Guy Wyser-Pratte is an activist hedge fund manager, who started his arbitrage career in 1967. The Wall Street Journal called him “the dean of the arbitrage community.”
"Risk Arbitrage" was originally the subject of Wyser-Pratte's MBA thesis and first published in 1971. This version is revised and updated, published in 2009.
The book explains and describes using over 50 examples from the 1970s through to the 2000s how arbitrage works in merger and cash tender offer situations and extends to "active arbitrage," an outgrowth of traditional risk arbitrage.
Arbitrage in the pure sense of the meaning traces back to Venetian merchants dealing, over benches, in currencies. In today's markets, technology keeps markets relatively efficient in the sense that, without huge investments in technology, one cannot buy and sell two equivalent instruments in different markets and profit without risk from the convertibility of the two.
Risk arbitrage, however, is the umbrella under which various forms of arbitrage related to announced or proposed corporate deals or transactions fall. Although not quite riskless, the degree of risk is defined and usually low. An arbitrageur takes risk on a particular deal or set of financing transactions being completed, as opposed to having any market or directional risk exposure.
Classical arbitrage began moving from riskless into risk arbitrage in the U.S. in the 1930s. Bankrupt railroads were being reorganized and the 1935 Public Utility Holding Company Act required public utilities to divest holdings in subsidiaries. Investors who exploited price differentials in the various securities being issued, redeemed or converted in a reorganization realized their profits only at the legal completion.
The corporate merger wave of the 1960s was, essentially, when risk arbitrage as a practice began to take off. The 1970s was epitomized by innovative deal structures, a new era of hostile offers and the introduction of Ivan Boesky. Junk bond finance propelled mergers and acquisitions activity in the 1980s, the decade of Michael Milken, "white knights" and "poison pills." By the 1990s, rising stock prices provided impetus for deals, but investors, becoming increasingly frustrated with boards using the "just say no" defense, started to take governance issues more seriously. After the Enron and Worldcom scandals, investors increasingly distrustful of corporate management teams, put more weight on governance and the era of wide-scale hedge fund activism had truly begun in the 2000s.
Wyser-Pratte seems to enjoy using the wedding analogy. The groom, the acquirer or initiator of a merger, is after the bride for her dowry. The arbitrageur must assess if the "marriage" is suitable, the probability that the deal will go through, the value of securities offered (including the parity), how long before "consummation" and finally any antitrust considerations. All these factors affect the risk and returns and dictate the level of the spread (between the bride and groom's packages of securities to be exchanged) at which it becomes attractive enough for the arbitrageur to invest in the deal.
For a somewhat technical subject, the book flows quite smoothly. Since all the examples are transactions in which the author participated, the context of each deal is provided. One gets a good sense of the interaction between the "arbitrage community," the Street and the various managements of the respective brides and grooms.
The final two chapters, titled "The Subterfuge Syndrome" and "Active Arbitrage," focus less on the mechanics of arbitrage transactions, but on the battles between entrenched board members - looking to maintain their comfortable status quo - and shareholders, looking to realize value in the company. By rounding up support from chunks of shareholding and publicly putting pressure on directors through filing court actions or simply petitioning hard at annual meetings, Wyser-Pratte was able to achieve some success in the at-the-time novel idea of getting boards to be more responsive to takeover interest.
This book is worth reading for anyone generally interested in arbitrage, mergers and acquisitions or those looking to understand the origins of some of the popular hedge fund strategies employed today.
Before the publicity provided by CNBC and social media platforms or activist websites and letters became a big thing - see Elliott’s letter to GlaxoSmithKline (GSK, Financial) for example - it's fascinating to learn the methods of a successful practitioner and pioneer of shareholder activism work the old-fashioned way, the fundamentals of which are still very valid today.
