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Contents
Preface Acknowledgments
AL MA TE RI ED IG HT
ix xii
PART ONE
The Arbitrage Process
CHAPTER 1 Introduction to Merger Arbitrage
Cash Mergers Stock-for-Stock Mergers
1
3
12 19
CHAPTER 2 Incorporating Risk into the Arbitrage Decision
43
45 60 68
CO
CHAPTER 3 Sources of Risk and Return
PY R
Probability of Closing Severity of Losses Expected Return of the Arbitrage
71
71 73 80 87 90 93 95 98 100
Deal Spread Two Aspects of Liquidity Timing and Speed of Closing Dividends Short Sales as a Hedge and an Element of Return Leverage Boosts Returns Covered Call Writing Commissions and Portfolio Turnover Bidding Wars and Hostile Bids
v
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Mergers Tender Offers Comparison of Mergers and Tender Offers
CONTENTS
103
103 108 109
PART TWO
Pitfalls of Merger Arbitrage
CHAPTER 5 Financing
Types of Debt Funding Financing of Mergers versus Tender Offers Uncertain Merger Consideration Conflicted Role of Investment Banks Fairness Opinions Systemic Risk
117 119
122 130 131 135 140 142
CHAPTER 6 Legal Aspects
Merger Process Takeover Defenses
145
148 156
CHAPTER 7 Management Incentives
Management Compensation Continuing Management Interest in Private Equity Buyouts Long-Term Planning in Management Buyouts Milking a Company through Related Party Transactions
163
165 171 173 182
CHAPTER 8 Buyouts by Private Equity
Private Equity’s Advantage CEOs Don’t Want to Sell to the Highest Bidder Private Equity Funds Have Their Own Agenda Buyouts as Financial Engineering
187
188 191 193 196
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CHAPTER 9 Minority Squeeze-outs
Boards Lack Effectiveness During Squeeze-outs Minority Shareholders Are in a Tough Spot Family Control
199
200 202 210
CHAPTER 10 Government Involvement
Antitrust Enforcement SEC’s Approach to Regulation State Governments Federal Government Trade Unions
213
213 223 231 236 240
CHAPTER 11 Four Ways to Fight Abuse of Shareholders in Mergers
“Just Sell” Is for Losers Case for Activist Merger Arbitrage Legal Tactics Public Opposition
243
243 246 248 262
PART THREE
Investing in Merger Arbitrage
CHAPTER 12 The Role of Merger Arbitrage in a Diversified Portfolio
Volatility of Stocks Going through a Merger Return and Correlation Characteristics of Merger Arbitrage Merger Arbitrage outside the United States Risk and Return of Merger Arbitrage Funds Benefits of Merger Arbitrage in a Diversified Portfolio
265 267
268 272 278 282 292
CHAPTER 13 Investing in Arbitrage
Trading versus Investing Leverage and Options Shorting Stocks Transaction Costs Managing the Cash Position Risk Management
301
301 302 309 315 318 325
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Standard & Poor’s Merger Arbitrage Index Separate Accounts Hedge Funds and Mutual Funds
CONTENTS
329 331 333
Notes About the Author Index
339 346 347