It has been well over a year since Amazon (AMZN 0.64%) announced it would acquire iRobot (IRBT 1.85%), the consumer robot company best known for its Roomba line of robot vacuum cleaners. The acquisition has stalled over regulatory concerns, and its initial terms have been amended. Nonetheless, iRobot shares are currently trading 43% below the updated acquisition price, creating a significant merger arbitrage opportunity.

Let’s examine what happened since the acquisition bid was announced and how investors could capitalize on this situation.

A brief timeline of Amazon’s proposed acquisition of iRobot

In Aug. 2022, Amazon announced its intention to acquire iRobot in an all-cash deal for $1.7 billion at a buyout price of $61 per share. Almost a year later, in July 2023, that deal was amended to a buyout price of $1.4 billion, or $51.75 per share, after iRobot took on $200 million in new debt to fund its ongoing operations.

Generally, for an acquisition deal to go through, it must confront two requirements. First, shareholders of the target company need to vote in favor of the deal. Second, the deal must be approved by regulators, and if it’s a cross-border business, regulatory bodies from multiple nations will need to approve it.

The amended agreement cleared the first hurdle on Oct. 12, 2023, when iRobot’s shareholders approved it at a special meeting.

The second hurdle has proven more complicated. The U.K.’s Competition and Markets Authority approved the original deal in June 2023, but the U.S. Federal Trade Commission (FTC) and the European Commission have yet to hand down their decisions. As of this writing, the FTC is still investigating the deal after formally requesting additional information in Sept. 2022. Notably, the proposed acquisition wasn’t included in the FTC antitrust lawsuit against Amazon from a few months ago.

Meanwhile, the European Commission sent a statement of objections to Amazon this month detailing its concerns. However, that doesn’t mean the deal will falter as Amazon will likely have the chance to offer remedies or better address specific issues to safeguard unconditional clearance for it.

Similarly, Microsoft needed to make concessions for its recent acquisition of video game giant Activision Blizzard, but the buyout price did not change from what the parties originally agreed to.

What’s a merger arbitrage?

With a potential buyout planned at $51.75 per share but iRobot stock trading near $36 as of this writing, investors may see an opportunity, one commonly referred to as merger arbitrage.

Merger arbitrage is a short-term investing strategy that involves buying shares of a company for which a buyout has been proposed while the stock trades below the expected acquisition price. Though Warren Buffett is famously a proponent of long-term investing, he has frequently participated in merger arbitrage, most recently around Microsoft’s purchase of Activision Blizzard and IBM’s acquisition of Red Hat.

In Buffett’s 1988 annual shareholder letter, he outlined the questions to ask before investing in a bid to take advantage of a merger arbitrage situation:

To evaluate arbitrage situations, you must answer four questions: (1) How likely is it that the promised event will indeed occur? (2) How long will your money be tied up? (3) What chance is there that something still better will transpire — a competing takeover bid, for example? And (4) what will happen if the event does not take place because of antitrust action, financing glitches, etc.?

In the case of the iRobot deal, for the first point, both the FTC and European Commission have expressed serious antitrust concerns. Second, the European Commission has a Feb. 14 deadline to deduce on the deal, meaning prospective investors’ money likely won’t be tied up too much longer. Third, a competing bid seems unlikely, given that the agreement was announced roughly 15 months ago and no such offer has emerged. Finally, through the first nine months of 2023, iRobot’s revenue is down 29% year over year to $583 million, and the company’s net losses widened 19% to $241 million. Between its significant top- and bottom-line declines and its recent advance to take on $200 million in additional debt, iRobot does not look appreciate an appealing investment as a stand-alone company.

A robot vacuum cleans the floor.

Image source: Getty Images

Is iRobot a merger arbitrage buy?

iRobot stock closed on Nov. 30 at $36.11 per share, creating an unusually high “spread” — the percentage between the stock’s trading price and buyout price — of roughly 43%. The market seems to be pricing iRobot as if the deal is unlikely to go through.

That doesn’t mean the deal is dead, but let’s circle back to Buffett’s thoughts on merger arbitrage. In his 1989 letter to Berkshire Hathaway shareholders, he wrote, “We will engage in arbitrage from time to time — sometimes on a large scale — but only when we appreciate the odds.” Not only are the odds in dispute when it comes to this particular deal, but iRobot likely doesn’t confront all of Buffett’s prerequisites.

Keep an eye out for more news from the FTC and European Commission, but in the meantime, the merger arbitrage opportunity with iRobot stock looks too risky for most investors.

John Mackey, former CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. Collin Brantmeyer has positions in Amazon, Berkshire Hathaway, and Microsoft. The Motley Fool has positions in and recommends Amazon, Berkshire Hathaway, Microsoft, and iRobot. The Motley Fool recommends International Business Machines. The Motley Fool has a disclosure policy.

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