John Paulson’s New Deals: Suncor Energy vs. Petro-Canada, Pfizer vs. Wyeth, Merck vs. Schering-Plough
Money poured in for John Paulson. Asset under management ballooned from $11.5 billion in June 2007 to $36 billion in November 2008, according to this statement. Forget about Warren Buffett’s Berkshire Hathaway’s high price per share ($90,000 per share and change), The minimum level of investment to invest in his funds is $5 million, making John Paulson in 1994 not qualified to invest in his fund in 2009.
Recently, John Paulson is found to be buying gold, gold mining company, and gold ETF, preparing his portfolio for the inevitable inflation that will come because of the countless government stimulus efforts around the globe.
Another investment theme, and a very important one, during the first Quarter of 2009, is his core competence of risk arbitrage. During 1Q09, GuruFocus found aside from the gold related purchases, John Paulson bought into three companies involved in merger and acquisition deals: Petro Canada ( PCZ) , Schering Plough Corp. ( SGP), and Wyeth ( WYE).
John Paulson built his career in Merger & Acquisition arbitrage trades. In an 2007 interview with Pension and Investment, John Paulson explain how he developed his expertise in this area:
What induced you to move into money management? When I in was in M&A at Bear Stearns, one of our clients was Marty Gruss. He ran a very successful risk arbitrage firm, Gruss Partners. … It was a small partnership and very profitable. Bears Stearns also was a partnership at the time and also very profitable. But it didn’t really compare to the type of profits that could be made in principal investing, investing your own money and earning the returns, rather than earning fees. I realized that there’s a limitation on what you can earn from fees and that the highest rewards would come from investing your own money, where there are no limitations on your earnings. That’s when I decided to move from investment banking to money management, and I became a general partner of Gruss Partners.
Question: Describe your investment philosophy. I really picked up my investment philosophy from Marty and his father, Joseph Gruss. He had two sayings that guided me going forward.
The first was: Watch the downside, the upside will take care of itself. That’s been a very important guiding philosophy for me. Our goal is to preserve principal, not to lose money. Our investors will forgive us if our returns don’t beat the S&P in a given year, but we are not forgiven if we have significant drawdowns.
The other saying really drives the same point from a different angle: Risk arbitrage is not about making money, it’s about not losing money. If you can minimize the downside, you get to keep all your earnings and that helps performance.
So far, he managed to uphold his principles in 13 out of the past 14 years.
The following are the brief review of the three merger deals John Paulson bought into. For any stock exchange deals, there ought to be a short side of the position, which Hedge Funds do not report and GuruFocus do not keep track.
Suncor Energy (SU) vs. Petro-Canada (PCZ)
On March 23, 2009, Suncor Energy (SU) and Petro-Canada (PCZ) announced their intention to merger the two companies to create a new company, subject to shareholders’ and regulatory approval. Under the terms, each share of Petro-Canada (PCZ)’s stock will exchange for 1.28 shares of new company’s stock; each share of Suncor Energy will exchange for one share of the new company’s stock. The announced term implied a 25% premium to the shares of the Petro-Canada based on the 30-day weighted-average trading price. It is expected the deal will be closed in 3Q09.
Based on today’s closing prices of SU ($30.27) and PCZ ($37.49), there is still a arbitrage gap of 3.35% if one buys a share of PCZ and sell 1.28 share of SU short.
Pfizer (PFE) vs. Wyeth (WYE)
On J anuary 26, 2009, Pfizer and Wyeth announced that they have entered into a definitive merger agreement under which Pfizer will acquire Wyeth in a cash-and-stock transaction. Pfizer ( PFE) will pay $33 in cash plus 0.985 shares of Pfizer stocks for each share of Wyeth ( WYE). The deal is expected to be closed by October 31, 2009.
Based on today’s prices: PFE ($44.52) and PFE ($15.10), if one buys one share of PFE and short 0.985 shares of PFE, he would profit $3.35 if the deal closes, a 7.5% profit on the long positions.
Merck (MRK) vs. Schering-Plough (SGP)
On March 9, 2009, Merck (MRK) announced its multi billion-dollar deal to acquire Schering-Plough (SGP). For each share of Schering, shareholders will receive 0.5767 shares in the new company plus $10.50 in cash.
Based on today’s prices: MRK ($25.32) and SGP (23.58), if one buys a share of SGP and short one share of MRK, he would profit $1.52 if the deal closes, a 6.4% profit on the long position.
In the GuruFocus column article, Columnist Dividend Growth Investor reviewed the two Pharm merger opportunities, with a reference to Warren Buffett’s thoughts on merger arbitrage.
Based on the average trading prices for the quarter, John Paulson spent about $230 million on Petro-Canada long position, about $180 million on Schering Plough Corp. long position, and over $1.2 billion on the Wyeth long position. Even for John Paulson who manages ten of billion dollars, the fund committed to these deals are significant.
The challenge for John Paulson is to deploy the funds pouring in because of his reputation. If not losing money is his primary goal, risk arbitrage is an area the he knows the most, an area he can deploy a large sum of money.