How a Risk Specialist Unlocks Market-Neutral Returns

you have to move on from your losers once once if we invest in a deal and a deal is terminated and all of a sudden it's not within our investable universe anymore you know the the Activision deal if that once that deal is terminated then we're not I'm not betting based upon they're gonna they're gonna come up with Call of Duty Five and it's going to be the most fantastic thing ever and I'm gonna make all my money back that might be true I mean it might be undervalued people think atvi has has very little downside and in fact they think of the deals terminated it may trade up above 75 but that's not the business that we're in and I think that the that lesson is sort of applicable to whatever kind of investing people do you know there's an old expression that says uh plan your trade and trade your plan if you if the reason why you're in an investment is not there anymore then you should think about whether you want to still stay in it we're doing things a little differently on three ideas today looking at merger Arbitrage with Roy Baron he's the co-president and CIO of Westchester Capital Management Roy welcome to the show you specialize in merger Arbitrage we haven't ever done that on the show before and so I think instead of asking you about your Global macro Outlook I think it's important for folks to understand exactly how you do this many people will be familiar with it but actually executing is something quite different so let's take a step back and just walk us through the steps before we actually get into your three ideas Roy well thank you Sam it's nice to be here um I appreciate you having me on merger Arbitrage is a very specific Niche type of investing strategy um it involves investing in the shares of companies that are involved in mergers and Acquisitions and other types of corporate reorganizations with the goal of profiting from the successful completion of those transactions not necessarily from the appreciation of the companies involved although they will typically appreciate but from the completion of the transaction which is why it falls into a category called Market neutral investing or absolute return investing so typically when a transaction is announced the stock will trade up because the transactions are typically announced at a premium to where the stock is has was previously trading and it will approach the deal price but it will trade all the way up to the deal price because there may be some uncertainty about whether the deal is completed there may be some uncertainty yes so the timing of the transaction or other types of factors such as the shareholder vote the regulatory approvals and things like that and all of those uncertainties uh cause the stock to trade at a discount to the deal price that discount is known as the Arbitrage spread and that Arbitrage spread is the amount of profit that we make if the deal is completed so you can understand that if the deal is completed whether it's in a down Market or an up Market or a sideways Market the investor or the arbitrageur in our case will realize that Arbitrage spread as the profit and that's how we make our money and that's why it's Market neutral the market goes down the deal is completed we still make our our profit which is the amount of the Arbitrage spread you're very well respected in this field you're very well known in this field and so my curiosity is I've been doing the preparation for this Edition is what's the edge that you have that others don't many people can look at a deal whether it's uh Microsoft Activision and we saw what happened with Regulators here in the UK and say they think this deal is going to close but obviously you see some type of edge in yourself and your team so what's the edge there are a number of edges that can be had I mean all the all the information is publicly available information so it's really what you do with it and how you analyze it my own background for example is I used to be a lawyer I used to be a you know a actually used to work at the security Exchange Commission and my partner Mike Shannon used to be an investment banker our lead analyst used to be a fundamental Analyst at a Major Bulge bracket firm and when a deal is announced we have to look at all the different possibilities of of timing of transaction completion that the types of of approvals that are needed and the things that can get away of the transaction actually being completed such as an Anti-Trust approval or in the case of a drug deal and FDA approval all of those things are various factors that we need to handicap the probability of being received and then we look at the market and see where it's trading and see if the market is appropriately discounting those factors or those approvals or those contingencies so we've been doing this I've personally been doing this since the mid 1990s as as my partner and all the members of our team have been doing it for for decades so would you say your Edge is the brain power that you have you have the experience here and you're looking at something and you're more sure than the market is that this deal is going to close this acquisition is going to happen I would say that's true I mean it's there's a matter of judgment it's very qualitative process there's some quantitative calculations that we use to determine whether you're getting paid an appropriate amount for the risk that we're taking and whether or not the market is appropriately pricing in the various risks but you know at the end of the day it's really a judgment call to decide whether or not um the transaction is appropriately reflected in the market um in terms of the prices trading at versus the transaction price then also in terms of of constructing a portfolio the portfolio really needs to be Diversified because in many instances the amount you stand to make is going to be little compared to the the the size of the potential drawdown or your downside or or it's known in the industry is the value at risk the VAR and so you have to make sure you have a very very high batting average uh just before we get into to the first of your three ideas Microsoft Activision as I mentioned is is the one that's on so many people's minds especially because the UK rejected the deal so walk us through was that uh was that a deal that you were going long on and how do people cope when something doesn't go through how did you see that and how do you look at it in hindsight it's a good question and that's an example of the type of research that that can add value to a process I mean if you look at it you think okay Microsoft's buying Activision they own Xbox they're buying a game maker what's the problem with that why why could Regulators possibly have a problem but in reality if you delve further into it The Regulators didn't have a problem and in particular uh the CMA which is the UK regulatory Authority that blocked the transaction didn't have a problem so much with the uh with the consoles as the potential growth of the cloud gaming industry cloud gaming is very very new and they were worried that if Microsoft controlled a bunch of quote unquote must-have games such as Call of Duty Etc that they would then be able to dominate the industry they'd be able to force the providers to use their own cloud service for um for data transfer and storage and it would be an anti-competitive transaction that's the standard that most Regulators use if a transaction would throat thwart competition or or foreclose competition then Regulators uh would like to either kind of control the transaction by imposing conditions or block it all together and in this particular case um Lena Khan at the FTC actually filed suit to block the transaction the EU may still approve it but the CMA which has a very very long process and is very difficult to overturn has decided that it's anti-competitive and they would they would like to block it so they have filed an action they have denied approval for it and Microsoft and Activision have said that they're going to appeal they're contractually obligated to do so so we'll probably see some appeal papers in the near future but it's unclear whether they will see it all the way through that remains to be seen at this point I would be surprised by the CMAs denial we we were not surprised uh the stock was trading at a significant discount but during dependency of the transaction the the fundamental value of Activision increase they reported good earnings it became more of a valuable uh valuable company and the stock traded up from the low 70s into the mid 80s it's currently trading at about 75. we had a position because we thought that the the transaction would kind of percolate as The Regulators were reviewing it and looking at it and the parties were filing their papers so we were set up long stock and short 75 strike calls and now that's that's in our public filings that's you know it's been publicly disclosed uh right now the stock is trading in the neighborhood of 75 or 76 and it remains to be seen where it will go to um if the parties decide not to file but we think that they will file an appeal and the stock will stay roughly treading water until that plays out they may still decide to terminate the transaction but your your view is that you think that it will happen in the end no no I I to be honest I think the deal is DOA I I think you know it it's such a long involved complicated and difficult road to travel that I don't think they'll be able to overturn the uh the CMA denial CMA is the name of the Anti-Trust regulatory Authority in the UK called the competition markets Authority but I would also point out that that the FTC and the U.S has sued to block it that's an administrative case and that is going on right now Microsoft is currently fighting that but again you know pursuant to the terms of their merger agreement they have to resist these types of legal uh legal entanglements up until What's called the termination date so we'll see what happens at the termination date of the transaction the parties will either have to continue litigating and extend the merger agreement or terminate altogether and so I think it's worth just noting that you're hedging you're hedging this by shorting these calls that's something that's quite complicated for for a group that's not Lakers to do for some of the individual investors sitting at home certainly many real Vision viewers would be familiar with it but I think it's worth noting that so people realize exactly what they're getting into because these three ideas are quite different from the other ones we've done on this program in the past I think that's a very good point I mean the way we invested in that deal is sort of a chicken's way of doing it because uh it was a 95 transaction the stock was trading in the 70s and started trading up all the way to 80 because um because of some good fundamental uh reports their quarterly reports their performance Etc and we would only lose money if the stock traded below 74 because we got paid a dollar for those 70 a dollar in premium for the 75 strike calls so we were a little bit scared and our antitrust Council warned us that the CMA was likely to have a problem with the transaction but if you know if you were long if you were straight long Activision you stood to make more money than we did if the deal was successfully completed but we were we played it in a more conservative manner in that we would only make that one dollar as long as it stayed above the strike price of the call which is 75 at at May expiration which is on May 19th hi I'm Ralph Howell the CEO and co-founder of realvision the financial world is a complicated world right now it's a really complicated macro picture and there's a lot of risks real vision and our YouTube channel help you navigate those risks so subscribe now to the channel and never miss an update there is simply too much going on so subscribe now thank you and let's jump into your first idea and that's going long Horizon Therapeutics it's Amgen that's looking to acquire them if we just take a step back and look at the stock price of long Horizon I'll focus on that for here because this is what you're going long so that's what's interesting here now this had a pre-announcement price of 85.50 there offering a hundred and sixteen dollars and fifty cents today it's trading at a hundred and eleven dollars so there's still a difference there between 116.5 and a hundred and eleven dollars for anyone who doesn't know Horizon Therapeutics it's a biopharma biopharmaceutical which makes medicines essentially walk us through this position and just to note of course you have a position here and you think that this deal is going to go through yes we think that the transaction is highly likely to be successfully completed Amgen is an experienced acquirer they're much bigger they have the money to purchase Horizon um there's no financing issues there's no shareholder issues this is a cash transaction in the case of a cash transaction an arbitrary will just buy the shares of the target company and not sell short the shares of the acquirer if we were receiving shares of the acquirer we would sell short the number of shares of the acquirer that we expect to receive upon deal completion but in this particular case we're getting paid cash so the the Arbiter is yours investment in this particular case would just be to buy shares of Horizon at 111 or 1125 wherever it's trading right now and then when the deal is completed we would receive 116.50 that difference the five dollars or whatever it is is known as the Arbitrage spread now on a you know on a gross basis if you look at it and say well I'm only making five percent or whatever um that may look different to somebody who's who invests on an annualized basis because if you make that five percent uh over the next two months then that's 30 annualized per year so we're not making this investment because we think that Horizon is going to go to the moon it's not going to quadruple like Google or Apple all we need is for that deal to be successfully completed so if the market goes down and Amgen trades down and Apple and Google trade down we're not going to lose money as long as the deal is completed we will still make that five dollars per share one thing I would note though and and I would say this about all the deals that we recommend is that the the upside downside profile is fairly asymmetric meaning that we stand to make less money than we stand to lose if the deal is not successfully completed because as you as you mentioned it was trading at 85 before the deal was announced so that means that in terms of risk management the way that we would manage a portfolio would be to buy a diversified portfolio of these these particular Investments now I'm giving you three ideas and they're all great and I and you know we think they have a high likelihood of working out but in terms of managing a fund or a portfolio in order to mitigate that single event risk we run a diversified portfolio so we're not going to have 50 of our book just in this one deal or in another deal and as you talk about these annualized rates one thing that jumps out at me the question I always ask on the show is what's your time Horizon wow Maggie whenever they do interviews on the platform and they just we stress this so much at real Vision because timing is everything when you go in when you come out is everything and that's right this is a very very different field because the time Horizon it could be much much shorter than other you know if you're waiting for Tesla to go up however many years you might be holding that stock waiting for tech stocks to recover you may not have and most likely won't have that type of time Horizon here so when you look at the time Horizon here what is your calculation are you hoping that it closes as quickly as possible are you hoping that it drags out and how do you think about your time Horizons in this case so that's a good question and that's part of the puzzle that we need to solve the transactions typically need all kinds of regulatory approvals I mean if you look at a public utilities deal they need a bunch of different states approvals if you look at a drug deal they may need FDA approval they may need um Anti-Trust approval in a variety of countries in which they operate technology if for example a broadcasting deal may need FCC approval as well so what we do is try to handicap the amount of time that the transaction is expected to take of course we would like to get our money sooner rather than later because if we're going to get 116.50 we want to get it sooner because at the later the longer it takes the lower the annualized rate of return is but either way we try to you know we play the cards that were dealt we we try to handicap how long the review will take we speak to antitrust Council by the way this is one of those things that you know when Dave Letterman talks about stupid Patrick's and he says don't try this at home or whatever it is very difficult for an amateur investor to to tick all those boxes and speak to an antitrust Council a Communications Council a drug counsel because you you need to have all that information in order to appropriately analyze the the Investments probability as well as the time frame and this particular case they have most of their approvals already we're waiting for an a final U.S Anti-Trust approval and we're expecting this to close within two months or so the company is still guiding us to first half of the year and if it closes in two months although you're making five percent as mentioned before that's 30 annualized so it's very you really have to have the resources to be able to do the Deep digging on this stuff and Roy what is your I won't say worst case scenario here because I'm we can always think of worse but what would what would be a pretty bad scenario here but you think was is within the realm of possibilities obviously that's not what you think is going to happen but what would what could happen here we'd say whoa this is not going to to plan what do you think the most likely scenario of a bad scenario is so the worst thing that could happen would be a regulatory blockage of the deal they'll say you can't buy Horizon they're you know their therapeutic devices they're rare disease disease uh treatments are are too important for you to buy them you're going to monopolize it you're going to raise the prices on everybody and we're just not going to let you close the deal in that case the transaction would be terminated and the stock would trade back down to what we call the Standalone price or it's fair value price which is typically where it would be trading uh prior to the deal being announced in this case we go only go back down into the 80s so you have maybe five dollars of upside and you have whatever it is you know 25 or downside which is kind of typical we think you know we think that it this is very very likely to be completed we think it's you know well into the 90s over 90 likely to be completed and it's probably trading it you know I want to say it's probably trading at like 75 percent uh implied in the market based upon where the where the stock is trading right now so we think it's underpriced it's inefficiently priced um and that if it's completed you make you can successfully make a nice annualized rate of return but the other potential outcome is that that it gets delayed and maybe there's some litigation or maybe the the uh they decide to to Grant the FTC additional time to review it so if it takes twice as long if it takes four months instead of two months then the annualized rate of return goes down although we still make that five dollars as long as it feels completed you make it sound very easy but I'm sure every deal doesn't always go to plan and that the backup the Hedge doesn't work I mean walk us through that a little bit because from what you say it sounds like you've got every base covered but we know that doesn't exist right there you know there's there's you can't create a risk-free investment because if it was risk-free you wouldn't make any money or you'd make less than you know less than a t-bill in this particular case the risk that we're taking is the rest of the deal will be completed and the stock trades back down you can hedge away things like deal failure risk you can't hedge away the risk of fraud natural disasters you know a number of years ago we invested in a deal in a an oil refinery deal and the refinery was hit by Hurricane destroyed it would destroyed the refinery and it's nobody could have predicted that but that's kind of the risk that you take you know in the old days they used to call the strategy risk Arbitrage now they call it merger Arbitrage same thing but you are taking those are the risks that you take and that's what you're being rewarded for otherwise you know you wouldn't be able to make money on these Investments and I'm sure that after that storm hit it caused you some pain yes you know the funny here's an interesting point is that merger agreements govern all the rights of the parties the obligations the contingencies and things like that and there's a clause inside all merger agreements that's called the material adverse change Clause that says that if something material happens that's bad on the part of either party then the other party can walk away and so um before September 11th um there was no mention in there of terrorist acts after September 11th you had Provisions in the contracts that said that uh this contract is still enforceable even in the event of a terrorist act it shall not be considered material adverse change and after that hurricane that I mentioned to you um there were Clauses inside that that said that um natural disasters are not considered or or acts of terrorism are not considered uh material adverse changes for the purpose of terminating the agreement so it's an evolving type of of of uh technology and and strategy that we need to be aware of in terms of the drafting of these agreements so we've seen it you know we've seen a whole evolution of them over time and and as a matter of fact right now there are Provisions in merger agreements that say that pandemics are not grounds for termination of the equipment let's jump into your second idea and that's going long aerojet uh Rocketdyne Holdings uh they're looking to be acquired by L3 Harris I should say L3 Harris looking to acquire them let's just take a step back and look at where this has been trading prior to rumors of a potential transaction it was trading at about 42.50 there is an offer in for 58 dollars per share and today it's trading around 56 dollars or a little above 56 dollars so just about two dollars difference from what they're offering uh if you don't know the aerojet company this is an aerospace and defense company just walk us through a little bit about these two companies and what you know about them why you think it makes sense well this is an interesting one because aerojet Rocketdyne had been previously in a merger agreement to be acquired by Lockheed and they made their filings and due to Anti-Trust concerns the transaction was terminated it wasn't Apparent at the time that the Department of Defense supported the transaction they're the most important player here they're the biggest excuse me they're the largest customer and you know unless they kind of give the thumbs up on it on a deal um it's not going to get in a defense deal it's not going to be approved by the Federal Trade Commission so that deal was terminated shortly thereafter a smaller competitor L3 Harris announced that they were buying aerojet Rocketdyne the reason the reason why deals are often terminated or blocked by regulatory authorities is because either they're going to dominate a particular product line in this particular case it was rocket engines or they may foreclose competition in other areas I.E products that use the rocket engines in this particular case L3 is a better buyer in our view because they don't compete with aerojet Rocketdyne in any areas there's no overlap in rocket engines and um and we've we haven't heard any objection from from either competitors customers or the Department of Defense yet in fact the the in the uh investor relations contact over at L3 Harris right now uh has stated to analysts that he believes that the Department of Defense does not object to the transaction so that's very important I mean as as you can tell from our conversation one of the main um considerations and Analysis that we do is with regard to regulatory approvals because that's what's going to hold up a deal that's going to going to control the timing and that that can block a deal uh there are other things that can block a deal such as a shareholder vote which we're gonna we have here this is a great premium nobody's gonna nobody's gonna vote it down uh the failure of financing financing is in place here so if you look at all kind of all the you know all the targets that need to be knocked down for for a deal to be successful these guys have them lined up pretty well um most importantly again I would stress is that they don't compete with each other um and the defense department has not objected to the transaction as of yet so we think it's going to close probably early September or so um it's trading at about a three and a half percent growth spread and if you annualize that again which is how you look at it because we want to compare apples to apples you know we're always comparing deals that have a month ago with a deal that's got six months to go the deal that guys as a year ago and we have to decide which ones are more attractive than each other because that's what we're going to decide to invest in in this particular case we think that we can earn a safe nine and a half percent annualized rate of return by investing in aerojet again this is an all cash deal we don't have to short the shares of L3 Harris and um and we think it's a high likelihood it's very highly likely to be successfully completed and and the market is is under pricing in our view and you think it's even more likely than the previous idea that we were talking about to go through and we were discussing going long Horizon Therapeutics oh now you put me on the spot I think uh I think that they're equally likely I would say that both in in the night over 90 likely to be successfully completed you know the only the only we haven't heard yet from from the FTC in a case of Horizon and we had we haven't fully heard from the Department of Defense but all all things all indications are that uh I I actually I give this one the edge I'd give the air jet The Edge um and and you know you can tell the market thinks so also because the annualized rate of return is a little bit lower in this implying that there's less less risk you know the old expression high risk High return people need to be compensated for risk that they take and getting in we talked earlier about how that the time frame is so important you know and getting in is it too late then for somebody to get in on a on an idea like this it's not as long as you to keep in mind that it's sort of a portfolio of one investment you can make that investment and the rate of return is great you just have to realize that you're accepting the risk that it will trade back down to where it was before or wherever the fundamental value is I mean there are times when a company you know is still likely to be be uh acquired because they're part of a merger agreement and the merger agreement requires the buyer to buy them but then they may order a bit or they may uh report a bad quarter in which case the downside may be lower than it was before so you know you taking you're taking that risk but at the end of the day we think it's a good risk to take and again it's part of our portfolio as disclosed and what do you think is the most likely scenario for this deal to go south the most likely scenario would be that you know the Department of Defense says to the the FTC you know what you know that we think about it uh we don't really want uh L3 to dominate the solid rocker rocket booster and missile propulsion technology um Market because we think that aerogene is better off as an independent company because then they can sell to a bunch of other companies uh we don't think that's going to happen but that would be sort of the worst case scenario in which case it would trade back down to what do we have for downside here low 40s um so that's a that's a big downside but you know again from a risk reward perspective we think the probabilities favorite being successfully completed and how would you play it if that down if that uh if that scenario came through so what we usually do is when we make an investment in a deal we hedge away any type of exposure that we can find that's directional in nature whether it's it's exposure to the acquiring Company stock in which case with short shares of the acquirer um if it's subject to financing we may we may put on some kind of a financing hedge we invest all across the world so if there's if they we're getting paid in a foreign currency we would hedge out the exposure to the foreign currency in this particular case all you can do um is buy the share of the target company there's nothing nothing really to hedge out because you're going to get paid in cash what we do also is to kind of hedge out the risk that we calculated the downside wrong or that the downside gets worse we sometimes put on a sector hedge we may have a defense department I mean a defense industry hedge of an index and we'll make we may sell a small amount of that short so if we think it's you know like 80 percent likely to be completed we may put on a a hedge for 20 of the value of that position on the industry sort of just to kind of eliminate the risk that the the stock would trade down just because of the risk that the about fair value trades down but other than that I mean if if somebody was going to go and buy this I would suggest they just buy the stock sit there let the deal close and then take their cash and if anybody has any questions for Roy about any of these ideas if you're watching this live feel free to drop them in the chat box right next to us and Roy will ask answer them with that I want to jump into your third idea and that's going long VMware they're looking to be acquired by broadcom uh VMware in case you're not familiar with it cloud computing that a lot of app developers make this one's interesting because it's not just a cash offer you also have to look at the shares of broadcom to understand it but we'll start by looking at the stock for VMware it's trading around 122.66 at the time of us filming this but if you look at VMware closely um you'll see that the shares um are currently I'm just looking through my notes Here uh there's there could be a 30 37 premium on these shares but I don't want to focus too much on that because you'd also get share areas of broadcom so walk us through here we'll have to keep both companies in mind when we do it but you also see that as as being key here but we might be able to put up some of uh vmware's um their their ticker as as we walk through this so this is an interesting one and um for those of you who don't remember VMware um is controlled by Michael Dell it was it was spun out and he owns I think he still owns like 40 of the company it was it was spun off from from Dell computers um and it's also interesting because the spread is so much wider than the the two I kind of threw you a couple of alley oops for the first two this one this one is a little bit more difficult um because there are a number of areas of complicated um electronic technology that that could cause issues for Regulators the reason why it's on our recommended list here is because we think number one is mispriced in the market um you know it's pricing in is as if there's like a 50 likelihood of it happening and we're probably think it's an 80 likelihood of it happened keep in mind that you're going to get about 71 and a quarter in cash and you're going to get about an eighth of a share of broadcom it's a little bit more complicated because you have the option to so to try to elect cash your stock but at the end of the day they're giving they're paying 50 cash 50 stock and everybody's going to get most people almost everybody's going to get cut back to half and half you you don't think that that'll happen and just to clarify those numbers as referring to earlier trading around 122 dollars today and if it were just to be the cash offer it'd be 142 dollars in in stock and per share and sorry 142 dollars per share rather but you don't think that that's what's going to happen you think that it will trigger a deal will be voted on where people would get both cash and stock and that's where you see the upside in this deal yes that's part of it because at the end of the day investors are going to elect for the most valuable consideration and the most valuable consideration is going to be oversubscribed so people are going to get cut back to 50 cash 50 stock or roughly whatever that percentage is it's right now this the stock is worth more than the cash so the combined value is worth about 150 dollars and 51 cents or so that you know if you add if you assume you're going to get 71 and a quarter of Cash Plus 0.126 of stock which is pretty much what everybody's going to get that's worth over 150 so it's it's a huge spread it's it's like almost 23 gross so you can make 23 if it closes again this is going to take a little bit longer I think we're using um we're using end of October and um the annualized that's 45 so as you can see you know in the in the Horizon deal because it has such a such a close time frame a such a short time frame um you know when you annualize the rate of return that that five percent turns into six thirty percent or whatever in this particular case the 23 turns into 45 because it's longer dated it's not going to close until October but the point being is that you shouldn't really look at it as as of right now that you're only going to get the cash because the the the broadcom stock is worth more than the cash and any rational investor will elect when you have when you have to fill out the forms of what you get you're going to elect stock you'll get you'll take as much stock as you can get because it's worth more and then and then you'll get cut back you only get half so that's that's the point of it but the reason why this is trading so wide is because there are some some potential concerns uh on the part of The Regulators the um the CMA which again as you know the UK coming things up again I guess sorry from this side of the place is that where you're looking right yeah um you know they they have some concerns in very it's very Arcane areas of Technology network interface cards and fiber channel which is the technology that that uh Cloud companies and Cloud computers use to transmit data from from the storage down to the computers that that are not storing it themselves and so they're worried about they're worried that if broadcom buys VMware they're going to make it more difficult for others to to use the VMware product and therefore force them to use broadcom products instead that's called foreclosure um and so that's being that's being scrutinized very carefully the CMA has said that they're concerned with that they haven't said they're blocking it we still think it's more likely than not that they will get the approval they're still waiting for uh Chinese approval they're waiting for U.S approval they're waiting for UK they're waiting for for CMA so there's there's a a road ahead where they need to knock got the approvals one by one and typically what happens is as these approvals are received one by one this deal spread will start to compress over time because there'll be less uncertainty less approvals that are outstanding less time for things to get to get messed up and so you know you'll see that and that in general you know for merger Arbitrage deals that spreads that start out wide as they become more likely to be as completed as time goes on the spread will tighten up and in the last week or so it'll be you know pennies or whatever but in this particular case it's super wide we think it's mispriced it's not a layup though I would tell you there is some risk that it might not happen but it's a very good opportunity for my risk award perspective and just so I'm clear is it the CMA again the regulator here in the UK that you think is the most likely scenario for this to go south yeah I think that's the CMA would be the weakest link in your side again and just again do you think it's too I I think I know the answer that you don't think it's too late for people are getting given how underpriced you keep on saying that you believe this is I don't think it's too late but you have to be aware that you're accepting the risk that the deal might not be successfully completed you know they they do need those regulatory approvals it's trading it you know as we mentioned it's a 23 gross discount um and and when it was originally announced it was it was true it was 37 below where it is right now so you do have some downside but the upside downside is a little bit more closer to one up one down than the prior deals that we were talking about which are one up five down and that's again to compensate you for the risk that the transaction might not be successfully completed I want to jump into some of the questions that we're getting Ralph Humphrey just put in how does Roy think about managing the cost of his Hedges with the benefits so specifically those hedges so it comes it kind of comes with the territory you when we calculate a rate of return we calculate a rate of return to the spread collapsing to zero so in other words when we've let's say take an example of a currency hedge when we buy a stock that's being acquired for let's say uh 10 euros we don't want to take the risk that the euro is going to trade up or down we want to make sure that that right now we know that a euro is I don't know what the FX is right now but we want to make sure that the dollar value is what we get for what we pay right now so we we don't want to take the risk that at at closing time the Euro will be worth more or less so we'll hedge it out so we we could be passing up an opportunity to make money if if we're lonely Euro or lose money if we're short to Euro but nonetheless that's what we do and the same thing applies to a stock for stock deal when we hedge out of stock for stock deal we we sell right now the shares of company that we expect to receive when the transaction is completed so right now we would be selling if we were setting up the VMware deal we'd be selling 0.126 shares of broadcom because we know for certain what we're going to get right now because we sold them right now and then when the deal closes somebody's going to hand me 1.12 six shares of broadcom that I'm going to I'm going to to use to cover my short of broadcom and then I'm going to get cash for the rest of it in a in a purely uh cash deal we don't need to put on a hedge because we're going to get you know in the case of there was a um The Horizon deal we're going to get 116.50 no matter what happens to the stock market no matter what happens to Amgen as long as the deal is successfully completed so the hedges are a very important part just to make sure that we don't have directional exposure I mean if you look at we manage a mutual fund called the merger fund and its beta is is below 0.1 and that's because the fact that the risk that we're taking is not the risk that the stocks will go up or down or the Market's going to go up or down because it's it's a market neutral strategy relatively um but the risk that the deals won't be successfully completed so that's why we have a low Beta And the reason why the beta is not zero is because sometimes people just take risk off in the market panic and you know we you it looks like you're a little bit correlated with the market people sell everything you know um no matter what but the point is is that risks of uh Hedges are very important to have on and but in our particular case we're only hedging the directional exposure and it's not that expensive so many of the ideas that we talk about on three ideas and the experts in their fields with whom we speak know the the cyclical and secular Natures of their fields and I'm quite interesting I think other others are as well is what is the the cyclical and secular nature of merger Arbitrage I mean we know that there have been many fewer mergers uh China's been a huge spot for for mergers going and acquiring companies around the world and that's come down through the pandemic is it volume that really helps your business succeed or can you succeed independent of volume just by focusing on whatever uh mergers are available um there are a number of answers to the million answers to the the question that you've been there's a number of subjects within that question yeah so so deal activity is somewhat cyclical and it's going to depend on a number of things it's going to depend on economic activity in a booming uh and booming economic environment companies may need to ramp up their production facilities their product lines and they may make Acquisitions um they may their stock may be doing so well that they have very expensive currency that they can use to make stock acquisitions um the interest rate environment might be so attractive because rates were low back as we know over the last couple of years that money was cheap and they would use it to make Acquisitions in a bad economic environment very often companies need to bolster their top line they need to grow they can't grow organically so they'll make some Acquisitions other times they may make an acquisition defensively because they need they're having trouble with the supplier or something like that so there are a variety of of different environments that lead to uh to to the cycles of M A Activity one thing I would point out though and that the probably the biggest the the biggest you know wave of of the cause of activity in the in the the past several decades has been the internationalization of the stock markets uh the the regulatory environments are have become much more predictable overseas and not just in the US and Canada so that companies are more willing to take on that regulatory risk and make the filings and and be able to predict and forecast whether they'll be able to close on a deal and also the capital markets have become much more internationalized so we're seeing so many cross-border deals uh you know Chinese Chinese are buying U.S companies U.S companies are buying European companies there's been a lot of activity in Japan and Australia uh Canada has always been active and that's sort of made the pie a lot bigger for people like us to invest in but there will be you know there will be Cycles um I would say you know since I mentioned earlier that it's very important that a portfolio be Diversified that it's a lot easier to diversify a portfolio when you have 250 deals to choose from than if then when you have 50 deals to choose from we think you can achieve appropriate diversification benefits with probably as little as 30 35 you know transactions in in your portfolio altogether we typically have anywhere from 65 to about 90. um and that's that's as fairly constant over time because there just tends to be a consistent flow of M A activity whether it's a bad economic environment or a good economic environment so just as we close at the show because you're one of the the Masters in this field that's what you're calling say about you I won't flatter you too much but what's the one piece of advice that you can take away from and and give to us and the people watching for some of the success that you've had maybe it's something personal how you conduct yourself in the workplace or some type of Ethics or what you've learned going from being a lawyer to working in in the finance field what's your your big takeaway foreign well I mean I I to start off I'd say always be ethical because you know there's a lot of a lot of ways to make money uh honestly there's a lot of ways to make money dishonestly so why not why not be honest all the time and be ethical uh always do your homework you know there's the the street is littered with bodies of people who didn't do their homework who just took Flyers who who invested on Trends people who invested on rumors you know in our space the one advice I would say is that you may get lucky investing on rumor one time if you hear a company's being taken over but but um you know you're risking a lot because the companies will trade up on rumor and they'll trade right back down if not that you're making there between the first piece of advice and the second piece of advice being honest being ethical and trading on some of those rumors and an interesting point I was speaking to our our book or our lead book or Mario that you guys who who booked this um booked this interview with you and he said an interesting line which uh you know one expert said you spend more time choosing washing machine than a lot of people do stocks they spend all this time on consumer reports and then they go in and look at a stock and oftentimes spend a lot less time on that and I'm sure you've seen you know how that can wreak havoc in people's lives in this field that's a great Point that's a great point I mean you work so hard for your money why not do the homework and and you know and and think about it before you make an investment instead of jumping on you know whether it's crypto or stocks or anything like that and any other pieces of advice you have for Us beside on it honesty ethics doing your your research what's been the key for you well the key for me is different than advice I would I would to investors I would give you know think about investing in pool Vehicles rather than just trading single stocks all the time because number one you have an expert managing the portfolio number two it's Diversified and and you know individuals may not have enough money to appropriately diversify their portfolio um so that's you know just as a general investing particular advice um as as far as you know kind of what what I've learned is that you know you can't you have to move on from your losers once once if we invest in a deal and a deal is terminated and all of a sudden it's not within our investable universe anymore you know the the Activision deal if that once that deal is terminated then we're not I'm not betting based upon they're gonna they're gonna come up with Call of Duty Five and it's going to be the most fantastic thing ever and I'm gonna make all my money back that might be true I mean it might be undervalued people think atvi has has very little downside and in fact they think of the deals terminated it may trade up above 75 but that that's not the business that we're in and I think that that lesson is sort of applicable to whatever kind of investing people do you know there's an old expression that says uh plan your trade and trade your plan if you if the reason why you're in an investment is not there anymore then you should think about whether you want to still stay in it yeah digging your heels in can often be a huge quality for Traders you've heard that so many times I'm guilty of that myself so I you know well I'm still learning well Roy Barron thank you very much not only for your three ideas but for your three pieces of advice for our viewers and thanks to the folks who sent in questions Roy Barron co-president and CIO of Westchester Capital Management will put all the trades in the tracker here so people can look at your ideas compare them to others and we'll bring you back on for a Victory lap as soon as the victory is ready thank you so much for having me say hi to Mario absolutely thanks everybody we'll see you on the next edition of three ideas [Music] thank you [Music] hey there revolutionaries to join a community sharing insights like you just watched head over to realvision.com there you will get unbiased insights and exclusive access to the very best brightest and biggest names in finance be a part of our community of lifelong Learners see you there

Channel: Real Vision

Views: 1,803

Keywords: Finance, Markets, Economy, Stock Market, Investing, Trading, Financial Literacy, Recession, Interview, Conversation, Strategy, Insight, Analysis, Thesis, Short Seller, Real Vision, Equities, Raoul Pal, Inflation, Stagflation, Monetary Policy, Money, Federal Reserve, Fed, Roy Behren, SAmuel Burke, generating alpha, alpha, sideways market, boring market, financial markets, finance podcast, 3 ideas, trading strategy, merger arbitrage trader, uncertain markets, make profits in 2023, trading 2023

Id: f5xKjb7JUpA

Length: 46min 30sec (2790 seconds)

Published: Tue May 23 2023