M and A After Deals Fail

Chidem Kurdas

Two ambitious merger & acquisition attempts fell through in the past month. Pharmaceutical biggie Pfizer Inc. was turned down by the British firm AstraZeneca, despite sweetening its offer three times. Advertising giants Omnicom Group and Publicis called off their $35-billion deal to merge.

Those two events suggest that it is not easy for businesses to merge or acquire one another under current conditions. If M&A is fizzling out, the future does not look bright for event-driven investment strategies, a major hedge fund sector.

But in fact investors continue to put money in such funds, showing their confidence that M&A activity will resume and create opportunities for managers who trade on events.

This confidence is based on several factors. One is that corporate cash hoards remain substantial, ready for strategic acquisitions. Two, companies have increased borrowing – signaling recovery of credit from the crisis – and this can be used for M&A. Three, private equity managers are still in a position to buy businesses, having unused commitments from their clients.

For these and other reasons, industry people argue, M&A activity will likely recover from disappointments and create events to invest in. Event-driven funds account for around 25% of big portfolios. That share is not expected to fall; it may rise.

Meanwhile, the Pfizer-AstraZeneca disappointment does not appear to have caused much of a loss to event-driven funds, thereby reassuring investors that the down side risk of the strategy is contained.

Lyxor reported that the effect of the Pfizer incident on event-driven hedge funds in its indexes was minor—their exposure was small. Some managers correctly predicted that there would be no deal and reduced their holdings.

Year to date through May, merger arbitrage funds returned 1.9% and special situations (another event-related strategy) 2.2%, according to Lyxor. That’s less than the stock market – S&P 500 is up 3.4% – though better than long/short equity funds. Investors have hopes for M&A plays in the rest of the year.

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