Edelman Senior Vice President Ira Gorsky
From Anadarko’s sale to Occidental to T-Mobile’s purchase of Sprint to Bristol Myers Squibb’s acquisition of Celgene, big deals on Wall Street often put shares in the hands of an unfamiliar investor: the risk arbitrageur, or Arb. In the article below for CorpGov, Edelman Senior Vice President Ira Gorsky reflects on years of experience as an Arb and provides advice to CEOs on how to manage this new type of investor as soon as a new deal is announced.
Keep Your Friends Close and Your Arbs Closer
By Ira Gorsky
Congratulations to you, the CEO of a public company. Your board and management team have just engineered a sale of your company at a significant premium, creating enormous value for your shareholders. It’s a great victory, with one small catch: your company’s beloved long-term shareholders, the ones who have stuck by you over many phases of your transformation, are now largely gone.
With the control premium, the current trading price for your stock has surpassed the long-term holder’s estimated intrinsic value. The value players have exited their positions because their investment thesis has been realized, and from now until the transaction’s conclusion, it is a risk arbitrage play – not the value investor’s game. Trading volume on the day of deal announcement was multiples of normal trading, the shareholder base has turned over. Welcome your new holders, “the Arbs”. You’re in their world now.
While you may view the Arbs as a loathsome bunch of short-term hedge funds with no regard for the company beyond the deal, you need them on your side. Arbs are well resourced, highly skilled and control billions in capital. Not only can Arbs help provide critical market information, they can influence the ultimate outcome of your transaction.
Your stock, which the Arbs now own, trades at premium to its standalone value; absent a deal, it would revert to its unaffected value. Since Arbs are picking up nickels in front of the proverbial steamroller, the ever-present risk of a steep drawdown makes Arbs highly reactionary to new data points. Their bet centers on how much money could be made or lost from now until the deal close or break. Arbs seek answers to the basic questions: “Will the deal close? When will the deal close? What are the variables? How much am I risking?”
The arbitrage analysis of estimating the probability of whether a deal will close starts with the Definitive Merger Agreement (“DMA”), the embodiment of each party’s obligation. The stricter the terms are in the merger agreement (the tighter the contract), the more difficult it is for a party to break the deal. However, if the DMA is conditioned upon events that have more risk or a less predictable outcome, that uncertainty will be a focus, and an opportunity for Abs to make money based on shrewd analysis. Any data points that cause Arbs to adjust their deal probabilities are likely to cause significant swings in the stock price. Expect your phone to ring – a lot.
The nature of the inbound investor call changes when Arbs enter the fray. Your new holders will care far less about your multiyear growth plan. Inquiries will be acutely focused on the potential hurdles to close, antitrust, financing, timing of the vote, etc.
The key determinants of deal completion, e.g. regulatory approval, are not discernible in the public domain. Information even tangentially connected to your company may be viewed as determinative (erroneous or not). As a semi-rehabilitated Arb, I will offer some guidance for communicating with the Arb community.
- Quash spurious rumors before they take on a life of their own.
There will be a delicate balance between keeping your shareholders informed and divulging too much. Revealing details about a confidential process may alienate the regulators. Providing nothing will create an information vacuum that could get filled with distortions.
- Be mindful of hot button items for Arbs.
Issuing a deal-related press release that isn’t a joint release will be considered highly meaningful. This will cause immediate speculation that the merging parties are not on the same page. Further, consistency of language will be heavily scrutinized during the life of the deal. Even a slight change in wording will provoke critical observation. Any reference to “fulfilling the obligations” of the merger agreement will be perceived as a reluctance to merge, but for the contractual obligation; the immediate read will be the parties are at odds and may be heading to court.
- Avoid the Arb Scrum.
For the uninitiated, the “Arb Scrum” refers to literally being surrounded by Arbs when making public appearances. At an investor presentation be prepared to be swarmed by Arbs like the paparazzi. The Arbs will jockey for position, throwing out deal related inquiries thinly masked as fundamental questions in the hopes of extracting tradable information. It is a dangerous place: it is the birthplace of misinterpretation. Your body language, word choice, facial expression will all be thoroughly examined with the inherent bias of each attendee, then rehashed in the collective Arb community. The scrum interpretation will fly across Bloomberg terminals, and what gets disseminated may not even remotely resemble what was originally said. Bottom line: avoid the scrum when possible and have Investor Relations act as your bouncer.
If the Arbs become concerned that the deal won’t be consummated, the spread will widen, and the acquiring company may view the discount to the takeout price as an opportunity to try to renegotiate the transaction seeking to cut the price. Be responsive to inbound inquiries and provide details when permitted. Arbs will take comfort in a company “handhold” and will be less likely to panic out of the stock. Your interests are largely aligned with the Arbs.
So keep your friends close and your Arbs closer.
Ira Gorsky is senior vice president of financial communications at Edelman in New York. He previously was a managing member of Arch Research Inc., where he developed research on M&A, activist campaigns, and other situations. He can be reached at firstname.lastname@example.org