Concentrated Merger Arbitrage Funds – Q3 2023 Update

I was about to wrap up this article when I heard about the passing of Charlie Munger. His wit and wisdom were unmatched and there were so many facets to him. A unique situation I am reminded of is how much risk he was willing to take early in his career, including at one point putting all his money in one arbitrage situation and borrowing even more to invest in it. I got a chance to hear him at the last Berkshire Hathaway meeting and had hoped to do so again next May. Rest In Peace Charlie.

I like artificial intelligence because we’re still so short of the real thing.

– Charlie Munger

With the closing of several deals that used to sport large spreads including the acquisition of Activision Blizzard (ATVI) by Microsoft (MSFT), the acquisition of Horizon Therapeutics (HZNP) by Amgen (AMGN) and VMware (VMW) by Broadcom (AVGO), arbitrageurs and other risk seeking investors have flocked to a new breed of deals with large spreads. Based on what I see on Twitter, investors have a lot of interest in Spirit Airlines (SAVE), iRobot (IRBT) and Capri (CPRI).

We have written about all three of these high risk/high reward deals on InsideArbitrage and in the case of Spirit, we have covered the deal multiple times. We wrote the following about the Spirit trial in our Merger Arbitrage Mondays article a little over a week ago:

The U.S. Department of Justice initiated legal proceedings on March 7, 2023, by filing a case in the District of Massachusetts. The objective is to prevent JetBlue from acquiring Spirit.

The DOJ cited violations of the Clayton Act, which is designed to promote business competition and prevent the formation of monopolies and other unethical business practices. The government contends that the proposed deal, by eliminating Spirit, the largest ultra-low-cost carrier (ULCC) in the nation, will result in higher fares, ultimately costing passengers billions.

Watching how this trial has been unfolding, we feel that the odds have improved in JetBlue’s favor. If the deal goes through, it will make JetBlue the fifth-largest carrier with a 9% share in airline seats. In response to the DOJ’s case about a void being created by Spirit’s acquisition, companies in the ULCC sector are looking forward to this acquisition hoping to grab market share. Frontier Airlines (ULCC), which was in a heated battle with JetBlue to acquire Spirit, also sees this as an opportunity, significantly weakening the DOJ’s case.

This deal reminds us of T-Mobile’s (TMUS) acquisition of Sprint. The deal was announced in 2018 and took almost two years to be complete after winning a similar case against the DOJ.  T-Mobile and Sprint merged to offer customers better rates, nationwide 5G access and new jobs. This led to more affordable and reliable options for consumers, making the market bigger instead of smaller, especially when consumers wanted more choices.

The risk of the deal falling apart or even getting repriced is significant and that risk is reflected in the 117% spread on the deal. With Q3 2023 13F filings out, I was curious to see if any of the event-driven funds I follow have a position in these deals.

Investment firms with over $100 million in assets are required to file form 13F with the SEC within 45 days after the end of each quarter. This filing provides a small window into the fund manager’s portfolio and is a great source for new investment ideas. You also end up with information that is potentially stale and as many investors have come to find out, you can’t just follow someone else into an idea without doing your own deep due diligence. The Gurus section of InsideArbitrage includes curated lists of professional investors and fund managers categorized based on their investment style.

We are currently tracking 49 event-driven funds of various sizes. There are firms with just 3 positions in their 13F portfolio and others with thousands of positions. This does not mean the former has their entire portfolio is just 3 positions as they may have exposure to other positions, including private companies, which  don’t have to be reported on the 13F form. The funds that I love tracking closely are the handful that have more than 50% of the portfolio concentrated in their top 10 positions. Three examples are:

• TIG Advisors with $3.21 billion in AUM and a 13F portfolio valued at $2.22 billion across 46 positions. Concentration in top 10 positions is 82%.
• Water Island Capital with $2.25 billion in AUM and a 13F portfolio valued at $1.1 billion across 81 positions. Concentration in top 10 positions is 54%.
• Twin Securities with $187 million in AUM and a 13F portfolio valued at $411 million across 12 positions. Concentration in top 10 positions is 99%.

I am going to focus on some of the new additions across the eight funds I am tracking.

• Pfizer’s acquisition of Seagen (SGEN) with its current spread of 6.93% was a new position for two funds but it was already in the portfolio of the six other funds (one fund has exposure through call options).
• Tapestry’s acquisition of Capri (CPRI) with its current spread of 15.95% was a new addition for five funds.
• Cisco’s acquisition of Splunk (SPLK) with a spread of 3.85% was a new addition for five funds.
• Danaher’s acquisition of Abcam (ABCM) with a spread of just 0.21% was a new addition for four funds. The spread was just over 6% at the end of September.
• Campbell Soup’s acquisition of Sovos Brands (SOVO) with a spread of 5.26% was a new addition for three funds.
• Kroger’s merger with Albertsons (ACI) with a large spread of 26.92% was a new addition for three funds.
• Only one fund added a minuscule position in iRobot (IRBT) and two others held prior positions through call options. One exited their iRobot position.
• None of the funds had a long position in Spirit Airlines (SAVE). One fund exited their position and another one purchased put options on  the company.

This is certainly an exciting time in the arb world but there is a reason this strategy is also known as risk arbitrage.

After reviewing these portfolios and their new additions I am inclined to take a closer look at Abcam and Sovos Brands.

I currently hold positions in Berkshire Hathaway, Pfizer, Seagen and Capri.