As Semiconductors Get a $52 Billion Cash Injection from the Fed, This Arbitrage Opportunity Looks Red Hot

By TradeSmith Research Team

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The S&P 500, our bellwether financial benchmark, has dropped 23% so far in 2022 — putting us squarely in bear market territory.

It’s been a tough year for investors. But you wouldn’t be reading this right now if you weren’t smart enough to realize that there are always ways to make money out there for those who know where to find them.

And for that, you came to the right place.

At TradeSmith, we’ve been keeping close tabs on the markets to bring you unique moneymaking opportunities in the face of volatility. And one of those opportunities is something called “merger arbitrage” or “risk arbitrage.”

These “arbitrage” opportunities are primarily quick-hit moves with the potential to deliver double-digit profits in a relatively short period.

They happen when one company plans to acquire another and is willing to pay a premium on the stock price to make it happen. Until the deal closes, the company being acquired trades “at a discount” to the deal price. But once the deal closes, the stock price of the company being acquired tends to soar.

These opportunities exist because not that many people are willing to pay for a stock with so much uncertainty around it — but those who do take the risk set themselves up for a potentially handsome reward once the deal is finalized.

Here’s how it works…

The Opportunity in Risk Arbitrage

In this example, Company A is being acquired by Company B. Company A is trading at $15 per share, so Company B offers to pay $20 per share to “sweeten the pot.” The difference between $15 and $20 is the “premium.”

Company B doesn’t have to pay a premium to acquire Company A. It does it in a bid to increase its chances of getting shareholder approval on the transaction and ward off any potential competing offers.

Until there is certainty that the deal will close, the stock price of Company A generally trades below what Company B will ultimately pay.

Once the deal gets finalized, the stock price for Company A ($15) tends to jump right up to the price it’s being acquired for ($20).

For the folks waiting around for confirmation that the deal is approved, by the time that approval does happen, it’s too late. The stock price has already shot up and the arbitrage opportunity is over. But investors who had the foresight to buy shares of Company A at $15 are rewarded with a quick 33% profit when those shares jump to $20.

These opportunities are called risk arbitrage for a reason: There’s no guarantee that a deal will close.

After the board of directors approves the deal, shareholders must sign off with a simple majority vote, at which point the deal goes for regulatory and antitrust evaluation. And any deal over $90 million requires review by the Federal Trade Commission and Department of Justice.

Each of these steps introduces risk of the deal falling through.

So, when you’re analyzing one of these risk arbitrage opportunities, it’s up to you to know your individual risk tolerance.

You need to ask yourself: If the deal doesn’t close, are you comfortable owning the company that was supposed to be acquired?

Keep that in mind as you evaluate today’s arbitrage opportunity, which capitalizes on a red-hot $573.44 billion industry that recently got a massive cash infusion from the U.S. government…

The U.S. Government Helped Make This Arbitrage Opportunity a Reality

The cellphone you’re using, the laptop you’re working on, even the car parked in your driveway — just about every electronic in your life is powered by a semiconductor.

As the small but mighty chips that make electronics “go,” semiconductors can be found at the center of virtually every industry in America.

In the ventilators, pacemakers, and blood pressure monitors keeping millions of Americans alive… in the weapons arming our military… and in the wireless infrastructure that keeps us connected.

It’s no wonder this vital industry is already valued at $573.44 billion — and on pace to hit a remarkable $1.38 trillion by 2029.

But the U.S. has a problem — one that the government is now willing to spend billions of dollars to solve.

Only about 10% of the world’s semiconductors are made here in the U.S., while the vast majority (75%) are manufactured in East Asia.

And after global supply chain disruptions caused a major chip shortage in the U.S., domestic chip manufacturing has become a top priority — one that’s a matter of national security as much as national pride.

The U.S. is now doubling down on its efforts to increase its semiconductor supply by passing the CHIPS Act, which will inject as much as $52 billion into the domestic production of semiconductors.

The promise of fresh funding has industry leaders like Taiwan Semiconductor Manufacturing Co. (TSM) and Samsung Electronics Co. Ltd. (SSNLF) committing to invest tens of billions of dollars in new and improved stateside facilities. Intel Corp. (INTC) has already pledged more than $20 billion toward building two chip fabrication plants in Ohio.

And that brings us to today’s arbitrage opportunity, which is on the table as we speak…

Intel’s Multibillion-Dollar Bid for Tower Semiconductor Creates Arbitrage Opportunity

The chip shortage in the U.S. created a huge swell of demand from domestic tech companies in need of semiconductors.

As the world’s top revenue-generating semiconductor manufacturer, California-based Intel saw that it was in a perfect position to meet that demand.

The company established Intel Foundry Services in March 2021 to operate as a “standalone foundry business unit” that would manufacture specialized chips for other commercial customers.

Then, on Feb. 15, Intel announced plans to scale up its manufacturing even further — this time by purchasing one of its competitors, Tower Semiconductor Ltd. (TSEM), outright in an all-cash offer of $53 per share.

That Intel-Tower Semiconductor deal is our arbitrage opportunity.

On the day of the announcement, the TSEM stock price jumped over 41% from $33.24 to $47.07.

It’s currently trading around $44 per share, which gives the stock room to run while potentially delivering an attractive premium of around 20% per share once the deal closes.

Arbitrage deals generally close between 100 and 200 days, but this particular deal was estimated to go a full 12 months — which puts the deal on track to close around February 2023.

Tower Semiconductor is an Israel-based chip manufacturer with operations in the U.S. and Japan, which Intel wants to fully integrate with its Foundry Services division.

Tower’s broader geographic reach and established customer relationships will help scale Intel’s Foundry Services — a major objective of Intel this year.

Plus, Tower’s specialty chip technology will broaden Intel’s portfolio of products and bring the company closer to its goal of breaking Asia’s chokehold on the chip manufacturing business.

How Does Tower Semiconductor Stack Up on Its Own?

Remember that part of the risk with these arbitrage opportunities is that the deal could fall through — and you could end up owning TSEM stock on its own merit.

So we ran TSEM through our investment tools to see how it stacks up.

TSEM entered the Green Zone on Feb. 15 after the proposed deal was announced.

The stock is in an uptrend, has a medium-risk Volatility Quotient (VQ) of 28.93%, and is recommended as a “buy” in at least one of the financial newsletters TradeSmith tracks.

Even in the absence of a deal, our tools indicate that TSEM is a solid performer with lots of potential.

We’ll be watching this deal closely.