Institutional Investor's Alpha Magazine - December 2007/January 2008 - (Page 57)

Strategies Merger Arbitrage Course By Neil O’Hara Changing C harles Sweat was feeling pretty good at the beginning of July. As co-manager of a merger arbitrage portfolio for $209 billion Dutch fund manager Robeco Asset Management, he’d made a decent return in the ﬁrst half of 2007 and had plenty of deals to play, including the $96 billion hostile takeover battle for Dutch bank ABN Amro. But by the middle of August, things had changed drastically. Troubles in the U.S. subprime mortgage market had spilled over into the equity markets, sending stock prices tumbling. Spreads on merger deals widened, and arbitrageurs began to fear that banks might not honor their ﬁ nancing commitments or that buyers might walk away from deals. An orderly retreat quickly became a rout. When a handful of investors were forced to sell sizable positions, others followed suit as deal spreads blew apart. But Sweat took it all in stride, using the opportunity to make a cheaper entrance into a handful of deals — a tack also taken at the time by many fund managers that don’t usually specialize in merger arbitrage. “When you see spreads move out across the board, it is more reassuring than when one or two move out,” says Sweat. “It tells you it’s not deal-speciﬁc; it’s strategy- or market-speciﬁc.” Though the market has rebounded somewhat since, the volume of M&A deals remains under pressure, as most of the big private equity transactions announced in the ﬁrst half of 2007 have closed or are falling apart. With private equity ﬁrms effectively shut out by the soaring cost of leveraged credit, corporate buyers have come to the fore, though the market has fallen back from the record activity in the ﬁrst half of 2007. Faced with fewer large deals, many merger arbitrageurs have begun turning to less-traditional event-driven transactions, such as buying companies up for sale at auction, those under siege by shareholdAs many traditional er activists or ones simply merger arbitrage seen as likely takeover candidates. Arbitrageurs investment opportunities are also casting a wider geographic net, looking have dried up, hedge for opportunities in Eufund managers have rope and Asia in addition to the U.S. moved into more Traditionally, arbitrageurs make money unusual deals, such as by capturing the spread between a stock’s price buying companies at the time a deal is anup for sale at auction nounced and its price when the deal is comor under siege by pleted. To do that in all-cash deals, they typishareholder activists. cally buy shares in the target below the deal value. In a share-exchange transaction, they also short shares of the acquirer to lock in the spread. When deal volume is strong, the strategy tends to do well. The ﬁ rst half of 2007 provided just such a scenario, as private equity ﬁrms launched a torrent of multibilliondollar buyouts: Blackstone Group paid $39 billion for Equity Ofﬁce Properties Trust; Kohlberg Kravis Roberts & Co. bid $44 billion for Texas power company TXU DECEMBER 2007/JANUARY 2008 • INSTITUTIONAL INVESTOR’S ALPHA • 57

Table of Contents Feed for the Digital Edition of Institutional Investor's Alpha Magazine - December 2007/January 2008

Institutional Investor's Alpha Magazine - December 2007/January 2008 Contents Letter from the Editor Longs & Shorts Pension Corner: Liberal Returns The Good Guy: Inner-city MVP Cover Story: Marathon Men Interview: Rizk Management Profile: Living on Hostile Ground Profile: Buy and Hold In Theory: The Fallacy of Portable Alpha Strategies: Changing Course Alpha Bytes: Behind the Scenes Unhedged: Commentary: An Activist Alternative

Institutional Investor's Alpha Magazine - December 2007/January 2008

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