New Year: Rising Market Tide Lifts Merger Arbitrage

This is the fourth article in an ongoing series that examines what’s ahead in 2004, from the viewpoints of industry experts.

NEW YORK (HedgeWorld.com)–Several factors suggest that good times might return to merger arbitrage strategies in 2004. After peaking in 2000, returns in this field declined in tandem with slumping merger and acquisition numbers. Capital moved away, attracted in particular by spectacular profits in distressed securities.

But in 2003, deal flow picked up, especially in the last quarter, as equity prices rose. Companies now are more willing to do deals with their stock, said John Paulson of Paulson & Co. Depressed share prices in recent years had discouraged activity. Now, however, the same deal can be done with fewer shares, he said.

Corporations such as General Electric, which have been quiet in this area, are proceeding with all-stock acquisitions. A strong economy and robust corporate earnings also are driving M&A. And large multinationals are looking to buy businesses across the world as part of their global expansion plans.

Mr. Paulson pointed out that there are several ways to make money in merger arbitrage. One source of profit is the difference in the price at the time the deal is announced versus when it closes. This spread is still tight because of record low interest rates, he said.

But the spread is not uniform across industries and deals. For example, in some cases the market has overcompensated for the risk of regulators blocking the transaction on antitrust grounds. These, as well as changes in the price after initial bids, present ways of earning profits, Mr. Paulson said.

“Overall, 2003 was better than 2002, and 2004 will be better still,” he said. New York-based Paulson & Co. manages US$1.7 billion in distressed strategies.

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