valuechaser

I got interested in this area after reading the Buffet partnership letters and like you was in search of good books that would maybe do a deeper dive but it turns out there isn't much out there. I think merger arbitrage trades, like other areas of the market, don't produce the excess returns they once did. In the past 15 or 20 years, most of the excess returns have disappeared as hedge funds have entered this area. I've looked at and done a few of these trades and found smaller transactions still provide an area of opportunity because those transactions are typically too small for most institutional investors to spend time on. With that said, look up the Rangeley Capital podcast. I think they did an episode on merger arb 101 and also dissect merger arb ideas so you can get some sense of what's involved. If you come across any other helpful resources, please do share.

Distressed investing is a fascinating area but it seems like a difficult strategy for an individual / retail investor to really exploit. Most distressed debt investors buy senior secured debt which is the highest security in the capital structure. In most cases, these are bank loans and due to their seniority allow the investor to control / influence the restructuring or liquidation. Unfortunately as an individual investor, its difficult if not impossible to purchase bank debt in the secondary market. As such, the only option is to buy bonds or debentures which are typical second lien or unsecured. Being lower in the capital structure means you have to be more precise with your recovery analysis and of coarse anything related to distressed investing requires a good understanding of the legal aspects of bankruptcy. With that said, it would be great to get a discussion on this subject going here. It would be very useful to hear people's experience with distressed investing as a individual / retail investor.

I worked in investment banking for a few years and learned how to build pretty detailed financial models, I also learned pretty quickly how useless models are as an investor. There are too many variables that need to be forecasted to make a DCF effective; add that to the fact that in most cases most of the value comes from your terminal value assumptions and what you get is a mechanism to spit out whatever value you want. Having said all of that, I'm relatively new to taking investing seriously and have done a lot of reading. Almost everything on value investing suggests forecasting is useless. I struggled with this idea because in the absence of forecasting, I wasn't really sure how I can measure intrinsic value, which is required to measure your margin of safety. I than came across Bruce Greenwald's from Graham to Buffet book and he presents some more reliable ways to measure value: replacement value and earnings power value. Obviously like all valuation models these have their flaws but they seem less flawed than DCFs so maybe take a look at that as well. I would also be interested to learn how most other folks on the forum measure their margin of safety because there are a lot of really smart people here. Apologies for the digression, to answer your original question, in addition to the McKinsey book, I would also check out the Scoopbooks Series on Investment Banking. They have a good book that goes through DCFs and is a bit more practical than theoretical.

To be honest I've just started looking into merger arb opportunities. The one place I have found useful is http://www.sinletter.com/merger-arbitrage/. I also just read the papers.

You can lock in a spread today by shorting the buyer. In this case for every one share of the target if you shorted .1775 shares of the buyer's shares you can lock in the spread I mentioned and realize it once the deal is completed. The spread will converge to 0 as it nears deal completion if all goes according to plan.

Thanks Hielko. Is there a reason you stick to the bigger deals? I have no experience with shorting stocks so not sure if there is a size barrier when attempting to short a buyer in a smaller deal. Just as an example I was looking at Carmike with a market cap of $738 million buying Digital Cinema which has a market cap of $37 million. Based on the terms of the deal and today's closing prices, there is a spread of 8.7% and the deal is expected to close in the 3rd quarter. A definitive agreement has been approved by both Boards and the CEO of Digital Cinema who owns 39.5% of the shares is supporting the deal. In this case, there is no financing or regulatory risk. Carmike won't need a shareholder vote to issue the shares and the transaction rationale is sound. The is a small deal with a great spread and would probably fly under the radar of most arb funds. I'm just trying to make sure there isn't something obvious I'm missing with regards to bigger deals versus smaller deals. Thanks again.

Before I get into my post, I must say discovering this Forum was one of the best things that has happened for my portfolio. There are some extremely knowledgable folks here and I'm hoping to get some input on a strategy that I've been thinking about. Just for some background, I'm relatively new to investing seriously. I managed a bit of my own money over the years but not very actively as my job took up most of time. I got more serious about it over the past year or so and have been non-stop reading since then to learn as much as possible. The value investing philosophy makes complete sense to me and for the most part I've stuck with Pabrai's recommendation to pick and choose my investments from investors that are several times smarter than me. As such, I've been going through 13Fs and looking for businesses I understand. This has worked out fairly well. Despite the success I've had so far, I've found very few opportunities in the recent months that I truly understand and which fit with some of the value criteria I have. In going through Buffet's partnership letters I discovered that he often invested a sizeable portion of his portfolio in merger/risk arb opportunities especially when the market was frothy. For some reason I never thought merger arb was compatible with value investing but reading Buffet's letters got me interested. Especially because I worked in M&A for a couple of years so I feel pretty comfortable with reading merger agreements and assessing the potential risks of a transaction. I was hoping to find out if people on the forum have had much experience with the strategy because I don't see many posts on the subject. Is it something you consider in a frothy market? Have you found the risk/reward profile of the strategy generally good. Any advice or reading materials you could recommend. Apologies for the long post and thanks in advance for any input you could provide.