Recently, chairman and CEO Warren Buffett of Berkshire Hathaway (BRK.A +1.46%)(BRK.B +0.98%), a $705 billion holding company that owns a diversified portfolio of businesses and stocks, announced a merger arbitrage play with Activision Blizzard (ATVI +0.00%), a video game publisher. Merger arbitrage is a short-term investing strategy of buying stocks of companies trading below their acquisition price. And despite being known as a long-term investor, Buffett has participated in merger arbitrages for more than 30 years.
Activision Blizzard is not the only merger arbitrage available in the public markets right now. Staying in the video game space, Take-Two Interactive Software (TTWO +0.93%), a video game holding company, plans to acquire mobile and social networking video game developer Zynga (ZNGA +0.00%) during the first quarter of Take-Two's fiscal year 2023, ending June 30, 2022. And while there appears to be a juicy merger arbitrage play on the surface, there's more than meets the eye.
Is Zynga a worthy merger arbitrage play?
When Take-Two announced the acquisition in early January, the video game company planned on paying a total value of $9.86 per share of Zynga -- $3.50 cash and $6.36 in shares of Take-Two common stock, valuing Zynga's enterprise value at $12.7 billion. With Zynga recently traded at $8.32 per share at close on Thursday, the "spread," or the percentage between the stock's trading price and buyout price, would be 16%.
Image source: The Motley Fool.
However, there was fine print in the announcement that could lower the price if Take-Two's price per share fell below a certain threshold. Specifically, the deal stated that if Take-Two's 20-day volume-weighted average price ("VWAP") ending on the third trading day before closing is below $156.50 to $181.88, then the exchange ratio would be 0.0406 Take-Two shares for each Zynga share.
NASDAQ: ZNGA
Key Data Points
And Take-Two's 20-day VWAP on the third trading day prior to May 4, 2022, was below the specified range at $139.19. Therefore, the exchange ratio would result in $5.65 in shares of Take-Two common stock. Coupled with the $3.50 in cash, Zynga shareholders would receive $9.15 per share. As a result, Zynga's actual spread is less enticing at 9.1%. Furthermore, Take-Two's stock recently dropped to $121 per share, meaning the 20-day VWAP is likely to fall even further.
Warren Buffett's merger arbitrage history
In 2018 and 2019, Warren Buffett made a merger arbitrage play after IBM announced it would be acquiring Red Hat at $190 per share. Additionally, in 2017 and 2018, Berkshire steadily purchased Monsanto Co. shares for over a year after Bayer AG announced it would be acquiring the company.
Notably, in all three cases, the acquiring company paid all cash for the acquired company. At Berkshire's most recent annual meeting, Buffett noted how these particular well-established companies created an outsized "spread," the percentage between the stock's trading price and buyout price, because of regulatory risks. However, there was no concern that the acquiring company couldn't afford the price tag.
Are there any other merger arbitrages available?
Even if it's unlikely that Buffett will participate in the merger arbitrage of Zynga because it isn't an all-cash deal and the spread fluctuates daily, there are other opportunities available. Most notably, Elon Musk has announced his intentions to acquire Twitter (TWTR +0.00%) at $54.20 per share in an all-cash deal, creating about an 11% spread based on its recent price of $48.87. Additionally, private equity giant Apollo Funds plans to acquire auto-parts maker Tenneco (TEN +0.00%) at $20.00 in an all-cash deal, representing a roughly 20% spread based on its recent price of $16.09.
As mentioned, but worth repeating: All acquisitions must pass regulatory approval in the U.S. and European Union. Over the past two years, regulators sued to block computer-chip maker Nvidia from acquiring British technology provider Arm and Visa's acquisition of Plaid due to antitrust concerns. Still, merger arbitrage can be a rewarding investing strategy. Just ask Warren Buffett.
