage UCTIS – Class I USD, launched in 2011. The investment process has remained unchanged over these 39 years, irrespective of whether the market environment was positive or negative. “We take what we believe is a conservative approach to M&A investing,” they say.
They tipically initiate deals with a small position size, which they may increase as deal hurdles and milestones are met. Position sizes are generally limited to ~5% of the total portfolio at cost, which contributes to the desired outcome of being diversified. Finally, they continuously monitor pending transactions for all the elements of potential risk, including: regulatory, terms, financing and shareholder approval. “We trust that our consistent approach will enable us to continue to earn positive risk-adjusted absolute returns for our clients”, PMs add.
Can you explain your approach to investing in M&A in the public markets?
The announcement of a deal is the beginning of our investment process. Simply stated, merger arbitrage is investing in a merger or acquisition target after the deal has been announced with the goal of generating a return from the spread between the trading price of the target company following the announcement and the deal price upon closing. This spread is usually relatively narrow, offering a modest nominal total return. Since deals generally close in much less than a year’s time, this modest total return translates into a much more attractive annualized return.
The objective of our merger arbitrage portfolios is to provide positive “absolute returns,” uncorrelated with the market. Returns are dependent on deal closures and are independent of the overall stock market movement. Deals complete in all types of market environments, including the recent 2022 market decline, which led to a +2.8% performance for the Merger Arbitrage strategy fund while the broader equity and fixed income markets were down double digits.
We have been managing dedicated merger arbitrage portfolios since 1985 as a natural extension of Gabelli’s Private Market Value with a CatalystTM methodology that is utilized in our value strategies. In 2011, we opened the strategy to European investors and have earned positive net returns for our clients in 13 consecutive years. The strategy is available in several currencies, including USD, EUR, GBP, and CHF.
We invest globally across a variety of listed, publicly announced merger transactions. Our portfolios are highly liquid, with low market correlation. Historically, the volatility is approximately 1/3 that of the S&P 500, and our beta is roughly 0.15. We watch and wait for transactions with high strategic and synergistic rationale in industries we know well, leveraging the fundamental research and collective knowledge of over 30 Gabelli industry analysts, who follow and analyze companies within our proprietary Private Market Value with a Catalyst investment methodology. They are experts in their areas of coverage. We comb through filings and merger agreements, and speak with management in order to outline a strong and clear path for deals to be completed.
You mentioned the aggressive anti-trust regulators impacted recent returns. Do you anticipate any changes in regulation under the Trump administration next year?
We believe the incoming Trump administration will usher in a much more deal friendly environment, with the expectation that there will be a change in leadership at both the Department of Justice (“DOJ”) and the Federal Trade Commission (“FTC”). We have already seen an increase of new deals announced after President Trump’s successful election. With friendlier M&A regulators paired with lower interest rates, we anticipate a deal boom for 2025, which may continue over the next four years.
How is the Fed’s rate cutting cycle affecting M&A activity?
In 2023, the U.S. Federal Reserve ended its series of interest rate hikes. This helped provide acquiring company managements with certainty of financing cost, giving confidence to M&A. With rate cuts beginning in 2024 comes lower costs of financing, which further encourages managements. Additionally, the steep market decline in 2022 caused market price dislocations, which prompted targets and acquirers to come to new price understandings. This began to wear off in the second half of 2023 into 2024.
While we have no crystal ball into the Fed’s actions, its comments indicate, and the market anticipates, further rate cuts to follow in the new year. We believe that, with rate cuts, deal volume should increase, as acquirers will be able to take advantage of the lower costs to finance their acquisitions, and further bolster M&A activity in the year ahead.
How are you positioned into the near year?
Our process is sector agnostic. We approach each deal on a risk/reward basis, investing in deals that we believe have the highest likelihood of closing. Our sector exposure is generally indicative of where we see attractive deals.
We are fully invested and are bullish on the M&A environment in the coming year due to favorable tailwinds:
- deal spreads are near the highest level in nearly a decade,
- a more favorable anti-trust/regulatory environment,
- prospect of further rate cuts, and
- an expected increase in deal volume under the Trump administration
If you are interested in learning more about the potential benefits of investing in M&A in today’s markets, the Gabelli UCITS team is available at SICAVInfo@gabelli.com or by calling +1-914-921-5135. Please visit us at www.gabelli.com/sicav for more information on our UCITS funds.
