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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
Gross spread = $0.04 (0.31%premium)
Current Price = $12.71 Payment Type Cash
Friendly bid
Tender offer expires 11/15/2010
Strategy: Long ADCT shares
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PsychiatricSolutions andUniversal Health
Gross spread = $0.08 (0.24%premium)
Current Price = $33.67 Payment Type Cash
Friendly bid
Tender offer expires 12/31/2010
Strategy: Long PSYS shares
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GymboreeCorp. and BainCapital
Gross spread = $0.54 (0.83%premium)
Current Price = $64.86 Payment Type Cash
Friendly bid
Tender offer expires 12/31/2010
Strategy: Long GYMB shares
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King Pharmaceuticals and Pfizer
Gross spread = $0.08 (0.56%premium)
Current Price = $14.17 Payment Type Cash
Friendly bid
Tender offer expires 6/30/2011
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
Tender offer expires 6/30/2011
Strategy: Long GENZ shares
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Insert excel filehere
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