Merger Arb

[valuechaser]

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.

[Hielko]

I certainly participate in some merger arbs from time to time. But a lot of the time the big deals with high spreads have a lot of difficult to handicap regulatory risk, and the big deals with little risk have spreads that are almost non-existent.

[valuechaser]

I certainly participate in some merger arbs from time to time. But a lot of the time the big deals with high spreads have a lot of difficult to handicap regulatory risk, and the big deals with little risk have spreads that are almost non-existent.

 

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.

[Hielko]

Because of the reasons outlined above I usually participate in smaller deals.

[tooskinneejs]

Valuechaser - the deal you mentioned is stock for stock.  so even if the deal closes, there is no guarantee you'll end up with more value than what you paid for your shares of the acquiree.

[valuechaser]

Valuechaser - the deal you mentioned is stock for stock.  so even if the deal closes, there is no guarantee you'll end up with more value than what you paid for your shares of the acquiree.

 

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.

[matjone]

this is interesting.  Valuechaser & Hielko - where do you look for these deals?  I am guessing the mainstream financial press probably misses a lot of the smaller ones.

[valuechaser]

this is interesting.  Valuechaser & Hielko - where do you look for these deals?  I am guessing the mainstream financial press probably misses a lot of the smaller ones.

 

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.

[Sleepwell]

Ran into this old post when searching merger arb stuff in the site.

 

Has anyone been active in the space lately? I currently have a position in TWX which still has some upside (bought at 87).

 

Also looking at MON, SYG and LSCC.

 

My main questions are:

What else are people finding attractive in this space now?

What books do you recommend? So far I've read Risk Arb by Guy Wiser and Deals, Deals and more Deals by one of Gabelli's PM

Where do you find merger arb ideas? Newspapers? Sites?

 

One of the main reasons I'm interested in this strategy is its market neutral nature, especially in this current market environment where I'm not finding a lot of cheap stuff and I think we will get a correction at some point.

 

Thanks

[rukawa]

The Chinese Go Privates deals are a lot like mergers arbs except they are not as sexy. They tend to have high spreads. Trina Solar (TSL) which can be found here is a good example:

http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/tsl-trina-solar/

At one point the spread on this was 25%

 

Anyways if I were looking for deals I would probably just search prnewswire. Most companies make announcements there. Try using their advanced search and searching for the phrase "merger agreement".

http://www.prnewswire.com/search/

[writser]

I'd be extra careful with mergers where politicians are involved. LSCC is a typical example of such a deal. What are the chances of the US government vetoing this deal? 1%? 50%? 99%? I have no idea. Hard to handicap for me. Most large caps with spreads that look 'too good to be true' have some regulatory issues. Stock-for-stock deals usually have a slightly larger spread due to volatility in the payout. But if you can stomach that (or hedge it) in the long run returns should be ok. I personally like Chinese reverse mergers as well and occasionally open a topic about them.

 

I currently hold the following deals, amongst others: SNBN, DEST, ALIOY, CCM, KZ, QUSA, SYUT. Deals that look interesting but I don't own at the moment: SWC, HW, FBRC, CXCD.

[scorpioncapital]

I evaluate a merger arb deal the same as if I was buying the target myself on the respective terms, with some weight given to the acquirer's behaviour and presentations. In other words, I look at it as if there was no transaction, look at the behaviour of the parties, the businesses, and the presentations produced. If it looks idiotic, I pass. Or if it looks like a bad deal because I don't like the business , or any signs of incompetence or bad behaviour. This, together with a little diversification, should allow you to do well. Of course, your standard for the deal doesn't have to be as high. You don't have to be looking for a target that is wide-moat, but it has to have something going for it. You might also limit yourself to strategic acquisitions as opposed to hedge funds doing a leveraged buy-out for no other reason that they can.

 

Also, I try to stay away from industries that are likely to run into snags or regulatory issues. Generally, industrials are pretty neutral here and have traditionally not had much problem.

[wisowis]

Curious what merger arbs people are looking at, given how much spreads have blown out now. I recently posted a thread for NorthView REIT (cash offer of $36.50, currently trading at ~$32), but here are a couple images from FT (h/t PlanMaestro) with some of the spreads on recent deals:

 

https://pbs.twimg.com/media/EUURmKDWkAAoZUZ?format=jpg&name=large

 

https://pbs.twimg.com/media/EUUR442XgAc0a6l?format=jpg&name=large