'Risk Arbs' Stumble and May Yet Win Big (Repeat): Minding Money
Bloomberg News
September 8, 1998, 5:58 p.m. ET
'Risk Arbs' Stumble and May Yet Win Big (Repeat): Minding Money
(Repeats to fix typographical error in 8th paragraph.)
New York, Sept. 8 (Bloomberg) -- Many money managers who buy
stock in companies about to merge lost money in August, but that
isn't dampening their enthusiasm that deals will make money for
them in coming months.
That's because the spreads between the prices of targets'
shares now, and the planned acquisition prices, widened in recent
weeks. ''This is as good as risk arbitrage gets,'' said Robert
Chapman, who runs Chapman Capital LLC in Los Angeles, which
invests in merger deals.
Last Monday, ''Arbitrage Week,'' a weekly tip sheet sent to
money management clients by Bear Stearns & Co., said spreads on
target companies were at their widest levels since the 1987 stock
market crash.
Take Daimler-Benz AG's pending purchase of Chrysler Corp.,
perhaps the most-favored transaction of arbitragers right now.
The spread between Chrysler's stock price and what shareholders
will get when the deal closes was about $4 a share at the end of
July. On Friday, it was $9.50. Capturing that spread could
translate into the equivalent of an annualized return of about 85
percent, managers calculate, assuming the transaction closes by
late November. That's up from about 30 percent a month ago.
Then there is Welsh, Carson, Anderson & Stowe, a New York
buyout firm that said it would buy Centennial Cellular Corp. for
$43.50 a share, or $2 billion in cash and debt, on July 2. The
stock reached a high of 41 1/2 on July 16. Today it closed at 34
15/16.
Pushing Spreads Wider
The reasons weren't only that the Standard & Poor's 500
Index tumbled 18 percent between July 17 and last Friday. Some
busted transactions and turmoil in emerging markets also helped
to push the price of target companies lower.
Managers, for example, got spooked after Tellabs Inc.
renegotiated its purchase of Ciena Corp. at the end of August.
When the deal was first announced in June, the transaction was
valued at $65.88 a share. After Ciena lowered its third-quarter
earnings and said AT&T Corp. wouldn't be buying as much equipment
from them, Tellabs lowered its price by 20 percent.
That event followed Lockheed Martin Corp.'s scrapping of its
planned $10.7 billion purchase of Northrop Grumman Corp. on July
16 rather than fight a legal battle with federal antitrust
enforcers and the U.S. Defense Department.
Funds that combined investing in mergers with, say, emerging
market bonds also contributed to the decline of takeover stocks.
In order to meet margin calls on the money losers in developing
markets, some funds were forced to sell parts of their more
liquid holdings, including stocks they owned.
Damage to Funds
The damage to funds hasn't been tallied yet. Carrie McCabe,
head of Blackstone Alternative Asset Management, with about $1.3
billion invested with hedge funds, said the better risk arbitrage
managers were down between 3 percent and 6 percent in August.
Mikhail Kimbarovsky, president of Hedge Fund Research Inc.
in Chicago, which advises hedge fund investors and invests in
funds itself, said losses of ''arb'' funds it follows were
anywhere from 1 percent to 7 percent.
''If the market normalizes, spreads will come in,'' McCabe
said. ''We have managers requesting more capital.''
With the Dow Jones Industrial Average surging 5 percent
today, the spreads are already starting to narrow. Chrysler's and
Daimler's spread narrowed to $6.33.
Managers say the transactions they like best are the ones
that make strategic sense, like Chrysler and Daimler-Benz, and
therefore have little chance of falling through.
The Arbitrager's Strategy
Wolfgang Armbruster, managing director of Wyser-Pratte &
Co., says other deals that fit into that category are American
International Group's pending acquisition of SunAmerica Inc.,
Tyco International Ltd.'s purchase of U.S. Surgical Corp.,
British Petroleum Co.'s buyout of Amoco Corp. and Berkshire
Hathaway's purchase of General Re Corp.
Risk arbitragers try to profit from takeovers by buying
shares of the target company and selling short -- or borrowing
shares of the purchasing company and immediately selling them --
in the hopes they can be bought back at a cheaper price later.
Shares of the acquiring company usually fall leading up to the
completion of the acquisition.
The reason the Chrysler-Daimler deal went so out of whack is
that arbitragers were having difficulty borrowing shares of
Daimler, they said.
At Bear Stearns, the largest positions it holds include MCI
Communications Corp. and short WorldCom Inc., Chrysler and short
Daimler-Benz, Southern New England Telecommunications Corp. and
short SBC Communications Inc., and Tele-Communications Inc. and
short AT&T Corp.
The deals managers are staying away from are ones involving
junk-bond financing, such as the Centennial Cellular transaction,
since buyers will have difficulty in this market selling such
bonds.
''The risks in deals have always been there, but now they
are displayed in neon lights,'' said Chapman.
--Katherine Burton in the New York newsroom (212) 318-2335/cws |
