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Mergers & Aquisitions: Takeover arbitrage opportunities

Posted December 30, 2007

‘If you successfully identify a takeover target 6-9 months in advance of a deal in today’s current environment you’re looking at gains from up to 40-50%.  However, there’s a less risky way to play the mergers and acquisitions boom and that’s through arbitrage opportunities.’ – Louis Basenese 

Baltimore – (TFN): The following was taken from Louis Basenese’s appearance this month on TFN Smart Trading Action Alert with Laura Cadden.  (Watch the financial video.)

Laura Cadden: Welcome to TFN’s Smart Trading Action Alert.  I’m Laura Cadden.  Listening to the news these days, you could get the impression that this is a terrible time to invest money in the stock markets.  If you believe one group of analysts, stocks are still at unsustainable highs and headed for a sharp correction.  Others point at recent volatility as an indication of increased risk, warning investors to stay out of the markets all together.  Of course, smart traders know that market volatility can be leveraged into profit opportunities, both on upward and downward movements of stocks and indexes.

My guest today is Louis Basenesse, associate investment director of The Oxford Club.  Welcome to the show, Lou.

Louis Basenese: Thank you very much.

Laura Cadden: Now you have extensive experience as a trader.  From that perspective what do you think of the current market climate?

Louis Basenese: You look at it in one of two ways.  Either the current market scares you, all the volatility, and you’re really thinking about cashing in your chips and sitting on the sidelines until this credit crisis passes over, or you look at it from the perspective of there’s great opportunity.  Naturally I fall into the latter camp.  I think investors tend to overreact either on the upside or the downside and if you have a watch list of companies that you’d like to buy at attractive prices, the market is serving up those opportunities now.

Tired of reading?  Watch the financial video….

Laura Cadden: Now do you use technical analysis in making those decisions or are you more of a special scenario trader?

Louis Basenese: I have to confess that technicals take kind of a back seat for me.  I am more fundamental and I look at special situations, in particular IPO’s, initial public offerings, and takeovers.  I think the reason I focus on those two areas is most investors ignore them completely and from the simple standpoint that when there’s less competition for these opportunities there’s greater profit potential.

Laura Cadden: Well, speaking of takeovers and acquisitions and mergers, there’s been an awful lot of that going on in the past year.  I know that you’ve been active in arbitraging some of these situations.  Can you tell us how you go about that?

Louis Basenese: Sure. You can look at playing the mergers and acquisitions boom from two angles, and the first would be simply to try and identify companies that are takeover targets 6-9 months in advance of a deal.  Historically, if you look at the average returns on those companies if you’re successful you’re looking at 25% but in today’s current environment you’re looking at gains from up to 40-50%.  However there’s also a less risky way to play the mergers and acquisitions boom and that’s through arbitrage opportunities, and arbitrage is simply after the deal has been announced, the offer has been made, the stock price of the company being acquired will run up but it’ll stop just shy. 

There will be a small spread in between the offer price and the actual stock price, and all you’re doing is playing to exploit that spread.  Historically, it didn’t make much sense because the spreads are about 3-5% but right now we’re in an environment where you’re talking 8-10%. Again it sounds kind of like small returns but if you add up these gains, 8-10% in 30-90 days and you repeat the process it adds up to a significant gain over the long haul.

Laura Cadden: Now takeovers often generate a lot of publicity.  Do you think that kind of increased trading volatility or the activity that comes from the publicity affects the gains?

Louis Basenese: It’s a great question and it really depends on the timing.  If you’ve positioned yourself in a company in advance of this news it’s the best thing that can happen.  It’s a windfall situation.  There’s plenty of instances where the rumor alone will push share prices up and you can cash out for a profit at that point.  However, if you haven’t positioned yourself in the company in advance of the news I would tell you to be cautious.  There’s a lot of speculation that goes on and the stock prices tend to be more volatile.

Laura Cadden: Of course some deals never take place like BHP Billington - Rio Tinto.  Is there a lot of risk to arbitraging?

Louis Basenese: Again, a great question.  I think there’s risk in any investment strategy.  It’s no different when you focus on takeovers.  With takeovers though you really need to mitigate that risk.  If the deal falls through you need to have a backup plan and the way I look at that is if you only focus on takeover companies that have solid fundamentals and underlying business on its own.  It’s kind of an insurance policy.  If the deal never materializes you still stand to benefit regardless.

Laura Cadden: So do you have any companies you’re looking at right now?

Louis Basenese: Actually there are three companies that I’m particularly interested right now, two on the strategic side, the first one being Micro Strategy.  Micro Strategy is in the business intelligence software space.  Rampant consolidation going on there right now.  You’ve seen three deals in the past 18 months.  Business Objects was one, Hyperion Solutions, and Incognos most recently being purchased by IBM.  I think that Micro Strategy, the ticker is MSTR, is the most compelling publicly traded candidate left.  Upside potential there around 30-40%.  Again another strategic play would be Colonial Bank Group, ticker there is CNB.  This is a regional bank operating in Alabama, Texas, Georgia and Florida. 

What’s happening here is most investors have just thrown out financials indiscriminately so the share prices have fallen.  Yes they do have some real estate exposure but I really like the management here.  They have a really strict underwriting discipline.  Just to give you an example everyone knows the Miami condo market was the hottest real estate market that was out there.  Colonial Bank Group loaned into that market but they stopped loaning any money into that market four years ago so well ahead of the curve, well ahead of the correction, and it represents a great opportunity for a national bank to come in and establish a presence in the Southeast. 

Now flip that… I said there were strategic opportunities and also in the arbitrage.  In the arbitrage space I like Huntsman Corp.  The ticker symbol there is HUN.  The thing that’s attractive, there’s a current spread of about 14%.  The deal is expected to close by the end of April, and the other thing that’s very compelling is the insiders are actually purchasing shares.  The spread has gotten to a point where they even find it attractive.  Both the president and the chairman stepped up recently to purchase about $500,000 worth of shares.  In my opinion if they’re buying the deal is going to go through.

To learn more about Louis Basenese's investment research service, The Oxford Club, go to http://www.oxfordclub.com/. 

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