Must-know: Analyzing the Time Warner Cable–Comcast deal (Part 11 of 11)
The annualized return is probably overstated
Arbs generally avoid utility deals—and for good reason. Typically, the companies have an aggressive expected timeline and these deals don’t close on time.
In the Time Warner Cable (TWC) and Comcast (CMCSA) transaction, you’re getting about a 10.6% annualized yield. That assumes the timing guidance is correct. But chances are, it isn’t. The companies might be able to get this through the FCC in 180 days, but New York State can take a long, long time.
Note that Comcast also spells out how far it’s willing to go with regulators. If regulators demand too much, which the merger agreement specifies as a “burdensome condition,” then Comcast can walk away. The deal breaker would end up being any divestiture of over 3 million subscribers. Arbs are undoubtedly calling Comcast, asking for more color on what constitutes a “burdensome condition.” The company probably isn’t going to give much more guidance than what’s already stated in the merger agreement.
The risk-to-reward ratio is probably about right for a deal with this sort of scrutiny. If the spread tightens to a 5:1 ratio, it’s probably an unwind. These aren’t hard and fast rules. But you should look at them as general guidelines.
Should you short the spread?
Given that the deal was a competitive situation before, you have to be careful that someone else steps in. While that’s highly unlikely in this situation, it’s a non-zero probability. You should probably take that into account.
While it often makes sense to reverse some merger spreads as a general portfolio hedge, utility deals aren’t really suited to this strategy. Why? Utility-type deals usually do close. It’s only a matter of dividing up the synergies with the regulators. Some arbs will reverse these deals in anticipation of a “scare,” which is a temporary widening of the spread on some negative news—typically a regulator commenting to the press that the deal’s in trouble.
Experienced arbs will take this as the standard choreography of utility transactions. The newbies might panic out of their positions or unwind some. The experienced arbs may use the scare to exit their position or even set some up. You probably can have some fun trading the spread around, as it will be subject to wild swings as politicians open their mouths.
Other merger arbitrage resources
You can find Market Realist’s primer on merger arbitrage analysis here .
Other important merger spreads include Covidien (COV) and Medtronic (MDT) as well as DIRECTV (DTV) and AT&T (T). You can find the analysis for the COV–MDT deal here .
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