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Thomas Streater
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I specialize in the Energy and Materials sectors because I have commercial experience within these areas. I do not have a long or short bias, I just try to find mispricing.
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  • Book Review: Risk Arbitrage By Guy Wyser-Pratte

    Guy Wyser-Pratte is an activist hedge fund manager, who started his arbitrage career in 1967. Risk Arbitrage was originally the subject of Wyser-Pratte's MBA thesis and first published in 1971. This version is revised and updated, published in 2009.

    The book explains and describes using over fifty examples from the 1970s through to the 2000s how arbitrage works in merger and cash tender offer situations and extends to "active arbitrage", an outgrowth of traditional risk arbitrage.

    Arbitrage in the pure sense of the meaning traces back to Venetian merchants dealing, over benches, in currencies. In today's markets, technology keeps markets relatively efficient, in the sense that, without huge investments in technology, one cannot buy and sell two equivalent instruments in different markets, and profit without risk from the convertibility of the two.

    Risk arbitrage however, is the umbrella under which various forms of arbitrage related to announced or proposed corporate deals or transactions fall. Although not quite riskless, the degree of risk is defined and usually low. An arbitrageur takes risk on a particular deal or set of financing transactions being completed, as opposed to having any market or directional risk exposure.

    Classical arbitrage began moving from riskless into risk arbitrage in the US in the 1930s. Bankrupt railroads were being reorganised and the 1935 Public Utility Holding Company Act required public utilities to divest holdings in subsidiaries. Investors who exploited price differentials in the various securities being issued, redeemed, and/or converted in a reorganisation realised their profits only at the legal completion.

    The corporate merger wave of the 1960s was, essentially, when risk arbitrage as a practice began to take off. The 1970s was epitomised by innovative deal structures, a new era of hostile offers and the introduction of Ivan Boesky. Junk bond finance propelled M&A activity in the 1980s, the decade of Michael Milken and "white knights" and "poison pills". By the 1990s rising stock prices provided impetus for deals but investors, becoming increasingly frustrated with boards using the "just say no" defense, started to take governance issues more seriously. After the Enron and Worldcom scandals, investors increasingly distrustful of corporate managements, put more weight on governance and the era of wide scale hedge fund activism had truly begun in the 2000s.

    Wyser-Pratte seems to enjoy using the wedding analogy. The Groom, the acquirer or initiator of a merger, is after the Bride for her dowry. The arbitrageur must assess if the "marriage" is suitable, the probability that the deal will go through, the value of securities offered (including the parity), how long before "consummation" and finally any antitrust considerations. All these factors affect the risk and returns and dictate the level of the spread (between the Bride and Groom's packages of securities to be exchanged) at which it becomes attractive enough for the arbitrageur to invest in the deal.

    For a somewhat technical subject, the book flows quite smoothly. Since all of the examples are transactions in which the author participated, the context of each deal is provided. One gets a good sense of the interaction between the "arbitrage community", the Street and the various managements of the respective Brides and Grooms.

    The final two chapters, The Subterfuge Syndrome and Active Arbitrage focus less on the mechanics of arbitrage transactions but on the battles between entrenched board members - looking to maintain their comfortable status quo - and shareholders, looking to realise value in the company. By rounding up support from chunks of shareholding and publicly putting pressure on directors through filing court actions or simply petitioning hard at annual meetings Wyser-Pratte was able to achieve some success in the at-the-time novel idea of getting boards to be more responsive to takeover interest.

    This book is worth reading for anyone generally interested in arbitrage and M&A or those looking to understand the origins of some of the popular hedge fund strategies employed today.

    Before the publicity provided by platforms such as YouTube or activist websites (valueyahoo.com, coal4india.com or factsaboutherbalife.com, etc) were available, it's facinating to learn the methods of a successful practitioner and pioneer of shareholder activism work the old fashioned way.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.

    Apr 21 9:13 PM | Link | Comment!
  • Bargain Basement

    For five years Esprit has been in steady decline. Now with the lowest market capitalisation in the Hang Seng Index it is in danger of dropping out of that benchmark. That fourteen of eighteen analysts have a "Sell" recommendation on Esprit speaks for itself.

    The apparel retailer is suffering from an identity crisis. With lines too expensive to be considered value and no longer fashionable enough for their price tags, Esprit has steadily lost market share to rivals.

    Gap had much the same problem, but improved designs and skillful marketing won it back some of the popularity formerly enjoyed. Compare this to Esprit's recent advertising campaigns. The hiring of supermodel Gisele Bündchen was a desperate attempt to change direction that showed Esprit was unaware of its own position in the market. It makes sense for Burberry to hire Kate Moss but Esprit is just not in that sector.

    Esprit's failing business model is more important. Unlike Fast Retailing, Esprit has not been offering functional, basic clothing at reasonable pricing. Unlike other "fast fashion" businesses like Inditex or H&M, Esprit has been unable to react quickly to the latest fashion trends. Esprit also suffers from slow turnover thanks to its wholesale segment accounting for nearly half its revenue. The associated inventory risk has proven costly.

    Since September 2011 Esprit has been undergoing restructuring, er, sorry, its "Transformation Plan". The stock is priced accordingly. With negative earnings, EV/LTM sales is a useful metric. At 0.54x Esprit is discounted compared to its more desirable rivals (Gap is the cheapest main rival at 1.1x).

    Appropriate comparables therefore, would be stressed apparel brands that were taken private last year such as Kenneth Cole at 0.5x (by Mr Kenneth Cole) or Benetton at 0.7x (by the Benetton family). This could be Esprit's route to a less painful restructuring, away from annoying analysts. Michael Ying, Esprit's leader during the glory days of the nineties, holds around 10% of the company. By teaming up with private equity, Ying could prove that, after Cole and Benetton, three makes it a trend.

    Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

    Apr 21 2:57 PM | Link | 1 Comment
  • Gross Savings (% Of GDP)

    Gross savings (% of GDP)

    Data from World Bank

    Mar 27 11:24 PM | Link | Comment!
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