Turns out, killing deals, or even attempting to do so, can be a profitable business.
That's the thinking behind an increasingly popular tactic for hedge-fund activists — and it seems to be paying off.
Carl Icahn recently used it to try to destroy Cigna's $54 billion purchase of Express Scripts. When reports of Icahn's plan surfaced on Aug. 1, Cigna's shares gained about 2 percent, while Express Scripts shares slumped 6.3 percent.
That upends the usual dynamic, in which the stock of the acquiring company falls after a merger announcement while that of the target company rises. Traditionally on Wall Street, traders betting on the success of a merger would buy shares of a target company and pair that trade with a short position in shares of the acquirer, reaping profit as the deal nears completion.
But Icahn's strategy, also employed by others, runs counter to this traditional merger arbitrage and is one researchers have dubbed "activist arbitrage."
As he explained in an open letter to shareholders on Aug. 7, Icahn bought stock of acquirer Cigna and shorted Express Scripts. Because most mergers tend to benefit shares of the target, blocking the transaction or lowering the deal price would pay off for shareholders in the acquirer.
On average, so-called activist arbitrageurs create an extra, risk-adjusted, 5.7 percent bounce in the shares of acquirers in the 20 days following the activists' disclosures, according to a new study by researchers at Columbia University and the University of Florida. On an annualized basis, the average gain in the period after the deal announcement to a resolution of an activist fight is about 5.5 percentage points higher than what shareholders in an acquirer would see without activist intervention, according to the researchers, led by Wei Jiang, Chazen Senior Scholar at Columbia.
"Our evidence indicates that activist M&A arbitrage serves as a governance remedy for acquiring firms' shareholders, as well as a profitable investment strategy for the activists themselves," the authors wrote.
That was the case when a $20 billion chemicals deal was killed last October after a group of activist investors argued the transaction would destroy shareholder value.