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Chris DeMuth Jr.
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"It's not given to human beings to have such talent that they can just know everything about everything all the time. But it is given to human beings who work hard at it - who look and sift the world for a misplaced bet - that they can occasionally find one." - Charlie Munger I look... More
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  • 4 Corporate Event Indicators And A Eulogy For Apollo-Cooper 2 comments
    Oct 15, 2013 2:55 PM | about stocks: CTB

    Simple vs. Complex

    Every losing cause has an allegory. The allegory is the story of how one could win despite the odds. This allegory is how improbable presidential candidates are able to dedicate years of their lives to campaigns that any casual observer could tell is hopeless. Most such causes exhibit a distain for precedent and statistical evidence. All rely on a complex strategy to overcome seemingly insurmountable odds. Count the "ifs". "If… and if… and then if… and finally we will be able to succeed if." This is often more problematic than it seems. Each additional layer of complexity offers new opportunities for new unforeseen problems.

    Is a deal complex? In the recent example of Apollo's deal to acquire Cooper, the amount of complexity was heightened by the following characteristics: cross-border, highly leveraged, and a small, inexperienced buyer. None of these characteristics are necessarily problematic, but each led to new problems such that the complexity compounded and eventually spun out of control.

    The fact that the deal crossed borders led to problems related to the buyers' currency when it collapsed during the course of the deal, which unnerved several of the banks responsible for raising the deal's substantial debt. Additionally, friction between the Indian buyers and the Chinese joint venture partners in Cooper's largest and most profitable subsidiary spilled over into a massive strike, litigation, and manufacturing disruption.

    Attempting a highly leveraged deal in a cyclical industry might work and it might not. But it certainly turns any issue confronting the deal into a multiparty discussion, as the banks responsible for the debt get seats at the table. If any problem arises, it will be two perspectives against one as the banks and the buyer try to walk as the seller tries to close. In the case of Apollo-Cooper, Apollo's desire to get out was fine with the banks. Once their motives aligned, their means compounded the deal's problems. Apollo can drag their feet until mid-November at which time the banks can demand documents that Cooper will probably be unable to supply.

    The buyer is a small company that has completed only one similar deal when they bought a Dutch tire company. So what? The fact that it is small is statistically significant: the relative market caps of deal partners make a big difference as to the likelihood that deals can close. Huge companies trying to buy small companies can complete dumb deals without anyone raising a fuss because it does not matter much. In such deals, management can pretty much do what they want without attracting too much scrutiny. But when small companies want to buy big companies, everyone chimes in and the feedback can be both negative and influential. Apollo's management team has not done this kind of thing enough to be able to predict the reaction. When the reaction was terrible, they had only a single deal precedent to point to. This proved insufficient to convince anyone that they knew what they were doing.

    Ease vs. Pressure

    There are many tasks that are harder to complete when one must complete them. The Apollo-Cooper deal's year end walk date put this deal under extreme pressure from day one. As soon as any problem emerged, the default outcome became a broken deal. That problem emerged when the arbitrator sided with the United Steel Workers (in a soundly reasoned and correctly decided opinion). Anyone wanting out had an easy route that involved having to do little while anyone wanting the deal had to be perfect - make perfect decisions and get perfect reactions and have all of that happen on a perfect schedule.

    Incentives vs. Intentions

    Since people like to talk about them, intentions are hard to ignore. Try. One of my favorite pieces of advice for raising a daughter is that when a young man shows up to date her, simply ignore 100% of what he says. His stated intentions will have such little predictive value that actually avoiding them entirely and instead focusing on what he does will make for more accurate character judgments. People lie. People lie all of the time, dozens of times a day, in matters great and small, and even with professional training it is impossible to catch all of the lies. How many of the world's problems - from capital markets or personal security all the way to geopolitics - could be predicted from the stated intentions of the key actors? Approximately none.

    What about incentives? Incentives don't lie. Shortly after announcing Apollo's deal to acquire Cooper, the buyer's share price declined from 92 to 55 Rs. This represented a cost to the family that manages Apollo (and is the company's largest shareholder) equivalent to over $100 million in US dollars. Presumably all that they would have to do to make some or all of that money back would be to find a way out of the deal. But could they find anyone to support such a move? Only every other Apollo shareholder, who also lost 40% of the value of their investment, many of whom marched into the management's offices to beg them to find a way out.

    Early in the course of the deal, this Apollo management team indicated that they supported the deal… a deal that would personally cost them over $100 million. This was a battle between the statement of good intentions versus the reality of hard incentives. May the best signal win.

    Fresh vs. Stale

    Early in my investment career, there was a young pop star who was famously open about discussing her virginity. The topic was a routine topic for tabloid fodder. "I'm a virgin"… "Still a virgin"… "Hey look at me, a virgin" etc. Then one day, as she was returned from a long weekend in St. Barts, she was stopped by a reporter to discuss the matter for the millionth time. But this time she became flustered and said something more along the lines of, "that is a really personal and inappropriate topic." The fact that she had a really long record on the topic meant that the latest comment was far richer in content than it would otherwise be. The same holds true when talking to management.

    Early in the deal, Apollo's comments on the deal were clear and consistent in support for the deal. Only after the CCT subsidiary problems did the verbiage change in important ways. Apollo then "hoped" that Cooper could solve their problems (without predicting that they would) and Apollo supported the "strategic" aspects of the deal (without commenting on the price or other aspects of the deal). Then, once Cooper held their vote, Apollo went silent. They stopped answering questions as they got lawyered up. Once the vote was held, the parties were openly operating under different interpretations of the merger agreement. Only people who had asked them repeatedly about the deal would detect the sea change from Apollo's management. All of a sudden the deal's status under the merger agreement was treated like "a really personal and inappropriate topic". Yes, the last that we had heard from them was their stated intent that they wanted to close, but as those checks became days and then weeks old, the most salient fact was that communication with the buyer had gone stale.


    Such indicators are useful only if they can operate faster and more accurately than the market can discount corporate events. In my experience, these are four of the most useful ones. In every situation that I analyze, I ask myself whether an event is simple, easy, aligned and fresh.

    Stocks: CTB
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  • Afanti Arbitrage
    , contributor
    Comments (23) | Send Message
    Those four indicators can be used to make a pretty good checklist for future risk arb situations. As Charlie Munger said: “All I want to know is where I'm going to die, so I won't go there.”
    15 Oct 2013, 05:48 PM Reply Like
  • Qniform
    , contributor
    Comments (3375) | Send Message
    Great summation and analysis. Oh, and the Credit Suisse essay on outcome bias applies here too, don't ya know... It's not like anyone made particularly bad decisions.
    19 Oct 2013, 05:52 PM Reply Like
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