Getting straight to the point, it just doesn't seem that trading takeover arbitrages makes money these days. If anything, the way to make money from takeovers is to short the takeover target, although I certainly do not advocate or practise that strategy. For me, the most profitable and stress avoiding thing to do is just walk away and look for easier ways to make money.
Before I go on, if you are unfamiliar with the term 'takeover arbitrage', it means buying the takeover target after the takeover has been announced. The ideal takeover is a binding, all-cash offer as it theoretically reduces risk, and leaves upside exposure should a higher bid(s) come along.
The problem however is that bids can and do fall over and the downside can be horrible, especially compared to the upside. To use the three most common words in finance, there is often no 'margin of safety'.
There are two reasons why I find it hard to get excited about takeovers these days: 1. many are 'indicative, conditional and non-binding' and 2. plenty of takeovers are just dodgy.
Treasury Wine Estates (TWE) had not one but two conditional offers and still a deal could not be finalised:
Graincorp still hasn't recovered after the government knocked back the takeover:
The recent collapse of the Reef Casino (RCT) was just plain fishy and regardless of what the actual truth is, the takeover arbitrageurs got a spanking:
The mining sector is littered with failed takeover attempts, despite often superficially valid takeover bids on the table.
Warrnambool Cheese and Butter (WCB) has been the only (that I can think of) truly success takeover arbitrage story from the past few years:
I haven't traded a takeover for well over two years now, and apart from the very occasional sitting duck that has lots of embedded value, I can't see me trading too many in the future either. Please contact me if you disagree!
Kristian
Disclosure: no position in any of the above names
Also been thinking about this. SAI global another recent one. I have been lucky not to be burnt by these as it is an area I have paid attention to a long time. I used to read Rene Rivkin's very early reports in the 90's who did this a lot. My feeling is we just need to be more thorough with research. I believe Buffett used this strategy more than a lot of people think early in his career. It's a strategy that has stood the test of time. Probably got to commit to playing many over many years. Hopefully the odd WCB can come up more often than the failures you mentioned. Has been tough lately though. Think we should still examine each future one on its merits as a potential investment. I get a bit wary of bids from private equity groups and those words indicative non binding etc. Also because of the examples you mention I think we will see bigger discounts to bid price which can tilt the risk/reward trade off a bit more to playing these in the future perhaps.
ReplyDeleteWhen you assess the upside/downside and know that markets are generally pretty efficient around takeover announcements (excluding the uptick in as news leaks), I think it's a case that merger arb becomes a less interesting field in the short term but that doesn't mean it isn't a reasonable fishing ground on the odd occasion.
ReplyDeleteYou just have to lower expectations with respect to returns from this strategy; I view merger arb as a substitute for cash as opposed to making it a serious investment. A lot of time would be wasted trying to scour the world for low single digit returns and trying to lever that position (I don't have the guts for that) as well as minimising downside risk.
If it's any sign, I think John Paulson, who got his start in arbitrage, is trying to shift one of funds that is purely merger arb to other strategies after being burnt by the AbbVie/Shire deal not going ahead. A lot of other funds got hurt putting that trade on too. So it's certainly tougher than what it's been in the past.
When you assess the upside/downside and know that markets are generally pretty efficient around takeover announcements (excluding the uptick in as news leaks), I think it's a case that merger arb becomes a less interesting field in the short term but that doesn't mean it isn't a reasonable fishing ground on the odd occasion.
ReplyDeleteYou just have to lower expectations with respect to returns from this strategy; I view merger arb as a substitute for cash as opposed to making it a serious investment. A lot of time would be wasted trying to scour the world for low single digit returns and trying to lever that position (I don't have the guts for that) as well as minimising downside risk.
If it's any sign, I think John Paulson, who got his start in arbitrage, is trying to shift one of funds that is purely merger arb to other strategies after being burnt by the AbbVie/Shire deal not going ahead. A lot of other funds got hurt putting that trade on too. So it's certainly tougher than what it's been in the past.
Thanks for the comments - interesting points.
ReplyDeleteI'm not incredibly familiar as to how John Paulson trades mergers, but I understand he tries to hedge some positions using sector ETFs. That is probably harder to do in many of the the small-cap arbs we see.
If looking for a cash alternative, perhaps consider fixed interest style products such as some of the hybrids? They have provided me good pickings over the years, although the usual caveat of buyer beware and I can't give you advices advice apply. Or to be honest, just cash or a term deposit itself.
I'm definitely not ruling out takeovers altogether, but I do completely agree there needs to be underlying value and be comfortable with the scenario that if the deal falls over, I'm happy to hold. I just don't see many that fit that bill.