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Introduction

I am no seasoned expert on antitrust law within the United States, however, I enjoy engaging in a certain trading strategy that goes by the name of merger arbitrage which essentially involves private or public companies acquiring publicly traded companies, and this just happens to be the rising scenario and potential arbitrageur’s opportunity with the recent talks surrounding both privately held Mars Incorporated and publicly traded Hershey looking to reportedly bid for and be the victor that would ultimately wholly acquire Chicago-based rebranded Kellogg, the snacking empire that now goes by the name of Kellanova.

Sorry, I’m just a sucker for run-on sentences.

In briefly outlining what merger arbitrage is from both a generic trading and 30,000-foot deal perspective, a deal such as this one might go a little something like this. 

In the sole case of Mars looking to formally bid for and buy Kellanova, for example, Mars would, after all of its behind the scenes discussions with consultants, bankers, lawyers and those on Kellanova’s team, ideally produce a definitive merger agreement (DMA), which is basically a formal announcement of the company’s intent to wholly acquire Kellanova, also including important aspects such as the deal’s terms. This outlines the stock price that Mars would intend on buying Kellonova out at, of course, having to naturally sweeten the deal a bit by offering current Kellanova shareholders a premium to the current stock price, making it worth their shares being bought out, especially since target shareholders do indeed play an integral part in green-lighting the deal and pushing it forward down the approval pipeline.

The shareholders usually go with the flow, truth be told, so long as the premium Mars would be paying to acquire all of the outstanding shares was exactly like the candy bars it sells; healthy enough. In this case, Mars Incorporated might offer to buy each share of Kellanova’s stock at a price of $82 (random but realistic figure), which would almost instantly bump up the stock price to about $80 and some change, the trader’s spread lying between $80 and $82, being the direct (pre-tax) profit the arbitrageur could enjoy if the deal ended up closing as planned.

Regulatory Considerations

At any rate, once the deal is formally announced in this fashion and the target’s stock price pops up near the target acquisition price (again, $82 in this example), the relevant regulatory agencies such as the stateside Federal Trade Commission (FTC) and Department of Justice (DOJ) get involved along with other relevant global governmental agencies (which would be the case for such a large scale, global deal such as this one) and mull through previous cases and deals and a host of other facts and figures that would aid them in ultimately determining whether or not the proposed acquisition put in front of them should be allowed to go through or not, performing troves upon troves of research in other areas as well. 

For the stateside agencies I mentioned, they are primarily looking at how this deal would impact consumers and the overall business landscape and industries the companies currently operate within. In the case of Mars acquiring Kellanova, if Kellanova were to be susceptible to this buyout (which is usually the case, but understand that it is not always the case), these companies are tasked with clearly and concisely outlining how such an acquisition would not end up being more of a burden on consumers. The biggest concern in this arena usually analyzes what would happen as a result of the combined pricing power of these two companies becoming one giant conglomerate and, at the end of the day, ultimately adhering to any of the conditions the aforementioned agencies demanded be part of the deal, so as to better ensure that the result of the proposed acquisition wouldn’t lead to consumers being stuck with paying more for either of the company’s products, that is, as a direct byproduct of the deal being closed.

In basic human terms, regulators want to ensure that the two becoming one don’t have too much pricing power that would negatively impact consumers as a result of the deal successfully closing.

With great market share comes great pricing power.

A modern example of this occurrence can be found in that Kroger is in the process of trying to acquire one of its most formidable competitors, Albertsons, and the FTC recently demanded that as a provision of the deal moving forward through the lengthy regulatory approval process, both parties are subject to divesting nearly 600 stores to one of their smaller competitors, C&S Wholesale Grocers, so as to help other smaller grocery operators remain competitive with the combined Kroger and Albertsons enterprise.

Regarding such a large (potential) deal, Mars and/or Kellanova might also be subjected to selling off some of its current business units or related plants and/or facilities in order to help other companies within the snacking and candy categories remain competitive as a result of the acquisition going through. For instance, if talks between Mars and Kellanova persist, a regulatory agency such as the FTC might stipulate that for the deal to be approved, Mars would have to sell thirty of its manufacturing facilities in the United States to say, Hershey, or it might have to sell off a handful of its renowned brands so as to, in essence, better spread out the competition and not maintain too much relative power.

The interesting thing that I will briefly mention about being a merger arbitrage specialist is that you ultimately do not care who ends up buying a publicly traded target company, but you just largely care about said target company being bought out in the first place, because that is when the spread fully closes and a pre-tax profit is generated for the arbitrage adventurer. 

Evidently, an arbitrageur’s dream scenario is a bidding war for a target company and the entirety of its assets, as this almost always drives up the perceived value of the company up, and with it, its share price.

Now, there are a few different considerations I consistently go through when pondering both officially announced deals but also merely reported deals such as this one that are floating in and around the business press.

My Process

First of all, I tend to not get immediately involved with deals that are not official, or that don’t have a definitive merger agreement attached, as mere reports can sometimes, believe it or not, just be mere reports and while I will admit that it is incredibly tempting to jump at the opportunity of buying into a potential deal that very well might morph into a legitimate, official deal being that you can potentially maximize your profit since the spread is going to be inherently greater than it would be upon just waiting for a deal to be officially announced, a risk arbitrageur is surely in the business of taking risk but even more so, from my vantage point, of specifically managing risk and focusing on consistently hitting singles, not home runs.

In other words, while it is great to have one’s ears close to the overall business and mergers and acquisition landscape, I have not found it to be the wisest strategy to invest in reported, potential deals but rather investing in officially announced deals.

Moving further down the investment pipeline, if a deal is officially announced, I initially consider whether or not the proposed merger or acquisition makes sense, primarily from a synergistic perspective. 

In the case of Mars and Kellanova (let’s just say for all intents and purposes this deal was officially announced), it makes general sense as to why Mars would want to buy Kellanova out and vice versa. First, if I happened to be a Kellanova shareholder (I will neither confirm nor deny), I’d enjoy the opportunity of having my ownership position bought out at a premium, but from a more business-rooted perspective, it makes sense for one gigantic snacking company like Mars Incorporated to want to buy a slightly smaller but still quite powerful operator like Kellanova due to the heightened market share it will surely gain, which will undoubtedly lead to higher revenues, more potential growth levers, the long-term cost savings Mars could incur while also feasibly making the case that it will lead to consumer prices remaining low as a result of the deal closing, the rationale usually being that it will be able to wield even more pricing power with its combined suppliers and subsequently keep prices on the lower end for consumers like you and me.

At least, that’s what the regulators like to hear.

As yet another brief point, being that Kellanova is a company that was recently spun off of what used to be Kellogg, it has become much more efficient than before, hence yet another reason Mars might be attracted to eating up the new, leaner and more efficient Kellanova.

Synergy, checked.

However, another piece of my initial analysis in these sorts of deals is pondering, if I happened to be an FTC official myself looking at this potential deal, whether or not I would objectively want to allow such a deal to go through.

In fact, regulatory risk tends to be the highest risk and by far the most common cog that gets caught up, slowing or fully preventing mergers and acquisitions from successfully closing or not.

This is the big one to worry about in this (potential) acquisition, as Mars already reportedly maintains somewhere in the neighborhood of 23% market share within the chocolate market in the United States alone, also bearing a rather extensive national and global footprint in other snacking and pet food markets, and Kellanova itself is already such a large player in snacking.

Although Kellanova does technically have different products and operates within different categories and markets than Mars, this might actually be a core reason a regulator might scrutinize this deal until the cows come home. Primarily, a regulator might think that Mars could be jumping into yet another, similar but technically different, line of business and market too quickly and think that it already has enough power in the chocolate and candy markets, and it doesn’t and frankly shouldn’t have any more power in the overall snacking landscape, especially by means of a multi-billion-dollar acquisition.

Interestingly enough, on the other hand, a regulator might actually be more inclined to approve the deal for that very reason, as it is sort of like what Amazon has done in past years, merely diversifying into new business categories while not necessarily dominating said categories, and Amazon’s efforts in these respects have hardly been thwarted, all things considered.

This is obviously where the arbitrageur has to perform their own thinking and make judgments on their own, and frankly where the science becomes an art more than anything.

This is my version of r/showerthoughts.

Anyways, if one ends up believing that the odds of the announced deal being eventually approved by the relevant regulatory agencies are higher than them being condemned and ultimately not approving the deal, one must still continuously monitor the facts and opinions that come out of the proceedings that follow, because things can and do often change and with that, one’s risk-reward profile. 

For instance, it is common that even if there is a mild whiff of regulators looking further into a deal, the target’s stock price tends to fall by a few percentage points, however, in this event, if the facts haven’t changed and your perspective regarding the objective efficacy of the deal closing haven’t change, an opportunity to buy the dip and increase your rate of return is presented.

Of course, if the facts change for the worse, it isn’t usually a bad idea to pare down or exit the position altogether.

Regulatory risk really does put the “risk” in risk/merger arbitrage.

Sure, there are other risks and considerations including financing risk, however, this type of risk doesn’t seem to be as prevalent as it used to be, for whatever reasons. Financing risk tends to be much less of a taxing roadblock than that of regulatory because the companies involved in the potential merger or acquisition have already engaged in copious amounts of discussion, both internally but also with the help of expert consultants, attorneys, bankers and many others (that most certainly charge a pretty penny, by the way) that help put a proposed deal together before it is even brought into the public eye.

With all of this research and structuring done prior to the official, public deal announcement, many financial bases are already covered and necessary financing facilities are usually set in stone.

In the specific case of Mars and Kellanova, while Mars’ core financials aren’t accessible due to it being a private company, it is hard to conceive a situation in which it cannot afford to finance and ultimately acquire all of Kellanova, hence why it isn’t the biggest concern of mine at the moment.

Yay or Nay?

If I do what I usually do and nerdily put myself in the shoes of a regulator, I truly believe that if the deal were to be formally announced and in play, Mars could make a strong case for acquisition, and while the official approval process would probably take a bit of time (think a year or a little longer), the business categories that each of these firms operate within are different enough so as to not make me, the fictitious regulator, exceedingly worrisome about too much power being concentrated in one company in one category.

In other words, if Mars were to be in the process of trying to acquire a direct competitor and fellow chocolate domineer such as Hershey, I would be far from inclined to offer my stamp of approval for such a market concentrated deal.

Instead, Mars honing in on buying Kellanova generally lessens the prevailing monopolistic worries and risks thereof.

Although I’d imagine both Mars and Kellanova may have some giving to do in order to spread out competition and allay my fears regarding having too much market share and pricing power that has the potential to negatively impact the consumer, both companies will likely give where they need to and if the deal were to be formally announced in the future, I think this historic deal could get pushed through in due time.

Big doesn’t always necessarily mean bad, but still, due diligence is always required and there are always risks associated with any sort of potential merger or acquisition.

DISCLAIMER: This analysis of the aforementioned stock security is in no way to be construed, understood, or seen as formal, professional, or any other form of investment advice. We are simply expressing our opinions regarding a publicly traded entity.

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