Merger Arbitrage: Sound Strategy for a Bear Market

With the stock market declines that hedge fund and mutual fund redemptions as well as the deleveraging on Wall Street have caused, investors are definitely wondering whether they would ever be able to reach their financial goals. The increasing volatility of the markets has certain stocks trading at multi year lows, despite strong fundamentals, pushing yields to multi-year highs.

In this market turmoil, I believe that sticking to fundamentally sound strategies such as value investing or dividend growth investing is the way to escape the day to day volatility. I also believe that learning more about value investing is essential, as the market will present many once in a lifetime opportunities for investors.

One value investing strategy is merger arbitrage. In my previous post related to CEG merger, I outlined the basic idea behind this strategy. I still believe that CEG deal will close by the middle of 2009. At current prices and if the stock keeps its 8% current yield, enterprising investors could make about 18%.

Furthermore I have kept my eyes open for other arbitrage opportunities. Rohm and Haas (ROH) is another merger arbitrage play to consider. In July, Dow Chemical (DOW) announced that it was considering acquiring ROH for $78/share in cash. You could check my analysis of ROH here.

On October 29 the shareholders of ROH approved the deal. Furthermore the Hass family, which owns over one third of Rohm-Haas, is a strong supporter of the deal, as it seeks to unload their position.

The merger is expected to close in early 2009, pending regulatory approvals, and the agreement provides that Rohm and Haas Company will retain its name and Philadelphia Headquarters.
An earlier article by Jimmy Lathrop listed some of the risks that could prevent this arbitrage opportunity to work out. The strongest reason in my opinion is this one:

1. There is a chance that the credit crisis could slow or scuttle the deal. Even though Warren Buffett arranged part of the financing to include sale of equity interests with Berkshire Hathaway (BRK.A) as well as the Kuwait Investment Authority, the main underwriters to pay the shareholders of Rohm and Haas Company will come through a loan provided by Citigroup (C), Morgan Stanley (MS) and Merrill Lynch (MER). To put things mildly, there is significant uncertainty as to whether one, two or all three of these banks who signed this agreement on July 10, 2008, will be a functioning entity on January 15, 2009.

I believe that ROH is a buy at these levels as long as the deal does not get derailed. Furthermore the stock is paying 41cents/quarter in dividends, which is a decent payment while you are waiting for the deal to close.

Disclosure: Author is long CEG and ROH

Comments

[bsharvy:]

You can also play merger arbitrage through GDL. But, I'm not sure how much opportunity there is when there's no credit in the world.

2008 Nov 27 08:19 AM

[PlanMaestro:]

Be careful in this environment, got caught in BCE deal (30% fall). Another interesting option is the acquisition of TurboChef by Middleby (financed by current facilities)

2008 Nov 27 09:28 AM

[weiwentg:]

Hey, I got caught in the BCE deal too!!

Kuwait Petroleum Corporation's reconsideration of the K-Dow deal could be bad news for the merger if KPC negotiates a lower price with Dow. That would leave them less cash to complete the deal. I'm assuming that's why the stock dropped Wednesday. Stay tuned...

2008 Nov 27 12:06 PM

[weiwentg:]

Hey, I got caught in the BCE deal too!!

Kuwait Petroleum Corporation's reconsideration of the K-Dow deal could be bad news for the merger if KPC negotiates a lower price with Dow. That would leave them less cash to complete the deal. I'm assuming that's why the stock dropped Wednesday. Stay tuned...

2008 Nov 27 07:55 PM

[Nikhil:]

What adv does GDL offer over an investor selecting merger arb names on his own and also choosing diff levels of agression for diff deals ? Interesting thing you pointed out, I didnt know about GDL earlier..


On Nov 27 08:19 AM bsharvy wrote:

> You can also play merger arbitrage through GDL. But, I'm not sure
> how much opportunity there is when there's no credit in the world.

2008 Nov 29 01:36 PM

[bsharvy:]

GDL is a fund of merger arb plays. So it offers diversity. It's the same choice you make when choosing to pick stocks or pick a fund. It also tends to trade at a discount (like now).

2008 Nov 30 01:32 AM

[Dividend Gr...:]

Looks like GDL has outperformed the market in 2008 by falling only 15%. ( total returns). The weird part is that GDL seems to be returning capital in order to maintain its 40 cents/quarter distribution.
It also looks to me as if the fund participates in all deals, which is someting I am not looking to achieve. By all deals I mean deals that are just announced, and still have obvious hurdles in front of them. For example on 6/30/2008 GDL owned shares of YHOO even though the merger was never approved by YHOO's board.

Please review this post on merger arbitrage:

www.dividendgrowthinve...

2008 Nov 30 05:12 PM

[Ying & Yang:]

A thought

This is what is wrong in America. The man who Built Burlington Coates (Worth 7-Billion Approx.,) stared in the depression and never took more than 100,000 (A YEAR as Salary till the last (3) years and now takes $250,000-a year. The avg., American makes $20-45,000 a year. I, have Built of Motels ,Condos and worked (7) Days a week most my life starting as a 6 year old boy for my Father (A old Depression Farmer)-*&* Was asked by the help if I, were adopted / or a step-son.As they saw me do a mans job starting at 6-AM (The workers arrived at 8-AM) and the (Workers left @ 5-PM) My Brother and I Stopped working @ 9-10-PM (7-Days a week)
Who the ____Do these people making $250,000 to Mr. Paulson with 160-Million Dollar Bonus think they are-?-

Wed ,need "America" back with manufacturing jobs paying $16-30- a hour and to build a nation of savers and Hard-workers.

Paul, this nation will not survive with this GREEDY-LAZY-Un-America... /Money-Money-Money/Gambling /Drugged-up/Alcoholic/... Income to the top Billionaires businesspeople /Congressman /Senators---Who have NO idea how a average American lives -works-or struggles/I, wish You could interview the Man who built Burlington Coates and show him what is written here and ask him his opinion.

George Washington and Thomas Jefferson /*&* Benjamin Franklin were willing to Die /Lose everything they own to get Us AMERICANS A CONSITUTION *&* A BILL of RIGHTS.

Franklin=invented the Eye-glasses and give the invention "FREE" to the "PUBLIC" as He said "GOD had given him---He also invented and give a type of Heating stove that used 1/2 the normal Lumber&/or Coal to Heat Americans --who would have Frozen otherwise---

I,could go on *&* on and these people of this Country *&* the "World" think Men of this Statue are dumb (Willing to give "ALL" for their fellow countrymen *&* women and the ABOVE is their re-payment-????) Our schools refer to them as a bunch of WHITE BALD-HEADED old MEN---???

I Fear people who know not their history are bound to repeat the worst of Human-Kinds-WARS-Depre... etch!!!!!!!

Franklins' biggest FEAR of Democracies was they end-up 1st as Republics then Democracies of a Pluralistic nature and then Anarchy---Them Dictatorship. (A "STALIN" (Murder 40-million of his own people) (Hitler(Murdered 3-6 Million Jews and on top of that FORCED THE GERMANS into a WART many DID not want and killed the protestors either in a similar manner to the Jews / or simple shot them in the Head *&* had a tractor dig large mass graves (Only to prevent a outbreak of diseases) As soldiers do not fight well sick---And Hitler wanted them fit to fight *&* die.) All Dictators are generally all alike and come out of "CRISIS" *&* People beg for them to bring order---Even at the lost of their "Freedoms" See the Roman / Greek / Persian/Turkish/Europe... that died of GREED-ME-Me_ME ---No Morales---No God---I am "GOD" Societies. Everything is O.K.,--Just ck., out Sodom & Gomorrah Fates---(Spelling may be off) --But You , all get the picture / *&* Message = Solution -Each *&* Every person start trying to emulate Benjamin Franklin / Thomas Jefferson / George Washington - Each in Your own way--- start by reading the History of
America-Goodbye for now *&* I pray the "BEST" for ALL of US-May God have Mercy on our Souls

2008 Dec 03 11:41 PM