Description

Merger Arbitrage Alpha:

Situation Overview:

Various risk assets are being sold / unwound over the last several weeks…creating a potential opportunity for longer duration investors. That said, we are in a market that is seeking immediate gratification, and higher probability pay-off structures. Risk arbitrage presents a compelling opportunity to invest in securities that accomplish the above, and also provide reasonably defined duration. We won’t bore you with the historical probabilities and success rates of strategic and LBO deals, and move right to the punchline.

Every 5-8 years we see a dislocation in merger arbitrage and an opportunity to allocate a larger amount of capital to this product. Now is a compelling time to invest in risk arbitrage. (prepping the credit trade / post BK reorg pitch for next year…)

Entry Catalyst:

There are various reasons for the widening in risk arbitrage spreads. Some include: investor flows leaving the event-driven space; mutual funds that had been seeking cash alternatives with a coupon, and were willing to hold for the close of a transaction have moved on due to lack of merger/event expertise as well as investor flows; idiosyncratic complexity / regulatory; quantitative funds; correlation of high yield credit instruments with mergers (although activism has materially higher ‘credit factor’); and contagion (a single deal break impacts the universe more than a single deal close is helping flows back into other deals)

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We see various issues impacting several deal spreads including the probability of a successful shareholder vote, regulatory and anti-trust complexity, potential for a financing scare, deals lacking true operational merit vs financial engineering, as well as weak definitive merger agreements (“DMA”). Here is the high level criteria for inclusion into the merger arbitrage basket:

Criteria for Inclusion:

·         US target (can have cross border buyer)

·         Target minimum market cap of $500mm

·         Reasonable average daily trading volume

·         Known proxy firm (in the event a shareholder vote is a condition to close)

We have attempted to bucket transactions into 3 categories and rank them accordingly.

Ranking:

1. Safe(er) Deals “Tier 1”: We consider a safer transaction to exhibit the following characteristics- strong DMA , financing in place with reputable financial institutions; board unanimous (or hold out wanted go shop / higher offer); strategic merits are rationale for deal

2. More complex than Tier 1 ranking “Tier 2”: potential anti-trust issue, but solvable under conditions in the DMA and the presence of a credible buyer. Depending on size of spread, can be sized in tier 1

3. Hairy (potential tail risk is difficult to analyze) “Tier 3”: Financial buyer (even if using portfolio company); weak DMA, potential problems if financing market conditions tighten

Allocation %:

1.    Allocate 50% to Tier 1

2.    Allocate 35% to Tier 2 (unless there is an oulier i.e. attractive to size at Tier 1 level)*

3.    Allocation 15% to Tier 3 (unless there is an oulier i.e. attractive to size at Tier 1 or 2, level)

*Specifically in Tier 2 deals we would increase the size: AGN / PFE, EMC / DELL (BXLT / SHPG would increase too, but spread less attractive than AGN and EMC)

**Does not include transactions to hedge or increase exposure using other parts of the target or buyer capital structure

Issue Spotting: The above rankings are impacted by a grid with the following criteria

·         Regulatory (sector and / or company specific)

·         Shareholder / other litigation (prior to deal)

·         Red flags: management incentives; buyer due diligence

·         Quant fund involvement

·         Strategic operational merits vs financial engineering

·         Financing

·         Ability to terminate / extend

·         Probability of competitive bidding situation

In the message section, we will occassionally share thoughts on transactions and the accompanying filings / investor presentations / other:

Appendix / Merger Contracts:

BUD / SAB DMA:

http://www.sec.gov/Archives/edgar/data/1140467/000119312515341957/0001193125-15-341957-index.htm

AGN / PFE DMA:

http://www.sec.gov/Archives/edgar/data/1578845/000119312515385647/d24024dex21.htm

EMC / DELL DMA:

http://www.sec.gov/Archives/edgar/data/790070/000119312515342168/0001193125-15-342168-index.htm

SLH / Vista DMA:

http://www.sec.gov/Archives/edgar/data/1324245/000132424515000057/0001324245-15-000057-index.htm

YOKU / BABA DMA:

http://www.sec.gov/Archives/edgar/data/1442596/000110465915076433/0001104659-15-076433-index.htm

RLD / Rizvi DMA:

http://www.sec.gov/Archives/edgar/data/1327471/000110465915076953/0001104659-15-076953-index.htm

CVC / Altice DMA:

http://www.sec.gov/Archives/edgar/data/1053112/000119312515321860/0001193125-15-321860-index.htm

CAM / SLB DMA:

http://www.sec.gov/Archives/edgar/data/941548/000095015715001036/0000950157-15-001036-index.htm

JAH / NWL DMA:

http://www.sec.gov/Archives/edgar/data/895655/000119312515402097/0001193125-15-402097-index.htm

KLAC / LRCX DMA:

http://www.sec.gov/Archives/edgar/data/319201/000119312515348701/0001193125-15-348701-index.htm

ADT / Protection One DMA:

http://www.sec.gov/Archives/edgar/data/1546640/000119312516463994/0001193125-16-463994-index.htm

HOT / MAR DMA:

http://www.sec.gov/Archives/edgar/data/316206/000095015715001303/0000950157-15-001303-index.htm

GMCR / JAB DMA:

http://www.sec.gov/Archives/edgar/data/909954/000110465915083470/0001104659-15-083470-index.htm

IM / Tianjin DMA:

http://www.sec.gov/Archives/edgar/data/1018003/000119312516467239/0001193125-16-467239-index.htm

RAD / Walgreens DMA:

http://www.sec.gov/Archives/edgar/data/84129/000110465915073649/0001104659-15-073649-index.htm

FCS / ON DMA:

http://www.sec.gov/Archives/edgar/data/1036960/000119312515380198/0001193125-15-380198-index.htm

ATML / MCHP DMA:

http://www.sec.gov/Archives/edgar/data/872448/000157104916010841/0001571049-16-010841-index.htm

WMB / ETE DMA:

http://www.sec.gov/Archives/edgar/data/107263/000119312515331008/0001193125-15-331008-index.htm

ALR / Abbot DMA:

http://www.sec.gov/Archives/edgar/data/1145460/000095015716001517/0000950157-16-001517-index.htm

FNFG / KEY DMA:

http://www.sec.gov/Archives/edgar/data/1051741/000105174115000202/0001051741-15-000202-index.htm

BXLT / SHPG DMA:

http://www.sec.gov/Archives/edgar/data/1620546/000119312516426678/0001193125-16-426678-index.htm

SNDK / WDC DMA:

http://www.sec.gov/Archives/edgar/data/1000180/000110465915071945/0001104659-15-071945-index.htm

***As we further research additional transactions or new deals are announced – we will add / re-allocate investment.

Catalyst

Transactions close