Merger Arbitrage - a Fundamental Approach to Event-Driven Investing

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  • Edition: 1st
  • Format: Hardcover
  • Copyright: 2/3/2014
  • Publisher: Wiley
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A wave of corporate mergers, acquisitions, restructuring, and similar transactions has created unprecedented opportunities for those versed in contemporary risk arbitrage techniques. At the same time, the nature of the merger wave has lent such transactions a much higher degree of predictability than ever before, making risk arbitrage more attractive to investors. Surprisingly, there is little transparency and instruction for investors interested in learning the latest risk arbitrage techniques. Merger Arbitrage – A Fundamental Approach to Event-Driven Investing helps readers understand the inner workings of the strategy and hedge funds which engaged in this investment strategy.

Merger arbitrage is one of the most commonly used strategies but paradoxically one of the least known. This book puts it in the spotlight and explains how fund managers are able to benefit from mergers and acquisitions. It describes how to implement this strategy, located at the crossroad of corporate finance and asset management, and where its risks lie through numerous topical examples.

The book is split into three parts. The first part, examining the basis of merger arbitrage, looks at the key role of the market in takeover bids. It also assesses the major changes in the financial markets over recent years and their impact on M&A. Various M&A risk and return factors are also discussed, alongside the historical profitability of merger arbitrage, the different approaches used by fund managers and the results of academic studies on the subject. The second part of the book deals with the risk of an M&A transaction failing in terms of financing risk, competition issues, the legal aspects of merger agreements and administrative and political risks. The third part of the book examines specificities of M&A transactions, comprehensively covering hostile takeovers and leveraged buyouts. Each part contains many recent examples and case studies in order to show how the various theories and notions are put into practice.

From researching prospects and determining positions, to hedging and trading tactics, Lionel Melka and Amit Shabi present the full complement of sophisticated risk arbitrage techniques, making Merger Arbitrage a must read for finance and investment professionals who want to take advantage of the nearly limitless opportunities afforded by today's rapidly changing global business environment. The book builds on its authors’ diverse backgrounds and common experience managing a merger arbitrage fund, providing readers with an enriching inside view on M&A operations.

Author Biography

LIONEL MELKA started his career in 1998 with Lazard Frères, where he undertook numerous M&A advisory engagements for blue chip clients (French State, LVMH, Air France, Saint-Gobain, Casino, France Telecom, Thomson, Air Liquide, Danone, Vivendi, or Kingfisher) in a large scope of situations: privatizations, friendly and hostile takeover bids, LBOs, asset disposals and IPOs. He then joined the M&A Department of Crédit Agricole, where he worked on various advisory assignments in the TMT-Defence team and, in 2005, he joined LCF Rothschild where he led many M&A cross-border assignments in various industry sectors. He is also a teacher at the University of Paris Dauphine and is the co-writer of Le Merger Arbitrage, a French reference book published in 2011 by Economica. Lionel received a Master’s degree in finance from the University of Paris – Dauphine.

AMIT SHABI started his career as a commander of an analyst team in a military intelligence unit of the Israel Defence Forces. Prior to founding Bernheim, Dreyfus & Co. and launching the Diva Synergy Fund, he worked in asset management at LCF Rothschild and then as an OTC derivatives sales at MAN group and BGC Cantor Fitzgerald. Amit holds a Master’s degree in business administration from the Sorbonne University and is the co-writer of Le Merger Arbitrage, a French reference book published in 2011 by Economica.

Table of Contents

Foreword by Michael Zaoui xiii

Acknowledgements xix

About the Authors xxi

Introduction xxiii


1 The Role of the Market in Mergers and Acquisitions 3

1.1 Structural Changes to the Financial Markets 4

1.2 Changes to M&A Practice 7

1.3 Market Evaluation of M&A 9

1.3.1 The price offered to shareholders of the target company 9

1.3.2 Structure – the key to evaluating an offer 9

1.4 Types of Synergies and Waves of M&A 11

1.4.1 Justification for transactions 11 Better efficiency 11 Obtaining market power 12 Acquiring specific resources 13 Benefiting from the intellectual property of the target company 13 Hindering the progress of a troublesome competitor 13 Blocking new entrants to a sector 14

1.4.2 Waves of M&A 14

Case Study: The Alcan/Pechiney Deal 18

2 The Different Types of Transactions 33

2.1 Types of Transactions 33

2.1.1 Cash transactions 33

2.1.2 All-share transactions 39

2.1.3 Mixed cash-and-share transactions 46

2.1.4 Collars 53

2.2 The Choice of Payment Method 57

3 Risk and Return Factors 59

3.1 The Different Outcomes 59

3.1.1 The transaction is completed 59 The probability of success 59 Risks of failure 60

3.1.2 The transaction fails 65 Estimating failure 66 Estimating potential losses 66

3.1.3 The transaction is completed at a price lower than the initial offer 70

3.1.4 Rival bids and bidding wars 70

3.2 M&A Timetable 73

3.2.1 Timetable considerations according to offer type 73 Takeovers 73 The unique case of tender offers 75 Mergers 76

3.2.2 Sector differences 77

4 The Merger Arbitrage Strategy 81

4.1 The Long-Term Profitability of the Strategy 81

4.2 The Factors that Influence Returns 82

4.3 The Different Approaches to the Strategy Developed by Specialist Managers 85

4.3.1 The deal’s risk zone 86

4.3.2 The use of leverage 87

4.3.3 The use of options or bonds 87

4.3.4 Investment portfolio analysis 89

4.3.5 Portfolio concentration 89

4.3.6 The role of trading 90

4.3.7 Classifications 90

4.4 The Conclusions of Academic Studies 91

4.4.1 Studies on the returns generated by merger arbitrage strategies 92

4.4.2 The role of arbitrageurs in the execution of M&A transactions 94

4.4.3 Other characteristics of merger arbitrage strategies 96


5 Financing Risk 99

5.1 The Different Financing Methods 99

5.1.1 Revolving credit 101

5.1.2 Bridge loan 102

5.1.3 Term loan 102

5.1.4 Syndicated loan 105

5.1.5 Mezzanine loans 106

5.1.6 The bond market 107

5.1.7 Contingent value rights (CVRs) 110

5.2 The Legal Security of the Financing 111

5.2.1 The UK legal framework 111

5.2.2 The US legal framework 113

5.2.3 The European legal framework in general 121

Case Study: The Dow Chemical/Rohm & Haas Deal 122

6 Competition Risk 129

6.1 Origins and Regulatory Framework of Competition Law 129

6.1.1 United States 129

6.1.2 Europe 132

6.2 Competent Authorities and Approval Process 133

6.2.1 United States 133

6.2.2 Europe 137

6.2.3 China 140

6.3 Competition Remedies 143

6.4 Country Differences in Evaluation 145

6.5 The Allocation of Competition Risk between the Parties 151

Case Study: The Oracle/Sun Deal 153

7 Legal Aspects of Merger Agreements 159

7.1 The Different Documents 159

7.2 Structure of a Merger Agreement 161

7.3 MAC Clauses 162

7.3.1 A negative definition of the MAC clause 164

7.3.2 MAC clauses and court decisions 165

7.3.3 MAC clauses and private-equity transactions 167

7.3.4 Why these clauses? 168

7.4 Other Legal Clauses 171

7.4.1 Go-shop clause 171

7.4.2 Break-up-fee clause 175

7.4.3 Matching-rights clause 176

7.4.4 Specific-performance clause 178

7.4.5 Dissenters’-rights clause 180

8 Other Risks 183

8.1 Administrative Authorizations 183

8.1.1 United States 183 The role of the CFIUS 183 Sector authorities 185 PSCs 187

8.1.2 Canada 187

8.1.3 Europe 190

8.2 Political Risk 190

8.3 Natural-Disaster Risk 193

8.4 The Risk of Fraud or False Accounting 195


9 Hostile Transactions 199

9.1 A General Overview of Hostile Transactions 199

9.1.1 Profile of the target company 200

9.1.2 The different parties involved in hostile offers 201 The buyer 201 The target company and its constituent parts 201 Other potential buyers 202 Arbitrageurs 203

9.1.3 The offer strategies 203 Direct purchase on the market 203 Tender offer 204 Directly approaching the board of directors 204 Proxy contest 205 Legal battle 205

9.1.4 The matter of price 206

9.2 Regulatory Frameworks for Hostile Offers and How They Differ in Different Countries 208

9.3 Defense Mechanisms 211

9.3.1 Preventive measures 211 Staggered vs unstaggered boards 211 Fair-price provision 212 Supermajority provision 213 Dual-class recapitalization 213 Golden parachutes 213 Employee stock ownership plans 214 Poison pill 214

9.3.2 Mechanisms adopted during an offer 215 The crown jewel defense 215 Litigation 216 Just say no 217 Countertender offer: Pac-Man 218 Asset restructuring 219 White knight and white squire 219 Going-private transaction/LBO 220 Greenmailing 220

9.4 Regulatory Differences in Different Countries 220

9.4.1 The UK 221

9.4.2 Continental Europe 223

Case Study: The Sanofi/Genzyme Deal 229

10 Leveraged Buyouts 239

10.1 Main Characteristics of LBOs 239

10.1.1 Principles 239

10.1.2 The different parties 242 The target company 242 The investment funds 242 The banks 244 The management 244

10.1.3 Exit opportunities 245

10.2 A Brief History of Private Equity 245

10.2.1 Emergence and growth of private equity 246

10.2.2 The explosion of private equity 247

10.3 How LBOs Affect Arbitrage 248

10.3.1 The reasons for the transaction 248

10.3.2 Financing 249

10.3.3 Competition risk 249

10.3.4 Agreement terminology and the use of reverse termination fees 250

10.3.5 Management and a potential conflict of interests 250

Case Study: LBO as an Arbitrage Opportunity: Del Monte Foods 251

Conclusion 257

Glossary 259

References 265

Index 271

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