So according to Corporate Finance I’ve studied so far in CFA, target company gains (NWA in this case) after the merger/acquisition. Does it mean, NWA would be a good bet to buy? Any suggestions/thoughts?
According to EMH, there is no gain whatsoever.
No, it doesn’t. It’s been said here before and I’ll say it again: In very few places is the deck stacked against the little guy as much as in merger arb.
It’s a pretty naive question, really. The target company almost always gains after the offer because the offer is supposed to be significantly more than the current stock price. At the current offer, NWA shares are trading below the 1.25*DAL by a little more than $1 in an all-stock deal so about 13% or something. So if you wanted to play the merger going through, you short DAL and buy NWA. As Naked points out, what makes you think you know more about the possibilities of this merger going through than the risk arb funds (who incidentally have lots of expertise on airlines because there are tons of distressed airline securities out there that are hedge fund stuff)? Ans: It’s not close. There is tons of hair on this deal and in the end you are playing a merger of two companies just out of Chapter 11 in a time of rapidly rising expenses and a recession. I think you should leave this to the pros.
NakedPuts Wrote: ------------------------------------------------------- > No, it doesn’t. It’s been said here before and > I’ll say it again: In very few places is the deck > stacked against the little guy as much as in > merger arb. I believe you, but I’m not sure I understand why. Yes, there are experts in arb funds, but what kind of information advantage do they have (again, I believe they have one, but I can’t put my finger on what it is). Anything else?
bchadwick Wrote: ------------------------------------------------------- > NakedPuts Wrote: > -------------------------------------------------- > ----- > > No, it doesn’t. It’s been said here before and > > I’ll say it again: In very few places is the > deck > > stacked against the little guy as much as in > > merger arb. > > I believe you, but I’m not sure I understand why. > Yes, there are experts in arb funds, but what kind > of information advantage do they have (again, I > believe they have one, but I can’t put my finger > on what it is). > > Anything else? Well, I’ll mention one possibility from the converse angle. The reason why bankers often look at trading multiples not only the day before a transaction announcement but also four weeks before is simply because it’s very difficult to keep whispers about potential merger activity completely silent. It’s understood that people should not be in the business of disclosing and acting on non-public material information, but word does get out and sometimes it gets into the hands of investors. When you’re spreading a comp set, the trading valuations you see the day before deals are announced are often contaminated with insider information getting out into the public market.
When you’re talking about trading multiples, what specifically are you talking about? Volume, a spike in P/E ratio, etc…
bchadwick Wrote: ------------------------------------------------------- > NakedPuts Wrote: > -------------------------------------------------- > ----- > > No, it doesn’t. It’s been said here before and > > I’ll say it again: In very few places is the > deck > > stacked against the little guy as much as in > > merger arb. > > I believe you, but I’m not sure I understand why. > Yes, there are experts in arb funds, but what kind > of information advantage do they have (again, I > believe they have one, but I can’t put my finger > on what it is). > > Anything else? What kind of information do you have? Do you now anything about the anti-trust problem? How about integrating aunion force with a non-union force? How about the synergies that caused by gate consolidation? How are the reservation systems? How are the planes and is there a mismatch between the DAL and NWA planes that will cause maintenance issues? Arre there fuel efficiency problems? What were the consequences of the Chapter 11 filings? Etc, etc.
Read the other section of that chapter - What type of takeovers happen in a declining industry? Answer: All types, because companies will try anything to survive.
I’d recommend sitting this one out but doing a mock trade to see what happens. Maybe do a couple different scenarios with and without leverage. Merger arb is usually taught in corporate finance classes to show what happens to the shareholder population after a merger is announced, not necessarily as a recommended strategy.
An even better plan is to take those synthetic AF positions and defend your choice. In particular, I would like to hear Tobias’ take on this because he seems to know lots about airlines. For what it’s worth - I’d play the merger going through. When push comes to shove, we all have an interest in healthy airlines and these two have decided this is healthy. It’s hard to accuse two companies right out of Chapter 11 as being exploitive (bankrupt robber barons?). The unions and govt will make themselves heard and then it goes through.
Open skies throws the proverbial spanner in here. That means you can have non-unionised efficient European airlines competing with them on international routes, even if they aren’t based in the destination country. That’s not good for the US airline industry…
I’m not sure we can compete with them on the Columbus-Akron route.
bchadwick Wrote: ------------------------------------------------------- > NakedPuts Wrote: > -------------------------------------------------- > ----- > > No, it doesn’t. It’s been said here before and > > I’ll say it again: In very few places is the > deck > > stacked against the little guy as much as in > > merger arb. > > I believe you, but I’m not sure I understand why. > Yes, there are experts in arb funds, but what kind > of information advantage do they have (again, I > believe they have one, but I can’t put my finger > on what it is). > > Anything else? I’ve talked with guys in this business (little guys, not even the big players) and the level of sophistication is amazing. First, they’ll tear apart the proxy statement to understand every last detail of the proposed merger. Obviously, these guys are experts in merger law, finance and accounting. They’ll speak with (or try to speak with) all involved parties, ie target co, any advising banks, lenders, sponsors if applicable to understand the likelihood the deal goes though. They’ll do detailed valuations of the pre- and post-merger companies to understand what their risk is. They’ll run monto carlo simulations using their defined risk parameters and estimates to judge whether or not they should hedge the transaction, and how much to hedge. Obviously, it’s the contacts and familiarity with these situations that put them far ahead of an individual saying “well, I think it’ll probably get done”.
soxboys21 Wrote: ------------------------------------------------------- > When you’re talking about trading multiples, what > specifically are you talking about? > > Volume, a spike in P/E ratio, etc… i was referring to an atypical trend in market cap-based ratios (volume is not a multiple)
JoeyDVivre Wrote: ------------------------------------------------------- > I’m not sure we can compete with them on the > Columbus-Akron route. I know that you guys think there isn’t anywhere else, but we have a place called overseas. The way you get there is on a plane. So the Chicago -> Stuttgart route is going to get more competitive - because instead of just Lufthansa and US airlines flying it, there can also be Irish, British and any other EU country based airline flying it. They will obviously compete on the most profitable routes. Hence overall profits down, irrespective of local routes.
They’ll be closing down hubs that are nearby and firing people, its a good thing for Northwest Inc., bad thing for its employees.
Joey and NakedPuts have pretty much nailed all the areas in which the merger arbs will know more than you. They know more from a legal and industry perspective. I am not in merger arb, just a long/short equity guy, but I had access to a conference call this morning with the former undersecretary of the USDOT who is certainly in a position to speak to the regulatory issues. Did you have the opportunity to listen in? If not, you are already at an informational disadvantage. For the record, I didn’t listen to it because I don’t own any airline stocks right now and I intend to keep it that way. Airlines are so 2006. I think the deal will go through amid some grumbling from the unions. I don’t think the gov’t will put up much of a fight with crude above $110, as they don’t want to have to be in the business of bailing out airlines again. Note that a few smaller carriers have gone bankrupt in recent weeks. However, if I was on that call this morning I would be in better position to speculate on the government’s current thinking. The merger makes a lot of sense in terms of network compatability with Delta strong in the East and the Atlantic and Northwest strong in the Pacific. Instead of being a problem, the aircraft are actually going to create a bit of synergy in the merger. Northwest flies the oldest (and most gas-guzzling) fleet in the industry. When two airlines merge, they always trim some unprofitable and/or overlapping routes so that the combined airline flies fewer miles (and aircraft) than the sum of the two standalone airlines. Anyone care to guess which aircraft will be on the chopping block? The 13% spread (or whatever it is now) seems reasonable to me. The unions will drag this out, there will be hearings and a bunch of other delays such that the deal isn’t going to close anytime soon. I would be surprised if it closes before November or December. You have to get paid for that time. Remember if you are short $100mm DAL and long $100mm NWA you have committed $200mm of capital to earn $13mm. A 6.5% haul for a deal with lots of hurdles and a 6+ month timeline makes sense to me. I am content to sit this one out and leave it to the pros. Note that I am an airline analyst and don’t even consider myself qualified to participate. Once there is an offer on the table, I agree with NakedPuts - leave it to the arbs.
OK, but are merger arb guys industry specialists? That would mean an awful lot of industries to cover, since mergers could happen everywhere. And, given the attempts to keep things quiet, I would think a lot of funds might be taken by surprise by merger announcements, and wouldn’t a merger arb fund that pre-trades decisions be liable for insider trading suits? Then, once an announcement is made, I think intense knowledge about the possibilities of synergies and union rules and legal structures would help on the margins for deciding whether a deal will fall through or not, but all that analysis takes time, and I would think a merger arb fund would need to put on a position the instant a merger is announced in order to profit from the convergence of stock prices. If they’re caught unprepared, how does all that information help them. If they’re caught prepared, doesn’t that leave them liable to insider information suits? So I guess the value of expertise here is to be able to decide quickly what deals are going through and what deals aren’t, but you’d still have to put on the trade (long acquired, short acquirer, usually) ASAP, no?
bchadwick Wrote: ------------------------------------------------------- > OK, but are merger arb guys industry specialists? > That would mean an awful lot of industries to > cover, since mergers could happen everywhere. > And, given the attempts to keep things quiet, I > would think a lot of funds might be taken by > surprise by merger announcements, and wouldn’t a > merger arb fund that pre-trades decisions be > liable for insider trading suits? > > Then, once an announcement is made, I think > intense knowledge about the possibilities of > synergies and union rules and legal structures > would help on the margins for deciding whether a > deal will fall through or not, but all that > analysis takes time, and I would think a merger > arb fund would need to put on a position the > instant a merger is announced in order to profit > from the convergence of stock prices. If they’re > caught unprepared, how does all that information > help them. If they’re caught prepared, doesn’t > that leave them liable to insider information > suits? > > So I guess the value of expertise here is to be > able to decide quickly what deals are going > through and what deals aren’t, but you’d still > have to put on the trade (long acquired, short > acquirer, usually) ASAP, no? Merger arb plays the deals in all different ways. They can play them to make or break. They can play other securities besides equity (a AA company buying a single B company creates lots of debt plays). They can play options (I personally hate those games). In fact, in some ways it’s just capital structure arb with the big P = probability merger happens.