As the market creeps higher and higher, the chances of sharp pullbacks increase.  At this time, I’m looking for non-correlated returns.  Risk arbitrage is one place where you may find them.  Take this excellent analysis from David Merkel author of the The Aleph Blog » Blog Archive » On Merger Arbitrage.

  • Merger arbitrage is a lot like credit analysis.  Analyze why the deal might not go through.  Your upside is capped, but your downside is unlimited.
  • Only work with binding commitments.  Do not speculate on “letters of intent.”
  • Do not speculate on mergers that the media cooks up.
  • Merger arbitrage is an “over-fished” area of the market.  The regular gains from it have been competed down to low yields.”

While I don’t disagree with the gist of it, I would note that lately there have been some deals with very little downside and some outside returns.  The Clearwire deal was trading below Sprint’s offer so any competing offer or sweetening of the deal would greatly enhance returns.  As it was there was little chance Sprint could not complete the deal and there was still risk premium to earn.

The Dell deal looks like it have very limited downside and potential for some surprise upside now that Icahn has amassed a large position.  It seems unlikely that Michael Dell and Silverlake will abandon their offer and that Icahn will relent without extracting his pound of flesh.   Icahn urges Dell to pursue a leveraged recapitalization and pay a $9 special dividend if the bid to go private is voted down by shareholders. Added to what Icahn calls the ‘stub’ value of $13.81 per share price proposed in the go-private bid, the special dividend would offer a value of $22.81 per share, ‘representing a 67 percent premium’ to the share price offered in the buyback.