Merger Arbitrage Investing

Today's Financial News - Posted July 11, 2008

Merger Arbitrage is often associated with Hedge Funds and is an investment strategy in which the stocks of two merging companies are bought and sold at the same time to create profit with little or no risk. Thomas Kirchner, an expert in merger arbitrage investing spills the beans on some exciting new deals.

by Krista Das

Baltimore — (TFN): Merger arbitrage is often associated with Hedge Funds and as an investment strategy in which the stocks of two merging companies are bought and sold at the same time to create profit with little or no risk.

Joining us today is Thomas Kirchner, who runs the Pennsylvania Avenue Event Driven Fund (PAEDX), a mutual fund that invests in merger arbitrage, and a blog called the Deal Sleuth. Thomas, welcome to Market Insights.

So tell us about investing in merger arbitrage. Not all merger investments are created the same. What is the best way to go about it?

Thomas Kirchner: Well you are absolutely right. You really have to look at each deal individually, and this is really what makes merger arbitrage much different from a lot of other strategies where you would look at some common metrics such as earnings or cash flow.

And merger arbitrage, really, you have to look much more at, at the legal aspects of how the deal is structured, and also at how the financing is going to come about in some of the deals that are paid for in cash. So that makes it a much different way of investing than traditional investments.

Krista Das: Now what about the risks? Like every market merger arbitrage has its cycle leading investors and Hedge Fund managers to question whether the strategy is dead. With the U.S. economy being in the state that it’s in, where in the cycle are we now and when was the last big bust?

Thomas Kirchner: Well we’re actually just going through the end of a bust cycle right now. We’ve, we’ve had a wonderful boom over the last three or four years, an incredible merger boom that was driven for the most part by cheap money, cheap lending, that allowed private equity funds to buy up a good chunk of the U.S. economy and take those companies private. And that provided us with wonderful opportunities to take advantage of the deal spreads and capture pretty good returns.

Now when the credit crisis hit, that came to an abrupt stop, and really penalized arbitragers a lot, and we suffered a fairly significant amount of losses for the short run. But now where we’re entering into the next phase, private equity is dead as buyers, but we’re seeing a new class of buyers come in, and those are the strategic acquirers who have been shut out of the market.

And in particular we have seen an increase of foreign buyers coming into the U.S. market trying to acquire companies here, because the dollar is so low, and if you are a foreigner it makes it very cheap for you to acquire U.S. companies.

****View the video here…

Krista Das: Thomas, what are some upcoming merger arbitrage deals that you’re excited about?

Thomas Kirchner: I’m excited about mostly small deals, and many of those are unfortunately too small to mention here. But I’ve got some interesting bigger ones as well. Anheuser Bush, the makers of the Budweiser beer, are maybe going to be taken over by a large European brewery, European/Brazilian brewery conglomerate, and that, if it goes through, will provide arbitragers with a pretty decent return.

Now that’s a very risky deal, and I almost would call it speculation rather than arbitrage. But on the arbitrage front we’ve got a few deals as well that could be interesting. For example, corn products are being taken over Bengal, that’s a stock for stock deal. But you’ve got to be careful if you play it. It’s got a call out provision, so it’s somewhat difficult to hatch.

Krista Das: What is the Pennsylvania Avenue Event Driven Fund all about, and what requirements do you have for investors?

Thomas Kirchner: Well we don’t really have any requirements, unlike a Hedge Fund that really has a very high minimum. You have to be qualified to invest. We’re a public mutual fund, so most brokerage firms offer our fund to their customers for, for a fairly small minimum investment. And the idea in creating the fund was to take a strategy that is normally only available to high net worth individuals and make it available to the mass market through the brokerage firms.

But not being a Hedge Fund, being a mutual fund, so you’ve got all the benefits of public disclosure and SEC reporting.

Krista Das: Thomas thanks for sharing with us the ins and outs of merger arbitrage. If you are interested in becoming an investor with the Pennsylvania Avenue Event Driven Fund follow this link.

****Make sure you sign up for our FREE TFN News Feed for breaking news, special reports and new financial videos. Sign up through your favorite reader here. Or, if you prefer, have the feed delivered to your email.