Is Matterport a Worthy Merger Arbitrage Play?

CoStar Group (CSGP -1.20%), the parent company of Apartments.com and Homes.com, announced its intention to acquire Matterport (MTTR -1.25%), a virtual tour software platform, for an enterprise value of $1.6 billion. CoStar management believes the deal will go through before the end of 2024, but it still needs to pass shareholder and regulatory hurdles. As a result, the proposed acquisition creates an opportunity known as merger arbitrage -- a short-term investing strategy where you buy stocks of companies trading below their acquisition prices.

So let's examine the finer print of the CoStar Group and Matterport deal and consider whether investors should capitalize on the merger arbitrage opportunity.

Details of CoStar Group's acquisition of Matterport

In late April, CoStar announced its intention to acquire Matterport, with each Matterport shareholder receiving $2.75 in cash and $2.75 in CoStar stock. The stock portion of the deal is complicated, however, because it is subject to what is known as a symmetrical collar.

Specifically, three days prior to the acquisition, CoStar's average share price will be established using the volume-weighted price of the previous 20 consecutive trading days. If the average share price falls between $77.42 and $94.62, the exchange ratio will be $2.75 divided by the average share price. If CoStar's average share price is less than or equal to $77.42, the exchange ratio shall be 0.03552, and if it's greater than or equal to $94.62, the exchange ratio shall be 0.02906.

Matterport's Merger Arbitrage Opportunity

As of this writing, Matterport trades for roughly $4.40 per share, and CoStar trades for $86 per share, creating a spread -- the percentage between the stock's trading price and buyout price -- of roughly 22%.

As for whether merger arbitrage is suitable for your investing style, frequent participator Warren Buffett offered the questions investors should ask themselves in his 1988 annual shareholder letter:

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.?

For the first point, the deal is subject to the approval of Matterport stockholders and regulatory approvals. Considering that management, which owns approximately 15% of Matterport, has already voted for the deal, it's likely to be approved by a shareholder vote. Over the past year, regulators have taken a tougher stance on mergers and acquisitions, notably opposing the JetBlue and Spirit merger and Kroger's proposed acquisition of Albertsons. Jonathan Kanter, the head of the Justice Department's antitrust division, recently commended the agency's success in halting mergers. He stated, "We took these actions to address the trends toward concentration of industry and put a stop to anti-competitive behavior before it takes hold." Despite the threat of more scrutiny, CoStar and Matterport each have plenty of competitors, which may ease regulators' concerns.

Next, management for both CoStar and Matterport believe this deal could be completed by the end of 2024. If that comes to fruition, a 22% return in roughly seven months is especially enticing, considering six-month Treasury bills are currently yielding approximately 5.4% and the compound annual gain of the S&P 500 has been 10.2% since 1965.

Third, a competing bid seems unlikely, given that the companies announced the agreement in April and no other offer has emerged.

Finally, if the acquisition fails, let's examine whether Matterport is worth owning as a stand-alone business. The company generated $39.9 million in revenue for Q1 2024, representing a year-over-year increase of only 5%. But its total subscriber count crossed over the 1 million mark, up 30% year-over-year. Looking at Matterport's bottom line, it is still unprofitable, posting a net loss of $36.1 million in its most recent quarter, a 33% year-over-year improvement.

While Matterport's growth is disappointing, the company's dependency on real estate is a legitimate excuse, as elevated interest rates weigh down the sector. Additionally, the company has a strong balance sheet, with no debt and $419 million in cash and investments at the end of its most recently reported quarter. If the deal were to fall through, Matterport's cash position would be boosted by a termination fee of $85 million paid by CoStar.

Put it all together, and a growth investor who believes the real estate market will rebound could make a case that Matterport is worth owning as a stand-alone company, especially since it still trades near a record-low price-to-sales ratio -- a standard valuation metric used for unprofitable, growth companies -- of 8.6.

MTTR PS Ratio data by YCharts

Is Matterport a merger arbitrage buy?

If you're still debating whether to participate in Matterport's merger arbitrage opportunity, let's consider more words of wisdom from Buffett. In his 1989 annual shareholder letter, he wrote, "We will engage in arbitrage from time to time -- sometimes on a large scale -- but only when we like the odds."

The odds for this particular transaction to pass regulatory scrutiny seem more favorable than previous mergers and acquisitions that haven't, and the spread is worthwhile for investors looking to capitalize on a short-term investing strategy. Keep an eye out for any news from the Federal Trade Commission and the Department of Justice, and watch for severe fluctuations in CoStar's share price. In the meantime, the merger arbitrage opportunity with Matterport stock is attractive.