Merger Arbitrage – Hedging the Time Period Deal Risk in M&A

In public market M&A transactions, where at least part of the consideration is stock of the acquiror public company, the value offered is subject to market risk as the acquiror’s stock price changes. Collars – long underlying, long put options, financed with short call options-  provide some degree of price protection to acquiror and target between signing (announcement) and closing.  Valuing the hedge correctly is key to making profitable M&A arbitrage trades.

Anatomy of Master Limited Partnerships——

This year I have substantially augmented our algorithms and allocation methodology to better reflect the inclusion of  Master Limited Partnerships within asset allocation and portfolio construction.

The MLP is a publicly traded partnership formed to own and operate natural resources assets. Suitable assets are stable cash generating assets that qualify under the tax code for certain advantages. Its tax efficient structure eliminates double taxation at the corporate level, and it allows for tax efficient contribution of assets from a sponsor into the MLP. Moreover, it allows a sponsor to contribute assets without relinquishing control through ownership of the partnership’s General Partner. Investors expect an MLP’s asset base to provide a pre-established minimum quarterly cash distribution with some expectations for internal and external growth while recognizing that incentive distributions to the sponsor reduce upside potential.

Contents: Overview of the MLP Structure, History, What is an MLP?, Concept, Creation: Key Criteria, Asset Areas, Typical Investor Questions, General Pros & Cons, Issuer/Sponsor Perspective, Illustrative Term Sheet, Illustrative IPO Valuation, The GP / LP Relationship, Distribution Policy, Tax Example: Cost Basis Illustration, Fees & Incentive Plans: Case Studies, Governance: Case Studies, Typical IPO Timetable

Rising Protectionism in Cross-border Inbound U.S. M&A

Protectionism includes foreign investment restrictions, antitrust regimes and takeover rules that regulators use to block or influence deal outcomes. Protectionism and trade barriers and inward-looking sentiment is seeping into policy and regulation. There have been many changes in discussions between Congress and Committee on Foreign Investment in the United States (CFIUS). Opposition is no longer just vocal; a lot of activity is taking place behind the scenes in Washington. Constituency interests, too are crowding out traditional policy interests. I describe what’s happening:

Contents:

M&A Activity Especially Inbound Drastically Reduces

Protectionism Norms: Evolving

Protectionism in Foreign M&A Deals: U.S. Actors

Protectionism in Foreign M&A Deals: Rising 

Foreign M&A Deals: Typical Post-Announcement Timeline Delay

Reaction to Japanese Investment: Exon-Florio Amendment

Exon-Florio Overview

CFIUS Reform: FINSA and FIRRMA

Reform: Overdue

Due Diligence Check List Questions: Acquirer

Post-Announcement Timeline

Post CFIUS >SEC Review Process

Share Purchase Considerations

Allocating to Alternative Investments

A pre-requisite for constructing any great portfolio is identifying skilled managers that an investor believes can consistently generate alpha. Although investors intuitively recognize the value of alpha, they have historically lacked the tools required to build portfolios that include active managers. ActiveAllocator addresses newer challenges by designing a rigorous, integrated and, perhaps most importantly, practical framework for active investing. Extensive testing provides evidence that our framework can significantly improve upon more traditional portfolio construction methods. Our approach is unique in that it:

  1. More accurately measures manager alpha and beta on historical basis.
  2. Explicitly forecasts manager performance by combining historical data with other information.
  3. Quantifies unique risks of active managers.
  4. Accounts for these unique risks when constructing portfolios.

While the details of this approach are outside the scope of this note we summarize the general characteristics of alternative investments here.

The Capital Allocator’s Perspective

Due Diligence Framework for Direct Investing.

The capital allocator is in the business of entering into partnerships with fund sponsors to potentially generate significant returns, mainly through long-term capital appreciation, by making, holding and disposing of privately negotiated equity and related investments. Such investments are usually made as a passive investor in vehicles directed by a third party fund sponsor; as a result, the investor has only indirect influence over-achieving ultimate investment objectives. I believe that a methodical approach to selecting sponsors—which combines scientific rigor with seasoned subjective judgment— may contribute to creating strong results in a variety of economic environments.

I present here a ‘best practices’ framework for selecting financial sponsors. I draw attention to important issues, metrics and considerations deemed worthy of exploration. What follows does not represent an exhaustive list, of course. Each investment and operational diligence mission inevitably take one down paths that are not common to other missions. One must be prepared for this—and even seek it and relish it. For, it is forays beyond the common and readily available, that enable real insight into the people with whom one entrusts with one’s capital.

I had written a piece way back when I allocated capital to inform my own understanding. Here is an updated version.

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Reflections on the Global Financial Crisis 2007- European Banks

As this decade closes, I reflect that as defining the Covid pandemic crisis has been to this decade, the Global Financial Crisis was to the previous. Narratives analyzing the 2007 GFC have been largely US centered, long on prose and short on detail. Not much is written on how the European banking sector was affected and the manner in which European banks navigated the 2007 GFC.

In this presentation I show that the combined misjudgments of central banks, regulators, rating agencies, investors and bankers  led to a buildup of an unsustainable amount of leverage in the global financial system. This was further exacerbated by the normal peak and downturn of the credit cycle in 2007-2008. Extreme volatility in dislocated markets tested negative correlation assumptions. Financial turmoil limited banks’ ability to transfer loans off balance sheet to ABS and secondary markets and resulted in the consolidation of conduits and SIVs.  Consequently, unplanned asset growth put bank capital ratios under pressure. Write-downs on sub-prime exposures, leveraged loans and impacted asset classes led banks to raise capital through equity and equity-linked markets or directly from sovereign wealth funds. Central Banks, much as they did during the Covid crisis, took bold actions to stimulate market liquidity as well as the economy.  This focus provided sufficient liquidity to keep interbank markets functioning;  banks recapitalized, loans were guaranteed, special liquidity schemes instituted as well as multiple other actions taken. Coordinated policy and response measures included political guarantees, deposit guarantee, rescue debt, collateralization and other actions. European banks subsequently raised capital, increased liquidity, reduced their U.S. structured credit exposure and relied on the economy to recover to reduce non-performing loans.

I conclude that during such crisis banks themselves have much recapitalization, balance sheet and business model restructuring to undertake. These are best done in close cooperation with governments and regulators. 

Convertible Debt and Hybrid Securities

Convertible Debt and Hybrid Securities are notoriously hard to value and near impossible to include purposively within asset allocation and portfolio construction methodologies. As equity-linked financing alternatives now abound, their variants too preclude a one size fits all approach. For example the Bond Hedge & Warrant (“BH&W”),  a structural enhancement to a convertible bond to effectively raise the conversion premium, adds complexity. Hybrid capital securities have evolved to now refer to a range of non-dilutive fixed income instruments that incorporate equity-like features. The accounting treatment for such securities too differs from those applicable to traditional in the United States.  

I highlight these and other considerations in our latest research piece. In this presentation I address five key areas of interest ; (i) What are Convertibles and Why are They Issued?; (ii) Overview of Convertible Debt; (iii) Overview of High-Equity Content Convertibles; (iv) Accounting Review; (iv) Investors and Market Dynamics

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