Recently, Berkshire Hathaway (BRK.A -0.56%) (BRK.B -0.45%), the $1.1 trillion holding company with a diverse portfolio of businesses and stocks, released its annual report, revealing a record $334 billion in cash, cash equivalents, and U.S. Treasury bills. One way Warren Buffett, CEO and chairperson for Berkshire, could deploy some of that cash is through merger arbitrage, a short-term approach that involves buying stocks of companies trading below their acquisition price.

Verizon's (VZ 4.14%) pending $20 billion acquisition of Frontier Communications Parent (FYBR 0.14%) has created one such opportunity. So, let's explore why Buffett, a famously long-term investor, favors this tactic and whether Frontier stock is worth considering.

A brief history of Berkshire Hathaway's recent merger arbitrage plays

Despite his reputation as a long-term investor, Buffett has engaged in merger arbitrages for more than 30 years, including three notable ones within the past decade.

In 2017 and 2018, Berkshire steadily purchased shares of Monsanto Co. after Bayer AG announced its plan to acquire the company. Then, in 2018 and 2019, Buffett made another merger arbitrage play following IBM's announcement that it would acquire Red Hat for $190 per share. Most recently, he added to Berkshire's Activision Blizzard position in 2022 after Microsoft revealed its intention to acquire the gaming company.

Notably, in all three cases, the acquiring company paid all cash for the acquired company, and all deals were successful. At a recent Berkshire annual meeting, Buffett pointed out that these well-established companies generated an outsized "spread" -- the difference between the stock's trading and buyout prices -- due to regulatory risks. However, there was never a concern that the acquiring company would be unable to afford the deal in cash.

For Verizon, which has $143 billion in net debt, the focus in an all-cash merger arbitrage should be less on its debt level and more on whether the acquiring company can come up with the money. With a market capitalization of $180 billion and $12 billion in unused revolving credit, Verizon should have no difficulty securing the necessary cash.

Image source: The Motley Fool.

A new arbitrage opportunity

Let's dig into the fine print of this merger arbitrage. In September 2024, Verizon announced its intention to acquire Frontier in an all-cash deal at the aforementioned price tag of approximately $20 billion, which equates to $38.50 per share. Notably, the management teams believed the deal would take approximately 18 months to clear approval by Frontier shareholders and regulators.

As of this writing, Frontier stock trades at $36 per share, creating a spread of 6.9%. As for whether Berkshire might participate in the merger arbitrage, Buffett listed his preferred criteria 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.?"

First, the deal cleared the initial hurdle, with Frontier shareholders approving the takeover in November. Since then, it's been quiet on the regulatory front, but the deal will need approval from state regulators in the 24 states Frontier operates, as well as Washington, D.C., and national agencies.

Verizon management believes the merger will benefit customers. CEO Hans Vestberg previously stated, "We are very confident that this will go through, but we will expect the process will be thorough."

Second, based on the original timeline, there are approximately 12 months to go, and a 6.9% return is currently better than current returns of Treasury bills (4% to 4.3%). It is important to note that if the deal goes through, it will trigger a tax event for investors, and if it takes longer than 12 months, it will be at a more favorable rate than if it's less than 12 months.

Third, a competing takeover bid appears unlikely, considering Frontier shareholders have already approved the Verizon deal.

Finally, if the deal doesn't go through because of regulatory concerns, Frontier's stock price may fall. However, Verizon will likely be required to pay a $590 million breakup fee to Frontier.

Is Frontier Communications a worthy merger arbitrage play?

To sum up Buffett's thoughts on merger arbitrage, 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."

In this particular case, Frontier might just check all of Buffett's boxes. Frontier may very well meet Buffett's criteria. Outsiders will have a clearer picture when Berkshire Hathaway releases its next few 13F filings -- a quarterly report that discloses a holding company's stock positions -- to reveal Buffett's official position.

As for individual investors, Frontier stock offers stability with a little bit of upside in an otherwise turbulent market. For those adverse to risk or otherwise bearish on the market in the short term, Frontier is a stock and merger arbitrage worth buying.