Merger Arbitrage

529 Pages·2016·3.81 MB·English

by  Thomas Kirchner

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Merger Arbitrage
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Merger Arbitrage
How to Profit from Global
Event-Driven Arbitrage
Second Edition
THOMAS KIRCHNER
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Copyright©2016byThomasKirchner.Allrightsreserved.
PublishedbyJohnWiley&Sons,Inc.,Hoboken,NewJersey.
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LibraryofCongressCataloging-in-PublicationData:
Names:Kirchner,Thomas,1968–author.
Title:Mergerarbitrage:howtoprofitfromevent-drivenarbitrage/ThomasKirchner.
Description:Secondedition.|Hoboken,NewJersey:JohnWiley&Sons,Inc.,
[2016]|Series:Wileyfinance|Includesindex.
Identifiers:LCCN2015046839(print)|LCCN2016002279(ebook)|
ISBN9781118736357(hardback)|ISBN9781118736807(pdf)|ISBN9781118736661
(epub)
Subjects:LCSH:Arbitrage.|Consolidationandmergerofcorporations.|
Stockexchangesandcurrentevents.|BISAC:BUSINESS&ECONOMICS/Finance.
Classification:LCCHG4521.K482016(print)|LCCHG4521(ebook)|DDC
332.63/2—dc23
LCrecordavailableathttp://lccn.loc.gov/2015046839
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CoverImage:©VladKol/iStockphoto
PrintedintheUnitedStatesofAmerica
10987654321
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Contents
Preface vii
Acknowledgments xi
PARTONE
TheArbitrageProcess 1
CHAPTER1
IntroductiontoMergerArbitrage 3
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CHAPTER2
TheMechanicsofMergerArbitrage 18
CHAPTER3
TheRoleofMergerArbitrageinaDiversifiedPortfolio 50
CHAPTER4
IncorporatingRiskintotheArbitrageDecision 103
PARTTWO
PitfallsofMergerArbitrage 141
CHAPTER5
SourcesofRiskandReturn 143
CHAPTER6
DealStructures:MergersandTenderOffers 188
CHAPTER7
Financing 217
v
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vi CONTENTS
CHAPTER8
LegalAspects 250
CHAPTER9
ManagementIncentives 293
CHAPTER10
BuyoutsbyPrivateEquity 328
CHAPTER11
MinoritySqueeze-Outs 341
PARTTHREE
InvestinginMergerArbitrage 361
CHAPTER12
GovernmentInvolvement 363
CHAPTER13
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FourWaystoFightAbuseofShareholdersinMergers 409
CHAPTER14
InvestinginArbitrage 435
Notes 475
AbouttheAuthor 483
Exercises 485
Index 497
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Preface
S
incethefirsteditionofthisbookinterestrateshavefallentonearzeroand
havedraggedreturnsonmergerarbitragewiththem.Withtheforeseeable
endoftheFederalReserve’szerointerestratepolicyitislikelythatinvestors
willallocatetomergerarbitrageagaininthenearfuture.Thisbookiswritten
asaguidetopotentialinvestorswhoseektounderstandthestrategybetter
prior to committing an investment, investors who may have an allocation
to merger arbitrage through model portfolios or maybe even their pension
plan,aswellasaspiringarbitrageurs.
Merger arbitrage, also known as risk arbitrage, has grown exponen-
tially since the 1980s from small operations within Wall Street firms to
standalonearbitragefundsdirectlyaccessibletothepublic.Yet,surprisingly
little has been written on the topic. A number of academics have written
studies about various aspects of the strategy. For the general public, I can
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count only six books on the topic. This small number pales in comparison
totheinformationoverloadthatotherareasoffinanceexperience.SinceGuy
Wyser-Pratte’stwomonographsinthe1970s,onlythreeotherbooksabout
mergerarbitragehavebeenpublished.OneofthemisIvanBoesky’sMerger
Mania.Maybepotentialwritersfearthatauthoringamergerarbitragebook
standsunderabadomenbecauseBoeskywasarrestedafewweeksafterthe
publicationofhisbook.Astheauthorofamergerarbitragebook,Icertainly
hopethatwritingabookandgettingarrestedarelinkedonlybycorrelation
andnotcausality.
InthisbookItrytogobeyondameredescriptionofthearbitrageprocess
toincorporatesomethoughtsonthebenefitsofaddingmergerarbitrageto
aninvestmentportfolio,andthevehiclesthatinvestorscanutilizetoaccess
the strategy. The expansion of the book’s horizon will make it more rele-
vanttoabroaderinvestmentaudience.Nevertheless,thefocusofthebook
remains on mergers and merger arbitrage and not asset allocation or port-
foliomanagement.
Thebookisorganizedintothreeparts:thefirstthreechaptersintroduce
the basics of the arbitrage process and explain the benefits of the invest-
mentstrategyinthecontextofaportfolioallocation.Chapters4to8discuss
moredetailsabouttheanalysisinvolvedinanarbitragedecision.Chapters9
to11 discuss specialtransactions that warrant particular diligence by arbi-
trageurs.Chapters12to14addressadditionalregulatoryaspectsaswellas
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viii PREFACE
practicalconsiderations,includingmeasuresarbitrageurscantaketodefend
theirinterests,suchasexercisingappraisalrights.
Thefirsttwochaptersexplainthebasictypesofmergersandhowtoset
upthearbitrage.
Chapter 3 is an interlude that explains the historical performance of
merger arbitrage as an investment strategy, and how it can be added to a
diversifiedportfolio.Thischapterinparticularwillberelevantforinvestors
whoarelookingtoaddmergerarbitragetotheirportfolio.
Chapter4expandsthebasicarbitragebyincorporatingrisk.Probabili-
tiesoffailureandpotentiallossesareincorporatedintothereturncalculation
to find an expected return of the arbitrage. Chapter 5 discusses different
sourcesofriskandreturninmoredetail,inparticularthetimingofmergers,
leverage,andshortsales.
Thedifferencebetweenmergersandtenderoffersisnotwellunderstood
bymanyinvestmentprofessionals.Thetermsareoftenusedinterchangeably.
Chapter6goesintodetailsandshouldbeofinteresttoallinvestors,notjust
thoseseekingtoreaduponmergerarbitrage.
Financing is often one of the most critical parts of an acquisition, and
soChapter7willlookatdifferentfinancingoptions.
Mergers are subject to a plethora of legal requirements, and I discuss
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cialbookandnotalegaltextbook,sothatmanyaspectsaretouchedononly
inacursorymanner.Boardsofdirectorshavetofollowanumberofproce-
durestoensurethatamergerisfairtoshareholders. Thiswillbediscussed
inChapter8.
Unfortunately,thelawthatissupposedtoprotectshareholdersisoften
disregarded when managers buy the companies that they are managing as
agentsoftheirshareholders.Chapter9looksatmanagementincentivesfor
getting mergers done and how the interest of managers are often diametri-
callyopposedtothoseofshareholders.
Similarconflictsofinterestbetweenmanagers,acquirers,andsharehold-
erscanbefoundinbuyoutsbyprivateequityfunds,discussedinChapter10.
Minoritysqueeze-outspresentrisksoftheirowntomergerarbitrageurs,
andthereforearediscussedinachapteroftheirown,Chapter11.
The government gets involved in the merger process on several levels,
federal and state. Despite the obvious importance of government regula-
tions, I have decided to relegate its discussion further to the back of the
book because I believe that the motivations of the market participants—
management, financiers, board members—are more relevant by far to the
success of a merger than government regulations, discussed in Chapter 12.
Astheysay:wherethereisawill,thereisaway.
Next,Istepintoaminefieldbyencouraginginvestorstoseektoexercise
theirrightsandgetfullvaluefortheirshareswhenacompanyistakenover.
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