In my prior post, “Allied Capital Goes from Value Trap to Deep Value,” I made the point that the Ares/Allied acquisition created a potentially interesting merger arbitrage opportunity. As astutely pointed out by commenter BeauZeau at Seeking Alpha, the merger arbitrage opportunity is not quite as large as I portrayed.

In a classic merger arbitrage, the investor ought to short the acquirer Ares Capital (ARCC) and buy the target Allied Capital (ALD). That is because, assuming that the deal closes, the target and acquirer shares are now representative of the same asset. Consequently, any price discrepancy between the two stocks represents a fundamental disconnect with underlying value*. In the case of ARCC and ALD, I posited that the proposed exchange rate of .325 ARCC shares for each ALD share creates an opportunity based on current closing prices.

For those that follow this blog, I once wrote about an asset class known as business development companies, particularly middle-market lending BDCs. These businesses typically concentrate on investing through the financing of middle-market private equity transactions. Over the last year, some have come under pressure as a result of government regulations over BDCs which require them to maintain certain asset coverage levels. As a result of the disjunction in the markets, mark-to-market mark downs on BDC portfolios resulted in some BDCs (most recognizably Allied Capital (ALD) and American Capital (ACAS)) falling out of line with asset coverage regulations, tripping debt covenants, and discontinuing dividends.

On Monday, a major shakeup was announced within the BDC industry. Ares Capital (ARCC), one of a few BDCs which has managed through the recession while maintaining a substantial dividend, announced that it was acquiring a former giant of the industry, Allied Capital (ALD). The acquisition is expected to be an all-stock deal where ALD shareholders will receive 0.325 shares of ARCC for each share of ALD they own.

Q2 2009 Earnings Call

August 06 2009, 11:00 am ET

No wait, even better. I have some senior subordinated debt from private school operator Instituto de Banca y Comercio, Inc. that I know you are going to love. How can you invest in these fabulous companies? Well, according to a recent 10-Q filing, if you buy shares of publicly traded Ares Capital (ARCC) you can become a part owner of these securities as well as a plethora of equally obscure ones.

Q1 2009 Earnings Call

May 07, 2009 11:00 AM ET

Q4 2008 Earnings Call

March 2, 2009 10:00 pm ET

Q3 2008 Earnings Call

November 6, 2008 10:00 am ET

In their 13F-HR filing for Q2 2008, Bruce Berkowitz and his cohorts at the Fairholme Fund continue their shift from energy into healthcare:

• Fairholme opened huge (relative) positions in Pfizer (PFE), Forest Labs (FRX) and UnitedHealth Group (UNH). The UNH position echos Seth Klarman’s endorsement. I don’t follow the pharma industry too closely but it seems as if Berkowitz traded Glaxo (GSK) and Bristol Meyers Squibb (BMY) for PFE. I’ve been seeing more positive financial press coverage on Pfizer so perhaps momentum is building toward looking past Lipitor’s pending patent expiration. Read his thoughts on PFE here. I took a quick Google Finance look at Forest Labs and that stock looks promising. Great cash flows, rock-solid balance sheet with no debt but maybe some patent and pipeline issues — I’ve added this stock to my watchlist.
• Berkowitz also added substantially to their Sears (SHLD) and United Rentals (URI) positions. Berkowitz’s thoughts on Sears and its chairman, Eddie Lampert, are well-known. SHLD seems to be a pseudo-value-investing watermark position — all the cool kids own it. I’ve glanced at it briefly but haven’t put in the time to value its real estate and branding assets.
• Fairholme continues the reduction of their energy exposure as Berkowitz discussed back in March 2008 on Bloomberg. The Canadian Natural Resources (CNQ) position was reduced significantly and if you watch the interview in the link provided, he talks about costs rising as fast if not faster than revenues for producers like CNQ. In fact, I’ve discussed this aspect of energy investing in the past — what I call the “receding horizon” effect, especially in the oil sands area (which is why I have only backdoor oil sands exposure via Devon). Curiously, he also sold off a good chuck of St Joe’s (JOE), which he had been talking up fairly recently. I don’t know whether the thesis on JOE has changed or if he just saw better opportunities.

Robert Rodriguez oversees the First Pacific Advisors family of funds [FPA], of which he handles the main fund with others running the others. Q2 2008 holdings are revealed for all funds in the latest 13F filing:

Q2 2008 Earnings Call Transcript

August 7, 2008 10:00 am ET

Benjamin Graham is widely regarded to be the founder of modern value investing. His greatest student, Warren Buffett, attributes much of his success to Graham’s teachings. In this article, we take an in-depth look at stocks that Ben Graham might have liked.

Many of the readers of my previous articles about buying dividends were concerned that they didn't have enough time to look at the stocks going ex-dividend for the following week. So for this article, I'm listing the stocks that are going ex-dividend for the next three weeks.

All of the following nineteen stocks that are going ex-dividend have yields greater than 3%, P/E ratios of 18 or less, and PEG ratios less than 1.9%.

Q1 2008 Earnings Call

May 8, 2008 10:00 am ET

Q4 2007 Earnings Call

February 28, 2008 10:00 am ET

Benjamin Graham is widely regarded to be the founder of modern value investing. His greatest student, Warren Buffett, attributes much of his success to Graham's teachings.

Though Graham believed that much research is necessary and that no stock screening methodology is perfect, he did give us some guidelines on how to perform initial screening techniques to limit the number of investments that should be researched further. The following is a list of the attributes he suggests investors look for first. The italics represent our changes to his methodology based on the current market:

Benjamin Graham is widely regarded to be the founder of modern value investing. His greatest student, Warren Buffett, attributes much of his success to Graham’s teachings.

Though Graham believed that much research is necessary and that no stock screening methodology is perfect, he did give us some guidelines on how to perform initial screening techniques to limit the number of investments that should be researched further. The following is a list of the attributes he suggests investors look for first. The italics represent our changes to his methodology based on the current market:

1. Price-to-book (P/B) ratio of less than 1.2.