Risk Arbitrage (Outline) - CL Edit 10.26

8/8/2019 Risk Arbitrage (Outline) - CL Edit 10.26

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Patrick Fruzzetti, Christopher Lentz, Lewis Silberman, Kimberly Williams


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Risk

Legal/Reg latory

Merger Agreement Details

Timing

Ret rn

TradingSpread NetSpread


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Why is it an interesting strategy?

US companies are fl shwith cash, $1.8 T, that will

drivemore M&A haracteristics ofRisk and Ret rn inRisk

Arbitrageby Mitchell & lvino

Risk arbitragepositively correlated withmarket ret rns

in severely depreciating markets

Uncorrelated withmarket ret rns in flat andappreciating markets


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2010 IndexRet rns throughSeptember:

4.0%HennesseeGroup Merger Arbitrage Index

5.51% Barclay Merger Arbitrage Index

4.63%HedgeFund.net HFN Merger/Risk ArbitrageIndex

20

10

SingleFund Example 2.51%The Merger Fund

http://www.economist.com/node/17103806?story_id=17103806&

FID=146332686&

FTO

EN=14944332

http://hennesseegroup.com/in

dices/returns/year/2010.htmlhttp://www.barclayhedge.com/research/indices/ghs/Merger_Arbitrage_Index.htmlhttp://www.he

dgefund.net/hfn_public/marketing_index_new.aspx?template=realtime.htmlhttp://www.mergerf

und.com/pdfs/TMF_performance_quarterly.pdf


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How to do it: Buy TheTarget apture the spread between themarket price and

announced tender price Asymmetric risk is not priced into themarket

Recent trend shows increased likelyhood of

consummation In2010 year to date, there is a significant increase in theproportionof announced

deals that close (or areexpected to close) in less than45or in less than 60 days. 29%of deals to closewithin 60 days, as compared with the 13% averagebetween2002-2010.

16%of deals to closewithin45 days, as compared with the4% averagebetween2002-2010.

Source: Barclays Third Quarter2010Risk ArbitrageReview


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3 AR


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3 AR


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3 AR


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3 AR


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3 AR


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How to do it: In a stock-for-stock transaction,short a number of acquirer shares equal to

theexchange ratio and purchase targetshares

Samepremise as cash arbitrage, but completed

via stock Moremoving parts, sinceoutcome is dependentonmarket prices ofboth stocks, non cashendpoint to trade


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WhyHolders Should Sell Realizemajority (>95%) of deal premium

Notworth risk of arb spread Merger Arb is not core competency 95%of deals close, but not worth the risk

In general, Holders overestimate the chances of an

another bidder/overbid

Harman Example Deal Announced April 2007 Stock trades up from ~$100 to $122. Deal ancelledSeptember 21, 2007 Stock plummets to $80.Slow

leak from 122 to 112 inpreceeding 4months


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HAR


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Optionalityenters intomerger arbitrage

trades in various forms.

Fixed-value collars rice aps

Walkaway provisions accompanied by price floors

Cancelled Deals

Huntsman/Hexion

Penn National Gaming/Fortress

3PAR Dell payment


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Focused trade selection Run a portfolio for alpha

Dont ownevery deal

Hedging Take advantage collapsed volatility inout-of-the-moneyoptions in riskier deals

Investment staffwith varied financial backgrounds Diverse sector and product experience

Outsource legal advisory Cost-effectivebut critical deal check

Primebrokerage relationships Lowers financing (leverage) and borrowing costs


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Howmany deals on at once? Initially, five Mixof cash and stock for stock or blends

Position sizing? Initially, equally-weighted

Transaction costs Wait three days (approx.) to initiateposition

Risk arbitrage desks likely to set spreads at cheap rates

Hedging Evaluate cost ofprotection

Leverage 2x inorder toenhance returns


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QwestCommunications andCenturyLink

Gross spread = $0.30 (4.72%premium)

Current Price = $6.43 Payment Type Stock

Friendly bid

Tender offer expires 6/30/2011

Strategy: Long 1 Q share and short 0.1664

CTL shares


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ADCTelecom and Tyco Electronics


Current Price = $12.71 Payment Type Cash

Friendly bid


Strategy: Long ADCT shares


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PsychiatricSolutions andUniversal Health



Friendly bid


Strategy: Long PSYS shares


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GymboreeCorp. and BainCapital



Friendly bid


Strategy: Long GYMB shares


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King Pharmaceuticals and Pfizer



Friendly bid


Strategy: Long KG shares


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GenzymeCorp. and Sanofi-AventisSA

Deal Price- $69 (20xoriginal 2011E = $3.45)

GENZ stating bid too low. Revised 2011E =$4.30-$4.60 (or ~$89 at 20xmultiple)

Current Price = $71.96

Payment Type Cash

Hostilebid


Strategy: Long GENZ shares


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Insert excel filehere


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Risk Arbitrage (Outline) - CL Edit 10.26

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