Mergers and acquisitions arbitrage is refining its strategies
The decision in January by the European authorities to block the proposed UPS takeover of TNT could put a damper on this activity… or perhaps boost interest in it.
The collapse of the proposed takeover by the US courier company UPS of its Dutch counterpart TNT Express, after the European competition authorities had indicated that they would block the deal, could have an impact on M&A arbitrage strategies. As a reminder, merger arbitrage funds only enter the picture, unlike the rest of the event-driven universe, when a buyer has announced its takeover bid for a listed company. In general this announcement triggers automatically, and almost instantly, a rise in the stock’s price to a level close to the bid price. Their investment strategy represents a bet that the deal will “close” (between two and six months) at this price which offers a spread with the current price or – the ideal scenario – at a higher price in the event of a higher bid (still fairly rare despite the projected upturn in M&A activity).
“We are, in a way, insurers that want to avoid investing in the 5% to 10% of deals which, historically, are not completed”, explain Lionel Melka and François Bourriguen, respectively partner and analyst at Bernheim Dreyfus & Co. “In the proposed TNT-UPS deal, no-one could have anticipated the European Commission’s decision, which was not based on an objective analysis (see box). This political unpredictability is fairly new”, add the two portfolio managers, whose event-driven funds (200 million dollars) could reduce their proportion allocated to “merger arbitrage” this year (from 75% to 50%).
Fabienne Cretin and Stéphane Dieudonné, respectively Head of Absolute Return Strategies and portfolio manager at OFI AM, put the situation in perspective: “Since 2010 and the appointment of José Joaquín Almunia only 4 transactions have been blocked* by the European competition authorities out of around 600 proposals examined (0.7 %). We do not think that the decision to block the acquisition of TNT increases the regulatory risk”, say the team whose specialised funds (OFI Risk Absolu, 100 million euros, and OFI Risk Arbitrages, 185 million euros) attach particular importance to diversification.
However, the portfolio managers recognise that regulatory risk is not the only risk and refer to the Nexen and Progress Energy bids in Canada, where opposition to the proposed deals was based on protectionist considerations vis-à-vis State-owned foreign companies, namely Cnooc (Chinese) and Petronas (Malaysian) respectively. The Canadian government finally gave its green light for the deals to go ahead, “but only on an exceptional basis” and subject to the condition that the said companies comply with the same rules as listed companies with regard to accounting transparency, governance and social policy, etc.
… and protectionist risks
“Arcelor-Mittal, Unocal-Cnooc, P&O-Dubai Port, Potash-BHP, etc. protectionist considerations have always existed and do not call into question the relevance of the strategy. On the contrary, an increase in the risk would also be reflected in the spreads”, notes Fabienne Cretin. “Such a risk is starting to emerge with the Chinese authorities (MofCom) which, while not yet blocking transactions – as long as the country still needs to invest abroad – are slowing down transactions”, adds Lionel Melka, using as an example the Xstrata-Glencore merger. A risk of delays in meeting the timetable could be potentially expensive for the targeted annual returns (5% to 10 % gross on an unleveraged basis) which are easier to achieve if the deal is completed rapidly (in three or four months).
“The M&A market is changing and the risks of failure, whether for political reasons (BAE-EADS, etc.) or strategic reasons (Rhön Klinikum-Fresenius, Illumina-Roche, etc.), seem to be increasing; we therefore favour investment managers that adopt an approach that is more fundamental than statistical and are capable of being very reactive thanks to their analysis, whether they are long or short”, adds David Gilleron, Co-CIO for Hedge Funds Solutions at Theam, using the example of the US fund York Lion, which exited TNT fairly quickly in the face of the prospective risk. “But we remain optimistic: transactions will inevitably increase if confidence returns, as in the United States, whereas the number of players specialised in this strategy is decreasing”, concludes the investor.
*Olympic Airlines-Aegean, Aer Lingus-Ryan Air, TNT-UPS, Nyse Euronext-Deutsche Börse.