Zulily–Liberty Interactive Deal: What’s the Risk-to-Reward Ratio?



Scenario analysis is a key part of merger arbitrage

In the risk arbitrage world, a negative expected return means a very, very safe transaction and the possibility of another buyer coming in over the top. Liberty Interactive (QVCA) is a high-quality buyer to which the acquisition of Zulily (ZU) makes strategic sense. Antitrust risk should be de minimis, so the biggest risk to the transaction would be a MAC (material adverse change) out of Zulily.

Given that Zulily has already announced earnings and that the deal should be done before the third quarter is over, there really aren’t too many things that could go wrong here.

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Generally speaking, your base-case assumption has to be that the deal closes as advertised and that you earn the spread. After all, a merger agreement is a contract. If Liberty Interactive tries to get out of the transaction without a MAE (material adverse effect), Zulily could sue to try and force specific performance. In other words, it could get a judge to order that the transaction be consummated.

What’s your downside if the deal breaks?

Before the deal was announced, Zulily was trading at ~$12.50 per share. If the deal breaks, does the stock go back there? It depends on the reason for the deal breaking. Probably not, because the only way this deal will break would be due to a MAE or another buyer. Regulatory risk is minimal.

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Risk-to-reward ratio

When the spread is negative, the risk-to-reward ratio is meaningless. If the deal happens as announced, the investor would lose about 13 cents a share or about 70 basis points. If it breaks for some other reason than a MAE at Zulily—which is highly unlikely—it probably goes back to $12.50. That isn’t the risk-to-reward ratio investors are focusing on, however. Read on.

Merger arbitrage resources

Other important merger spreads include the deal between Baker Hughes (BHI) and Halliburton (HAL) or the merger between Freescale Semiconductor (FSL) and NXP Semiconductor (NXPI). For a primer on risk arbitrage investing, read Merger arbitrage must-knows: A key guide for investors.

Investors interested in trading in the tech sector should look at the Technology Select Sector SPDR Fund (XLK).


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