Friday, January 23, 2009

Merger Arbitrage As A Substitute For Cash Equivalents

The past fifteen months have been instructive to all investors. Painful as well. No one, including myself, has had the right vision that resulted in consistent profits. Even short sellers closed out profitable trades and bottomed fished stocks that negated their short vision. 

The world is awash in cash and it yields virtually nothing. Nobody's ready to jump back head first into equities, government bond yields are extremely low and a bubble is percolating, the recession makes corporate bonds appropriate only for amateur credit analysts, municipals are going to see tax collecting problems and defaults, and bank CDs are very low yielders. An exception to the last statement is available for those that are willing to put money into the country's worst banks in amounts that are under the FDIC umbrella.

So what do you do with all of the cash you've pulled out of equities? Cash , while keeping you solvent, doesn't grow net worth, send the kids to college, pay for retirement, or let you sleep well at night when you're worrying about the foregoing. Wrigley, Budweiser, Puget Sound Energy and other merger arbitrage opportunities have offered very attractive returns, far superior to money market investments.

In normal times merger arbitrage is a game of pennies. This past year, with the credit markets in turmoil, the spreads available to willing investors have been generous. Certainly, and especially in this market, all announced mergers are not completed and an investment in the acquiree can end up in a loss. but deals are still getting done and the spreads, at times, have been exceptional.

Wrigley and Bud allowed the arbitrageur to buy shares, at a large discount to the closing price, after almost all of the risk was removed from the transaction. Puget Sound was, and is still, a very similar situation. Several weeks ago the stock was selling for $23 and the takeout price price was $30. There was some risk of the deal falling apart, but if it did, you would still be left with a good utility that pays a dividend. It wouldn't be the worst investment in this market. Since then, the final regulators have blessed the deal, closing has been set for February 6, the company has said they will pay an additional pro-rata dividend till closing, in addition to previous shareholder approvals and regulatory approvals. Still, you can buy PSD for about $29 and get back $30 on or near February 6th. Put $29 in a savings account, money market fund, or any other short term investment and see if you get back $1 in a years time. Yes, it's possible the deal won't close, the Attorney General of Washington has until January 29 to appeal the approval that his office has already given, but the odds are looking very good that money can be put to work effectively in this arbitrage.

No comments:

Add to Technorati Favorites