Throughout the past three months, several mergers, including the $14 billion merger between Pfizer Inc. (PFE, Financial) and Medivation Inc. (MDVN, Financial), were announced. In part one of our study, we discussed how the John Paulson Merger Arb Checklist determines the success rate of mergers. This article will further the study by analyzing some of the recent mergers and predicting the success rate based on historical results.
Definitive agreements and limited regulatory risk are important
As implied in part one of the study, mergers that have definitive agreements and limited regulatory risk are more likely to succeed than mergers with high legal risk and weak agreements. Even if a merger has strategic rationale, the merger could still fail due to legal issues. Pfizer, which announced three mergers during the past two years, terminated its merger with Allergan PLC (AGN, Financial) due to “adverse tax law changes” as mentioned in a previous article.
For each of the seven criteria, we can assign a weight depending on the predictability of merger success. In other words, the criteria that best determine the success of mergers receive higher weights.
Based on the distribution of merger scores for the past two years, the minimum score required to ensure merger success at the 98% confidence level is about 3.9. The merger score distribution is moderately right skewed with a mean of 4.0, and the scores range from 2.1 to 5.0. Even though just 54% of mergers have scores of at least 4.0, mergers generally succeed unless they score lower than 2.7.
Three major merger announcements and their success potential
As discussed in its Aug. 22 current report filing with the Securities and Exchange Commission , Pfizer announced its merger with Medivation. The $14 billion merger is expected to increase Pfizer’s revenue growth and EPS growth through the fortification of the parent company’s innovative health and oncology businesses. Since the merger announcement explicitly states “definitive agreement” and suggests high strategic rationale, these two criteria receive a rating of 5.
As mentioned earlier, just because a merger has definitive agreements and high strategic rationale does not guarantee a successful merger. Pfizer’s merger announcement also lists “subject to U.S. antitrust clearance,” a warning sign that this merger has moderate to severe legal risk. Based on the merger rubric, if the merger announcement mentions antitrust issues, the “limited regulatory risk” receives a rating of 1. Overall, the merger score is about 3.8, slightly less than the target score of 3.9. Should the Pfizer-Medivation deal ultimately fail, the most likely reasons for the failure would be legal and antitrust issues.
The technology sector featured two major merger announcements: the merger between Verizon Communications Inc. (VZ, Financial) and Yahoo! Inc. (YHOO, Financial), and the merger between Microsoft Corp. (MSFT, Financial) and LinkedIn Corp. (LNKD, Financial). Both mergers are cash deals: Verizon will acquire Yahoo for $4.83 billion while Microsoft will acquire LinkedIn for $196 per LinkedIn share. A previous article evaluated the Verizon-Yahoo merger directly using Paulson’s checklist. With our results from the merger and acquisition study, we can more accurately predict the success of this merger. Based on the newly revised merger rubric, the Verizon-Yahoo merger receives the following scores.
Using the defined weights for each of the criteria, the overall merger score for Verizon-Yahoo is 2.4, suggesting that this merger is not likely to succeed. However, since this merger was recently announced, the ratings may fluctuate as the merger receives the necessary approvals. The Verizon-Yahoo merger still has potential to succeed, but it does face several obstacles.
On the other hand, the Microsoft-LinkedIn merger has a higher chance of success since its overall merger score is 3.9. This score is based on the following ratings as described in the chart below.
Conclusions
While historical results can provide expected results for future mergers, we cannot assume a merger will succeed just because it received a high merger score. Many factors can unexpectedly occur between the time of merger announcement and the expected time of merger completion. In his book, “Managing Hedge Fund Risk,” Paulson highlights both types of risks that mergers face: macro risks and micro risks. Even if the merger receives all of the required approvals and is expect to close, financial and economic recessions can still thwart otherwise successful mergers.
Disclosure: The author has no position in any of the stocks mentioned in this article.
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