Deals… Deals… And More Deals
Regina M. Pitaro
Risk (or merger) arbitrage is one of the classic special situations equity categories. The premise of the area is that when corporations merge there are opportunities to assume risk of the corporate transaction. This strategy has been a tool used by many investors (Ben Graham, Warren Buffett, Mario Gabelli, Seth Klarman,etc). In terms of profit, merger arbitrage is less profitable today simple because it is easier. Ease of participation leads directly to increase competition. Learning about and thinking about the ideas of merger arbitrage, though, is a great way to introduce oneself to the ideas of earning profits that are not based on disagreements of future earnings (as is often the case when investing in traditional equities). Occasionally there are still some that make profitable trades!
Deals, Deals, And More Deals (DDaMD) is one of my favorite books in this space. Although not written by Mario Gabelli, DDaMD is published by Gabelli University Press (to date I do not know of any other books they have published) and Gabelli did urge the author to write it. Regina works at Gabelli Asset Management Company and is Mario’s wife. Perhaps merger arb is standard dinner conversation in the Gabelli household.
DDaMD gives some of the basics that one would expect from a book on merger arbitrage- an introduction to arbitrage and the heyday of merger arb during the wave of conglomerates and the LBO craze. There are two parts of the book that are worth reading and re-reading:
- Chapters 5-8 (Analysis of a Deal, Common Deals, Less Common Deals, and The Cast)
- The Appendices.
Chapter 5: Analysis of Deal walks through the basic questions that one should analyze in a merger arb deal. One must answer the basic questions of spread (gross rate of return), time, and players. Merger arb differs from traditional long equity in the sense the annualized return can essentially be determined exactly (upto delays in closing). The risk is that the actual event takes place- so the work goes into determining if the transaction will close. Of the three (spread, time, players) most analysis gets focused on the players- who are the buyers, sellers, their incentives and strategies, and the background on the deal. Every deal is different. Some deals are hostile, some are friendly. Some sellers are desperate and some buyers are greedy. Sometimes shares are spread across many shareholders and other times 40% of the shares are in the hands of a few (and they’ve already committed to the deal!).
Chapter 6 goes on to discuss the most common merger arbitrage deals: the all-cash merger and the stock-for-stock merger. Chapter 7 looks at some of the lesson common deals: minority buyouts, bidding wars, leveraged buyouts, stubs & recaps, and liquidations.
Chapter 8 focuses on the cast. Corporate events always have a myriad of players: lawyers, accountants, investment bankers, institutional shareholders, regulators, etc. It pays to know each type and to give them consideration in your analysis. A deal may look great to everyone- except a regulator. That doesn’t mean a deal won’t go through, it just may mean the deal has to change.
Many students read a book like this and feel they appreciate the big ideas, but are stumped on how to do it themselves. The appendices of the book help address this issue. Appendix I gives a decision tree for how to analyze a deal and Appendix II (one of my favorite parts) gives examples of 152 merger arb deals. Each description is about half a page.
I hope you enjoy if you’ve never read this book!