Hedge funds are known for buying up shares of companies that are to be taken over.
The strategy known as merger arbitrage has proven its worth for years, according to one proponent.
However, many hedge funds do the opposite by selling the acquired target short.
It has been known for years that hedge funds buy shares of companies that want to sell themselves, but the global COVID 19 pandemic has now forced funds to do the opposite, the Wall Street Journal reported.
Merger arbitrage betting
Hedge funds that buy shares of a target company usually participate in so-called merger arbitrage. A company agrees to sell at a fixed price on a set date, but if the shares are trading below the takeover price, an arbitrage opportunity arises. These investors are almost certainly guaranteed a profit – even if it is only a few pennies per share, since an M&A agreement has already been signed, sealed and delivered.
However, according to the WSJ, the pandemic increases the likelihood that these confirmed M&A deals will be delayed. In addition, the deals could be revised at a lower price, leading to a weaker economy and damaging consumer sentiment, which is often the culprit.
According to Northstar Risk Corp., the probability that companies will revise their M&A deals before the COVID disaster has increased from 4% in January to 33% in mid-March. Although it has declined since the peak of the pandemic, at 20% it is still significantly higher than at the beginning of 2020.
The funds are moving fast
Raj Vazirani is the CIO and Merger Arbitrage Manager of Vazirani Asset Management and explained to the WSJ how he is realigning its strategy. He said that the strategy of buying and holding target companies had worked well for nine years. However, this was no longer the case and he gave an example.
Independent Bank Group Inc (NASDAQ: IBTX), a Texas-based bank holding company, reached an agreement in late 2019 to acquire Texas Capital Bancshares Inc (NASDAQ: TCBI), a Texas-based bank holding company, in a $5.5 billion deal.
The transaction was completed as expected, but Vazirini noted a change in sentiment in April, which the CEO of Independent Bank expressed during a conference call. Instead of holding the long position, he completely reversed the price and briefly closed the share.
This proved to be the successful deal, as the deal was cancelled and Texas Capital’s shares dropped in the news.
Iron-clad deals also in danger
The owner of the shopping center, Simon Property Group Inc. (NYSE: SPG), has agreed to sell its rival Taubman Centers, Inc. (NYSE: TCO) for $3.6 billion and, according to WSJ, contained an ironclad clause preventing Simon from exiting the business because of the virus.
Simon agreed to pay $52.50 per share for Taubman, but his shares are well below target at around $40. Westchester Capital Management’s portfolio manager, Roy Behren, told the WSJ that he believes the deal will close, but is not willing to bet big.
His fund sold part of its position in Taubman in the expectation that the very unsettled mall environment would justify renegotiating the price.