Chris DeMuth Jr: Event-Driven Portfolio For May 2015

|
Includes: AABA, ABBV, AOL, AZN, BCE, BHGE, BNCC, CHTR, DRC, ERIC, EXC, GLNIF, HAL, HE, ISSI, JNPR, LO, MCGC, MYL, NEE, ODP, PCYC, PFE, PFLT, POM, PPO, PRGO, RAI, SHPG, SIEGY, SPLS, T
by: Chris DeMuth Jr.

Summary

This event driven portfolio is structured to offer a return of about 17% +/- 3%.

It is statistically diversified enough to avoid any particularly large exposures.

It should thrive regardless of the overall market's direction or the overall economy's strength.

Every day, I sift the world for misplaced bets. What specific categories do I search for investment ideas?

Ideas will fall into the following categories:

  • Value Investing
  • Event Driven
  • Special Situations
  • Arbitrage

I am particularly interested in some of the more obscure event driven niches.

My less typical categories include:

  • Mutual conversions
  • Odd lot tender offers
  • Merger securities
  • Squeeze outs

Event Driven Portfolio Construction

If you are interested in receiving these types of investment ideas, please simply click here to follow my ideas. I am currently at work on at least one idea in each of the above categories. When my research is done, I will invest and write about the investments.

Meanwhile, what does my portfolio of event driven ideas look like in the beginning of May 2015? One could put together an event driven portfolio composed of 10% cash at the ready to deploy to future opportunities and 5% positions in each of these five potential takeover candidates and thirteen definitive merger arbitrage opportunities. If you want details on the specific opportunities, please click on the company names to pull up additional information.

Potential Takeover Candidates

Target / Acquirer

Ticker / Ticker

Parity

Spread

Return

Time Warner Cable / Charter

TWC / CHTR

$172.98

$15.73

10%

AstraZeneca / Pfizer

AZN / PFE

$87.43

$19.55

29%

Juniper /Ericsson

JNPR / ERIC

$35.00

$8.09

30%

Yahoo! / AOL

YHOO / AOL

$56.00

$13.49

31%

BNCCORP

OTCQX:BNCC

$25.00

$8.10

48%

Definitive Merger Arbitrage

Target / Acquirer

Ticker / Ticker

Parity

Spread

Return

Hawaiian Electric Industries / NextEra Energy

HE / NEE

$33.08

$1.99

10%

Dresser-Rand / Siemens

DRC / OTCPK:SIEGY

$85.20

$2.32

11%

Integrated Silicon Solution / SummitView

ISSI

$19.25

$0.80

11%

MCG Capital / PennantPark Floating Rate

MCGC / PFLT

$4.74

$0.18

12%

Baker Hughes / Halliburton

BHI / HAL

$74.00

$4.87

16%

Polypore / Asahi Kasei

PPO

$60.50

$1.78

17%

Office Depot / Staples

ODP / SPLS

$10.86

$1.44

20%

Pepco / Exelon

POM / EXC

$27.25

$1.42

21%

DirecTV / AT&T

DTV / T

$94.07

$3.62

23%

GLENTEL Inc / BCE

OTC:GLNIF / BCE

$26.65

$1.24

29%

Pharmacyclics Inc / AbbVie

PCYC / ABBV

$261.24

$6.69

30%

Lorillard / Reynolds American

LO / RAI

$72.05

$2.46

40%

Perrigo / Mylan

PRGO / MYL

$244.94

$59.01

47%

Annual Net Return

This portfolio will probably have about a 14% annual net return off of the definitive merger arbitrage portfolio. Depending upon whether or not any of the potential takeover candidates become definitive deals over the course of the next year, those could add up to an additional 7% of return for a total upside of about 21% in 2015.

Cash

The 10% cash position can be subsequently deployed opportunistically in demutualizations, odd lots, or other one-off opportunities that arise from time to time. Also, a cash position of at least this size can be helpful when funds with high cross ownership run into trouble, as occurred as recently as October 2014. All spreads can widen substantially regardless of risk, so it is nice to have cash to inject into such liquidity-driven panics. Also, cash is one of my favorite tools for dealing with the next market collapse.

M&A Monitoring

If you are interested in monitoring these investment ideas and similar situations, I have three ways do so. First, you can follow individual articles via clicking on the company names above. From time to time there may be author updates regarding deal progress.

Secondly, for a simple way to track these types of ideas, you can monitor them at my Event Driven Portfolio on Motif Investing. If you sign up here, we each get $100, which we can put to work in event driven investments such as the ones in this portfolio.

Thirdly, you can join Sifting the World to get my most edgy and actionable event driven ideas. I curate my most current event driven information and offer potential takeover candidates, including one that was acquired during the first month of the forum.

Liquidity and Closing Schedule

These deals are scheduled to close over the course of the next year starting within less than a month. The next two deals to close will probably be LO and PCYC. For every $100,000 of portfolio, one could invest up to $5,000 in each of these names. That would equal about 71 shares of LO and about 19 shares of PCYC. If they close as anticipated, the proceeds will probably equal about $175 for LO and about $127 for PCYC.

By early July, there should be exits from DTV with a potential $199 gain, GLN for a $298 gain, and PPO for $151. The perpetual cycle of deals closing has positives and negatives. The positives include the fact that capital can be conveniently redeployed whenever capital is returned. Also, these investments have the equivalent of a floating rate as capital will be returned in time for any rise in interest rates.

On the other hand, it takes some amount of work to manage the balances as they keep changing. Also, this tends to be somewhat heavy on short term capital gains. That is not always the case, however. LO and DTV are two that are likely closing by the middle of the year and they have been long-term long ideas that I have had for many years.

Deal Closing Calendar

Target / Acquirer

Ticker / Ticker

Parity

Spread

Closing

Return

Lorillard / Reynolds

LO / RAI

$72.05

$2.46

6/1/15

40%

Pharmacyclics / AbbVie

PCYC / ABBV

$261.24

$6.69

6/1/15

30%

DirecTV / AT&T

DTV / T

$94.07

$3.62

7/1/15

23%

GLENTEL / BCE

GLN/ BCE

$26.65

$1.24

7/1/15

29%

Polypore / Asahi Kasei

PPO / N/A

$60.50

$1.78

7/1/15

17%

Pepco / Exelon

POM / EXC

$27.25

$1.42

8/1/15

21%

Dresser-Rand / Siemens AG

DRC / SIEGY

$85.20

$2.32

8/1/15

11%

MCG Capital / PennantPark

MCGC / PFLT

$4.74

$0.18

9/1/15

12%

Integrated Silicon / SummitView

ISSI

$19.25

$0.80

9/12/15

11%

Baker Hughes / Halliburton

BHI / HAL

$74.00

$4.87

10/1/15

16%

Hawaiian Electric / NextEra

HE / NEE

$33.08

$1.99

12/3/15

10%

Perrigo / Mylan

PRGO / MYL

$244.94

$59.01

1/1/16

47%

Office Depot / Staples

ODP / SPLS

$10.86

$1.44

2/1/16

20%

Tax Considerations

One strategy for personal accounts would be to put deals likely to close within a year in tax advantaged accounts and to put deals that are likely to take more than a year in taxable accounts. That way, short-term capital gains are minimized.

Broken Deals

Some merger arbitrage funds have narrow mandates that force them out of securities if deals break. This can lead to extremely poor exits. Instead, consider hanging in there for a while if any of these break. In one recent example, AbbVie abandoned its acquisition of Shire (NASDAQ:SHPG). Many narrowly mandated merger arbitrage funds sold immediately without any sensitivity to price. However, if one held on, the shares recovered from a precipitous decline. By the end of the year, the shares recovered more than half of the loss and by the end of the first quarter of 2015, they recovered all of it.

Doing It Yourself

For holders who are interested in this strategy as less than a full-time job, one way of thinking about this is as follows. Stock deals can be a useful way to get access to shares that you would otherwise want to own but on sale.

Cash deals can be a useful way to get yields that are as high as bonds that have greater risk of permanently impairing capital. With a statistically diversified portfolio of ideas with positive expected values, you can make is reasonably likely that you will enjoy an acceptable overall outcome over time.

Professional Event Driven Resources

What if it is your job? What resources can be brought to bear? At work, I have colleagues including portfolio managers and analysts who source ideas and monitor positions around the clock. We have outside experts who pick apart every legal, financial, and strategic aspect of each deal. We pore through the primary source documents and repeatedly contact each of the principals, typically those outlined in the background sections of proxies.

What level of detail can one reasonably be expected to know? One typically knows whose office lights are on during the weekend, where corporate jets are pointed, whose boards have simultaneously scheduled calls, who has documents heading to the printer, and which factories are prepared for day one of the merged company.

More importantly, one can reverse engineer the strategic dynamics surrounding merger contracts in order to determine their strengths and weaknesses. There are many specific tactics for understanding deal risks. As with many types of investing, once it is in the press, it is already in the price, so the important work all comes before the news cycle on given deal developments.

Caveat

These investment ideas are typical of hedge fund investing, but may not be suitable for all types of investors. If this topic is not something that you are monitoring professionally, here are some additional thoughts on sizing, risk, and actively managed ideas within the context of a broader secure financial strategy.

Conclusion

Take the probability of loss times the amount of possible loss from the probability of gain times the amount of possible gain. That is what we're trying to do. It's imperfect, but that's what it's all about.

- Warren Buffett

Like other types of investing and, more broadly, everything involving risk and uncertainty in real time, event driven investing is a matter of expected value. We try to be right every time, but there are always some bad outcomes. Historically, depending upon the timeframe, we have experienced adverse outcomes between fourteen and thirty-six percent of the time in individual positions.

Even when we have losers - and we always have some losers - we want the overall portfolio set up so that we protect our principal, the winners pay for the losers, and we have a reasonable return left over. There is always going to be a certain amount of noise beyond our control, but if the portfolio is structured properly, the range of outcomes will typically be between decent returns and, occasionally, some pretty indecent ones.

Disclosure: The author is long TWC, AZN, JNPR, YHOO, BNCC, HE, DRC, ISSI, MCGC, HBI, PPO, ODP, POM, DTV, PCYC, LO, PRGO, GLNIF.

The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Chris DeMuth Jr is a portfolio manager at Rangeley Capital. Rangeley invests with a margin of safety by buying securities at deep discounts to their intrinsic value and unlocking that value through corporate events. In order to maximize total returns for our investors, we reserve the right to make investment decisions regarding any security without further notification except where such notification is required by law.

Editor's Note: This article covers one or more stocks trading at less than $1 per share and/or with less than a $100 million market cap. Please be aware of the risks associated with these stocks.

About this article:

Expand
Author payment: $35 + $0.01/page view. Authors of PRO articles receive a minimum guaranteed payment of $150-500.
Want to share your opinion on this article? Add a comment.
Disagree with this article? .
To report a factual error in this article, click here