Merger arbitrage how to profit from global event driven arbitrage

Table of Contents Series Page Title Page Copyright Preface Acknowledgments Part One: The Arbitrage Process Chapter 1: Introduction to Merger Arbitrage Notes Chapter 2: The Mechanics of Merger Arbitrage Cash Mergers Stock-for-Stock Mergers Note Chapter 3: The Role of Merger Arbitrage in a Diversified Portfolio Volatility of Stocks Going through a Merger Merger Arbitrage Universe Merger Arbitrage Spreads Performance Characteristics of Merger Arbitrage Performance of Merger Arbitrage outside the United States Risk and Return of Merger Arbitrage Funds Benefits of Merger Arbitrage in a Diversified Portfolio Benefits of Merger Arbitrage in a Rising Interest Rate Environment Quantitative Easing Notes Chapter 4: Incorporating Risk into the Arbitrage Decision Probability of Closing Severity of Losses Expected Return of the Arbitrage Notes Part Two: Pitfalls of Merger Arbitrage Chapter 5: Sources of Risk and Return Deal Spread Two Aspects of Liquidity Beneficial Participation of Arbitrageurs Timing and Speed of Closing Dividends Short Sales as a Hedge and an Element of Return Leverage Boosts Returns Covered Call Writing Commissions and Portfolio Turnover Bidding Wars and Hostile Bids Chinese Companies Notes Chapter 6: Deal Structures: Mergers and Tender Offers Mergers Scheme of Arrangement Tender Offers Comparison of Mergers and Tender Offers Burger King Provision: The Best of Both Worlds SEC's Approach to Regulation Notes Chapter 7: Financing Types of Debt Funding Financing of Mergers versus Tender Offers Uncertain Merger Consideration Conflicted Role of Investment Banks Fairness Opinions Systemic Risk Notes Chapter 8: Legal Aspects Merger Process Corporation Codes Takeover Code and Its Derivatives Key U.S Court Decisions Takeover Defenses Creeping Takeovers and Mandatory Acquisitions Best Price Rule Market Manipulation Notes Chapter 9: Management Incentives Management Compensation Continuing Management Interest in Private Equity Buyouts Long-Term Planning in Management Buyouts Milking a Company through Related Party Transactions Notes Chapter 10: Buyouts by Private Equity Private Equity's Advantage CEOs Don't Want to Sell to the Highest Bidder Private Equity Funds Have Their Own Agenda Buyouts as Financial Engineering Activists Replace Private Equity Notes Chapter 11: Minority Squeeze-Outs Boards' Lack Effectiveness during Squeeze-outs Minority Shareholders Are in a Tough Spot Family Control Notes Part Three: Investing in Merger Arbitrage Chapter 12: Government Involvement Antitrust Enforcement Tax Policy Securities Regulators State and Provincial Governments National Governments China: The Great Wall of Laws Trade Unions Notes Chapter 13: Four Ways to Fight Abuse of Shareholders in Mergers “Just Sell” Is for Losers The Rise of Shareholder Activists Case for Activist Merger Arbitrage Legal Tactics Public Opposition Notes Chapter 14: Investing in Arbitrage Trading versus Investing Leverage and Options Shorting Stocks Transaction Costs Managing the Cash Position Risk Management Merger Arbitrage Indices Separate Accounts Hedge Funds and Liquid Alternatives Notes About the Author Exercises CHAPTER CHAPTER CHAPTER CHAPTER CHAPTER CHAPTER CHAPTER CHAPTER CHAPTER 10 Index End User License Agreement List of Illustrations Chapter 1: Introduction to Merger Arbitrage Figure 1.1 Frequency of the Occurrence of the Term Arbitrage in Printed Books Figure 1.2 Frequency of the Occurrence of the Terms Merger Arbitrage and Risk Arbitrage in Books Figure 1.3 Risk Spectrum of Merger-Related Investments Figure 1.4 Stock Price of Dresser-Rand Group around the Rumor of an Acquisition by Siemens Figure 1.5 Payoff Distribution for Stock Investors Figure 1.6 Asymmetric Payoff Distribution Figure 1.7 Lefèvre Diagram of the Put Option Characteristics of Merger Arbitrage Figure 1.8 Lefèvre Payoff Diagram of Cash Mergers Chapter 2: The Mechanics of Merger Arbitrage Figure 2.1 Stock Price of Autonomy before and after the Merger Announcement Figure 2.2 Idealized Chart of Stock in a Cash Merger Figure 2.3 IRR Calculation of Annualized Return in Excel Figure 2.4 Stock Prices of B2Gold and CGA Figure 2.5 Evolution of the CGA/B2Gold Spread Figure 2.6 Fluctuation of Health Care REIT's Stock Price Prior to the Merger Figure 2.7 Optionality in Mergers with a Fixed-Value Collar Figure 2.8 Optionality in Mergers with a Fixed-Share Collar Chapter 3: The Role of Merger Arbitrage in a Diversified Portfolio Figure 3.1 Daily Price Changes (in pence) of Autonomy Corporation before and after the Merger Announcement Figure 3.2 Cross-sectional Distribution of Daily Returns (a) before and (b) after the Announcement of a Merger Figure 3.3 Variance of Daily Returns (a) before and (b) after the Announcement of a Merger Figure 3.4 Number of Mergers and Waves of Merger Activity since the year 1895 Figure 3.5 Worldwide Volume of Mergers (in US$ trillions, left axis) and Level of the S&P 500 Price Index Since 1992 (right axis) Data: Factset Mergerstat Figure 3.6 Percentage Cash and Stock Mergers over Time Data: Factset Mergerstat Figure 3.7 Average Annualized Merger Arbitrage Spread Figure 3.8 Distribution of Merger Arbitrage Spreads (Annualized) in the Middle of Each Year Figure 3.9 Percentage Spread of the Kinder Morgan / El Paso Merger Figure 3.10 Piecewise Linear Regression of Excess Merger Arbitrage Returns versus Market Returns Figure 3.11 Piecewise Linear Regression of Excess Merger Arbitrage Returns Figure 3.12 Assets Managed in Merger Arbitrage Funds Figure 3.13 Monthly Performance of Merger Arbitrage Hedge Funds, the S&P 500, and Bonds Figure 3.14 Performance of Three Merger Arbitrage Hedge Fund Indices Relative to Stocks and Bonds Figure 3.15 Risk/Return Trade-off for Merger Arbitrage Figure 3.16 Performance of Various Merger Arbitrage Hedge Fund Indices Relative to the HFR Hedge Fund Figure 3.17 Efficient Frontiers for Combinations of Stocks and Bonds as well as Stocks, Bonds, and the HFR Index Figure 3.18 Risk/Return Trade-off for Mutual Funds That Use Merger Arbitrage Figure 3.19 Efficient Frontier for Mutual Funds That Use Merger Arbitrage Figure 3.20 Performance of Merger Arbitrage in Periods of Rising Interest Rates Figure 3.21 Performance of Several Hedge Fund Strategies in Periods of Rising Interest Rates Chapter 4: Incorporating Risk into the Arbitrage Decision Figure 4.1 Stock Price of Unisource after the Collapse of the Merger Figure 4.2 Typical Breakup Fees for Targets of Different Sizes across All Transactions Figure 4.3 Typical Breakup Fees for Targets of Different Sizes Only for Transactions That Have Breakup Fees Figure 4.4 Percentage of Transactions with Breakup Fees (a) $50–500 Million (b) >$500 Million Figure 4.5 Prevalence of Breakup Fees Percentage of Transactions That Contain Breakup Fees for (a) U.S Mergers with an Announcement Value between $50 and $500 Million (b) Announcement Value of More Than $500 Million Figure 4.6 Evolution of Breakup Fees for (a) U.S Mergers with an Announcement Value between $50 and $500 Million (b) Announcement Value of More Than $500 Million Figure 4.7 Canadian Breakup Fees (a) Prevalence of Breakup Fees (b) Level of Breakup Fees Figure 4.8 U.K Breakup Fees: (a) Prevalence of Breakup Fees (b) Level of Breakup Fees Figure 4.9 Autonomy Prior to Its Acquisition by HP Figure 4.10 Pinnacle Resources and Quest Resource Corp after the Canceled Merger Figure 4.11 Evolution of Acquisition Premia Chapter 5: Sources of Risk and Return Figure 5.1 Evolution of the Spread of the Autonomy Merger Figure 5.2 Price (left scale; line) and Volume (right scale, in thousands; bars) Chart of Autonomy Common Stock Figure 5.3 Volume Chart of Trustreet Series C Preferred Stock Figure 5.4 Order Book for MCG Capital Figure 5.5 Order Book for Mylan NV Figure 5.6 Lafarge North America Figure 5.7 Covered Call Writing Figure 5.8 (a) Implied Volatility and (b) Option Trading Volume of Superior Essex Inc Figure 5.9 Stock Price of Anheuser-Busch Cos Figure 5.10 Stock Price of Genentech and the S&P 500 Index Figure 5.11 Bidding War over 3PAR Chapter 6: Deal Structures: Mergers and Tender Offers Figure 6.1 Direct Merger Figure 6.2(a) Forward Triangular Merger Figure 6.2(b) Reverse Triangular Merger Chapter 7: Financing Figure 7.1 Verenium's Stock Price after BASF's Acquisition Proposal Figure 7.2 Price of the Sanofi/Genzyme CVR Figure 7.3 Leveraged Loans: All in Spreads Chapter 8: Legal Aspects Figure 8.1 Legal Universes for Mergers and Acquisitions Figure 8.2 Price of the ISS Global A/S 4.75% Bond Due 09/10 Figure 8.3(a) Timetable for “schemes of arrangement” under the Takeover Code with relevant rules of the Takeover Code or Section of the Companies Act Figure 8.3(b) Timetable for takeover offers under the Takeover Code with relevant rules of the Takeover Code or Section of the Companies Act Figure 8.4(a) Timetable for Takeovers in Switzerland Figure 8.4(b) Timetable for Takeovers in Italy Chapter 10: Buyouts by Private Equity Figure 10.1 Stock Price of Merisel at the Time of American Capital Strategies' Acquisition Proposal Chapter 11: Minority Squeeze-Outs Figure 11.1 Stock Price of infoUSA after the 2005 Earnings Release and Gupta's Acquisition Proposal Figure 11.2 infoUSA's Stock Price, 2006–2008 Figure 11.3 Chapparal Resources Chapter 12: Government Involvement Figure 12.1 Stock Price of Esmark Chapter 13: Four Ways to Fight Abuse of Shareholders in Mergers Figure 13.1 Late Stages of a Company's Life Figure 13.2 Number of Annual Activist Merger Arbitrage Events (U.S Mergers Only) Chapter 14: Investing in Arbitrage Figure 14.1 Leverage Coupled with Short Selling Leads to Negative Alpha Figure 14.2 Fees and Short Sale Activity (Utilization of Shares Available) around Dividend Payments Figure 14.3 Frequency of Merger Closings by Calendar Month, 1990–2013 Figure 14.4 Performance of the IQ Index and S&P Merger Arbitrage Indices Relative to Other Asset Classes Figure 14.5 Risk/Return Trade-off for the S&P Merger Arbitrage Index Since Its Inception List of Tables Chapter 1: Introduction to Merger Arbitrage Table 1.1 Orders of Arbitrage Chapter 2: The Mechanics of Merger Arbitrage Table 2.1 Cash Flows in CGA/B2Gold Merger Table 2.2 Losses Suffered at a Constant Percentage Spread in a Rising Market Chapter 3: The Role of Merger Arbitrage in a Diversified Portfolio Table 3.1 Correlation of Merger Arbitrage Spreads to Different Interest Rates Table 3.2 Merger Arbitrage Returns for Different Portfolios Table 3.3 Statistics of Monthly Return for Merger Arbitrage Hedge Fund Indices Compared to Stocks and Bonds over a Quarter Century, 1990–2014 Table 3.4 CAPM* Statistics of the Merger Arbitrage Hedge Fund Indices, Relative to the S&P 500 Table 3.5 Various Downside Risk Measures Table 3.6 Ranking of Merger Arbitrage Relative to Traditional Investment Strategies Table 3.7 Ranking of Merger Arbitrage Relative to Other Hedge Fund Strategies Table 3.8 Performance of Merger Arbitrage Prior to Quantitative Easing (1990– 2008) Chapter 4: Incorporating Risk into the Arbitrage Decision Table 4.1 Failure Rates of Mergers According to Fich and Stefanescu Table 4.2(a) Average Breakup Fees for Completed and Canceled U.S Mergers with an Announcement Value between $50 and $500 Million Table 4.2(b) Average Breakup Fees for Completed and Canceled U.S Mergers with an Announcement Value of More Than $500 Million Table 4.3 Average Acquisition Premia over the period 1995-2013 Chapter 5: Sources of Risk and Return Table 5.1 Arbitrageurs' Holdings of Target Company Stock in Selected Mergers Table 5.2 Time Periods Required to Close a Merger in the United States, by Industry Table 5.3 Time until the Collapse of U.S Mergers, by Industry Table 5.4(a) Timing of Public Company Mergers in Canada Table 5.4(b) Timing of Public Company Mergers in the United Kingdom Table 5.4(c) Timing of Public Company Mergers in Australia Table 5.4(d) Timing of Public Company Mergers in France, Austria, and Germany Table 5.5 Improvement in the Arbitrage Spread of the CGI Mining/B2Gold Stockfor-Stock Merger for Different Levels of Short Rebates Table 5.6 Overview of Spreads from Examples in Chapter Table 5.7 The World's 20 Largest Completed Hostile Takeover Transactions, through Year-End 2014 Chapter 6: Deal Structures: Mergers and Tender Offers Table 6.1 Mergers and Tender offers in several common law jurisdictions Table 6.2 Timing in Mergers and Tender Offers, 1980–2005 Real estate investment trusts (REITs) ReFlow Management Co., shares acquisition Regulation, SEC approach Regulation SHO Regulation T Reincorporation, impact Related party transactions Reporting periodicity, variation Restoration Hardware, acquisition Returns annualized return arbitrage, expected return daily returns excess merger arbitrage returns extension risk, impact leverage, impact monthly return statistics portfolios, merger arbitrage returns projections short sales element sources Reverse merger arbitrage Reverse triangular merger Revlon v MacAndrews & Forbes Rising market, constant percentage spread (losses) Risk arbitrage downside risk measures management risk/return profile split statistics, CAPM framework systemic risk Risk-free interest rate, indicator consideration Risk-return trade-off (risk/return trade-off) Rohrabacker, Dana Royal Bank of Canada (RBC) Rue21, Inc Rule 13-e3 (Rule 13-E3) (SEC) Rule 14d-10 (SEC) Rule 14E (SEC) Rule 425 filing (SEC) Rumors Rural/Metro Corporation, Emergency Medical Services acquisition S Sack, Burton Sale financing Sale-leaseback transactions, structuring Salix Pharmaceuticals, Allergan acquisition Sanofi/Genzyme CVR Sarbanes-Oxley law Savasoglu, Serkan Schedule 13D (SEC), purchases Schedule 13E-3 (SEC) Schedule 14A (SEC) Schedule 14D-9 (SEC) Schedule K-1 (IRS) Schedule TO (SEC) Scheme of Arrangement, See Arrangement SCPIE, The Doctors' Company acquisition Second requests Securities Securities and Exchange Act, Section 10b-5 Securities and Exchange Commission (SEC) acquirer/target filings filings merger regulation regulation approach rules tender offer regulation Security Capital, MTN Capital acquisition Sellers Semi deviation Shannon, John Shareholders abuse, occurrence activism activists, rise base, composition (change) beneficial owner status board disenfranchisement, justification economic exposure, absence investment exit opposition (mergers) price maximization, board (impact) proxy campaigns public opposition reincorporation, impact selling shareholders, payment shares, withholding stock sales, impact Shares borrowing withholding Sharpe ratio Shell acquisition of Cove Energy plc, breakup fee Sherman Act of 1890 Shorin, Arthur T Short biased hedge funds, performance Shorted stock, dividends payment Short-form merger Short sales activity closing, process hedges, comparison naked short sales, prohibition selling pressure Short sellers, position coverage Short selling bans Short-term capital gains (generation), merger arbitrage (usage) Siemens, acquisition (rumor) Silconix, Vishay Intertechnology acquisition Silver Lake Partners, acquisition proposal Simon Properties Simple interest, calculation Single stock futures, OneChicago offering SISU Capital Ltd Small-cap premium, manifestation SOE See State-owned enterprise Soft dollars (brokerage commission) Solomon v Pathe Communications Corp Sortino ratio Southeastern Asset Management, merger stake Southwest Airlines Co Sovereign Bancorp, Groupo Santander acquisition Spain, takeover timetables SPAR-Mutual algorithm Special takeover defenses Special voting rights Speculation, arbitrage (differences) Spreads annualized spread, increase average annualized merger arbitrage spread bid/offer spreads deal spread dispersion, downtrend evolution (Autonomy Corp.) information, problem leveraged loans merger arbitrage spreads overview problems, avoidance widening width/tightness Spruchverfahren Squeeze-outs Standard & Poor's 500 (S&P500) Index Standard & Poor's (S&P) Depositary Receipts (SPDR) Standard & Poor's Merger Arbitrage Indices Stapled financing State Administration of Foreign Exchange (SAFE) State Administration of Industry and Commerce (SAIC) State Administration of Taxation (SAT) State governments, impact State laws, impact State-owned Assets Supervision and Administration Commission (SASAC) State-owned enterprise (SOE) Stefanesco, Irina Stifel Financial Corp acquisition Stock-for-stock mergers analysis, perils arbitrage, comparison cash mergers, contrast cash receipt market movement protection short leg Stock-for-stock offer Stock-for-stock swap Stock-for-stock transactions Stocks appreciation rights arbitrageur shorting bonds (combination), efficient frontiers cash merger, idealized chart combination investors, payoff distribution market, development mergers, percentage multiple classes options ownership, percentage preannouncement stock returns preferred stock, series price, examples shorting short seller trading volume (description), liquidity (usage) volatility Stonington Partners Strategic alternatives Strine, Leo Summary term sheet Sungard Data Systems, acquisition Sunoco Inc., Energy Partners, LP acquisition Superior Essex Inc., option trading volume Supervoting shares, usage Supra-national regulations Survivorship bias Swiss Performance Index (SPI) Switzerland, takeover timetables Swoboda, Otto Symmetric performance fee, risks Systemic risk T Takeover Code Takeovers best price rule board buybacks (leveraged recapitalizations) buyer lockout creeping takeovers cross-border transactions cumulative voting defenses entire fairness, requirement exit rights freeze-out hostile takeover transactions, ranking Imaging Ltd./Coviden merger agreement, voting conditions mandatory acquisitions mandatory takeover rules, characteristics market manipulation mergers, coerciveness No Increase/No Extension statements Pac-Man takeover defense poison pills shareholders speculation, presence staggered boards, impact stocks, multiple classes U.S court decisions Takeunder Target balance sheet, cash (availability) breakup fees cumulative abnormal stock returns loss severity Target company Tashman, Adam Taubman Centers, Inc., ownership battle Tax deferral, application inversion policies post-inversion reporting (mutual funds) Tax Increase Prevention and Reconciliation Act of 2005 Tender offers acquirer/target SEC filings advantage amendment arrangement, scheme bidder, share ownership completion deal structures extension financing funds, sources judicial review, impact law jurisdictions mergers Rule 14E requirements SEC regulation shares, withholding speed, increase statements summary term sheet timing 3G Capital, Burger King merger 3PAR Ticking fee Tight spreads Time-weighted portfolio, structuring Tokyo Electron (ETL)/Applied Materials, merger agreement Topps, lawsuit Top-up option Total return swaps, sellers Touchstone Merger Arbitrage Fund (TMGAX) Tower Australia, Dai-Ichi Life Insurance Company (arrangement scheme) Tracking error Trade unions, impact Trading insider trading investing, contrast Trane, Ingersoll-Rand acquisition (account) Transactions Atmi, Inc transaction bonus agreement (disclosure) breakup fees costs going-private transactions hedging, accuracy timing, arbitrageur analysis Transkaryotic decision Treasury bills (T-bills) Treasury yield, short-term trough/peak Treynor ratio Triangular mergers, types Tropicana Casino license, withdrawal Trough, criteria Trustreet Properties, General Electric acquisition Trustreet series C preferred stock, volume chart 220 requests U UCITS-compliant funds UCITS funds Uncertain merger consideration Unisource Energy, Kohlberg Kravis Roberts & Co acquisition Unisource stock price, postmerger collapse United Kingdom (UK) breakup fees City Code on Takeovers and Mergers public company mergers, timing Takeover Code United States antitrust rules incorporation laws United States mergers United Steelworkers (USW), Esmark contract University of Massachusetts Amherst, MAR data Unocal v Mesa Petroleum Unreasonably small capital, presence UOP, Inc., majority shareholder Upmarkets, consideration Upper Deck Upside/downside capture ratio U.S minority shareholders, impact Utilities, takeover (failure) V Valeant Pharmaceuticals Valuation opinion Value-at-Risk (VAR), usage Value trap Van Gorkom Vector Capital Verenium Corporation VistaCare, acquisition Vodafone, Supreme Court ruling Volatility implied volatility low-volatility strategy Volkswagen AG, Porsche SE takeover Volume-weighted average price (VWAP) Vulcan Materials Company, Energy Transfer Partners, LP, acquisition W Walkling, Ralph Wallace, Carter Wang, Jia Wasserstein, Bruce Weighted average cost of capital (WACC) Wells Fargo/Wachovia merger, effect Westfield America Trust Wide spreads Wild Oats, Whole Foods acquisition (FTC injunction) William Blair, fairness opinion Wilshire Enterprises Windfall profits, types Windrose Medical Properties World Focus, debt Wynn Resorts Y Yang, Taewon Yeoh, Soon Chin Z Zilbermints, Boris WILEY END USER LICENSE AGREEMENT Go to www.wiley.com/go/eula to access Wiley's ebook EULA ... The Arbitrage Process Chapter 1: Introduction to Merger Arbitrage Notes Chapter 2: The Mechanics of Merger Arbitrage Cash Mergers Stock-for-Stock Mergers Note Chapter 3: The Role of Merger Arbitrage. .. of Merger Arbitrage This chapter discusses the first three types of merger consideration and how arbitrageurs will set up an arbitrage trade and profit from it: Cash mergers Stock-for-stock mergers... Portfolio Volatility of Stocks Going through a Merger Merger Arbitrage Universe Merger Arbitrage Spreads Performance Characteristics of Merger Arbitrage Performance of Merger Arbitrage outside the