Investors Should Avoid iRobot’s Merger Arb Opportunity With Amazon (NASDAQ:IRBT)

Amazon.com, Inc. (AMZN) and iRobot Corporation (NASDAQ:IRBT) announced on August 5 that they had agreed to merge in a $1.7 billion deal, or $61 a share.

Recent market volatility could drive many investors towards merger arbs like iRobot, given it provides a decent place to park cash while earning a return during a bear market.

While I applaud that strategy, I believe buying iRobot will be a poor choice given it offers a small return of 5.5% and because the deal will likely drag on due to regulatory concerns.

This article will delve into what regulators will be looking for in this merger and why it will likely be held up by regulatory agencies for quite some time.

What Regulators Look for in Deciding to Challenge a Merger

Based on the 2020 Vertical Merger Guidelines, regulators look at 5 factors when considering the impact of a merger on competition:

• 1) Does it lead to efficiencies that enhance competition and benefit consumers?
• 2) How does it affect competition in the market for the product, in this case, robotic vacuums? This mainly focuses on matters such as market share of the merging firms.
• 3) Can the merger lead to collusion among competing firms?
• 4) Can the merger lead to anti-competitive practices taken against competing firms? Can iRobot leverage its position as a subsidiary of Amazon.com to disrupt the sales of competing products on Amazon’s website?
• 5) How does it affect competition more broadly across the value chain? What impact does it have on the suppliers of the product?

There is also the issue of consumer data, which could be a big debate for this merger in particular.

Why Amazon’s Purchase of iRobot Will Raise Regulatory Question Marks

Clearly, the merger will lead to efficiencies for iRobot. Firstly, it eliminates some of the costs associated from listing its products on Amazon, which can be passed on to the consumer in the form of lower prices. It’s also possible that its products could be used as part of Prime subscriptions. The company could also see improvement in marketing and R&D spend if it works closely with Amazon’s other smart home products like Alexa and Ring. The last two points are speculation on my part, so we will have to wait and see how that pans out in the future.

The other good news for this merger is that it doesn’t lead to an immediate increase in market share, since Amazon does not have a competing product in the robotic vacuum market.

It is also safe to assume that Amazon isn’t seeking this merger to collude with competitors and raise the prices of robotic vacuums.

But that’s about as good as it gets for this merger as it potentially measures quite poorly on points 4, 5, as well as consumer data privacy.

According to the Q2 10-Q, 27.1% of iRobot’s sales are through one retailer. It doesn’t mention which retailer, and I tried finding out but unfortunately couldn’t.

But because sales are concentrated with one retailer, regulators will be all over this merger regardless of whether that retailer is Amazon or not.

If that retailer isn’t Amazon, regulators will want to know what the merger will mean for the sales of Roomba on other sales channels. Will Amazon pull the product off other sales channels?

If that retailer is indeed Amazon, then it will raise a question about all competing products that rely on Amazon for their sales.

In fact, given Amazon’s history of self-preferencing, regulators will be looking closely to see how the merger will affect competition in the robotic vacuum market. I’ve mentioned the possibility of including iRobot as part of Prime subscription, regulators will want to see if such a possibility is an unfair advantage that iRobot gets as a result of the merger. They will also be looking to see if Amazon can use its position as an e-commerce behemoth to disadvantage competing products on its platform. Regulators could challenge the merger if they feel they can prove Amazon will disadvantage competitors if it merges with iRobot. Unfortunately for the latter, not only has Amazon engaged in self-preferencing practices, it is also criticizing laws that attempt to reign in those practices.

The most relevant example of Amazon using its market power following a merger was with Ring. A letter sent by privacy advocate groups to the Federal Trade Commission claimed that

By 2021, Amazon Ring had crushed competing smart doorbell makers – selling as many units as its four closest competitors combined

They noted that Amazon’s strategy relied on selling the product for low prices and integrating it into Amazon Prime. These are the kind of allegations that will see regulators take their time in trying to weigh whether to challenge the merger or not.

Regulators will also explore whether Amazon can use its size to pressure suppliers to raise prices on competition, by occupying a lot of manufacturing capacity, for example. This is one of many scenarios that regulators will look at according to the Vertical Merger Guidelines.

Of course, regulators might not have enough proof to merit a challenge or to block the merger, but the time they spend reviewing that possibility should be off-putting for investors seeking a merger arb opportunity, given the meagre 5.5% return.

Then there is the issue with consumers’ data. Amazon already has access to the footage outside consumers’ homes, the sound in their homes with Alexa, and now it could have access to footage inside the home with Roomba.

Regulators will be keen on exploring the impact that could have on consumers’ privacy, especially in light of reports Ring shared data with police without warrants. They will look to see whether the merger affects the quality of consumer privacy, which is considered a form of non-price competition.

To my knowledge, there was no merger blocked on privacy concerns, so that bodes well for this merger. However, it does indicate that the merger could take many months to close.

Google’s (GOOG, GOOGL) deal to acquire Fitbit could provide a good indicator of how long the iRobot acquisition could take. Google needed a year and two months to close the deal. The two deals are similar in terms of the size of the acquirer and the consumer data implications. But note that, unlike Amazon, Google did not have a sales channel for Fitbit and other competing products.

As a result, I do expect the deal to take longer than a year to close. At a 5.5% spread between the current market price and the purchase price, investors might be better served considering other alternatives like Microsoft’s (MSFT) acquisition of Activision Blizzard, Inc. (ATVI).

Conclusion

Investors might be wise to consider merger arb opportunities, but they should steer clear of iRobot. Amazon’s deal to acquire the robotic vacuum maker will probably close, so I wouldn’t assign iRobot’s stock a sell rating. However, the deal could drag on due to the many regulatory complications. At a 5.5% spread, investors should look elsewhere for more lucrative opportunities.