Cheyne hedge fund eyes "golden period" for merger arbs

Tue Feb 28, 2012 10:50am EST

* Says investors wary of complex deals

* Cheyne European Event-Driven hedge fund raises $500 mln

* Says LTRO cut volatility, likely to fuel further deals

* Sees more deals in core Europe than periphery

By Laurence Fletcher

LONDON, Feb 28 (Reuters) - Bold merger arbitrage funds are set to enjoy rich pickings this year amidst a rebound in M&A activity, helped by the reluctance of many investors to trade complex deals after last year's choppy markets, says hedge fund firm Cheyne Capital.

Simon Davies, whose European Event Driven fund, has raised $500 million since launch in October 2009, told Reuters that last year's volatility had made many investors "quite risk averse", meaning there is room for arbs to profit from more complex deals.

Merger arb funds try to make money by betting on M&A deals, often by buying shares in the target company in the hope it will rise to the offer price and betting that the share price of the acquiring company will fall.

These funds, which pride themselves on their in-depth research, tend to prefer more complex, all-share deals or bids with lots of uncertainties, for example around whether regulators or shareholders will accept the deal, to more straightforward takeovers.

"Risk appetite is coming back, but only for things that are perceived by the market as extremely safe. If, on the face of it, a deal has any issues, then the risk/reward of the investment is often much better," Davies told Reuters in an interview this week.

"We are entering a potentially golden period, where there can be a lot of deals and not too much interest in trading them, outside of the standard safe situations," he added.

His comments coincide with a resurgence of mergers and acquisitions in recent months, boosted by high corporate cash balances, low valuations and a slump in market volatility that is persuading boards to move ahead with deals they had postponed during the worst of the euro zone debt crisis.

The most prominent deal has been commodity trader Glencore's 25 billion pound proposed takeover of mining group Xstrata, which some hedge funds have been eyeing up.

Meanwhile, India's state-run Oil and Natural Gas Corp and GAIL India are reportedly planning to offer $2 billion for Cove Energy, joining a bidding war that has already seen offers by Thai state-controlled PTT and Royal Dutch Shell.

Elsewhere, United Parcel Service has bid for Dutch mail delivery firm TNT Express.

COMPLEX

While M&A volume was up last year, it fell in the second half as Europe's debt woes deepened.

"There are plenty of companies with valuations that, although they've recovered somewhat, are nowhere near back to their highs," said Davies.

"However, they've got very strong market positions and would be of interest to much larger conglomerate companies in that sector with large cash balances. TNT is a good example of this and there's a good chance there'll be more than one bidder."

While many recent deals have been cash rather than more complex share bids, Davies said such deals "can still have good rates of return ...especially if there are complex issues such as antitrust, unhappiness among the target shareholder base regarding the price etc. This last issue is frequently a concern in a recovering market".

Cheyne's bets include a 2.39 percent stake in hedge fund administrator GlobeOp, which has received a bid from TPG Capital. Software firm SS&C Technologies has since said it is considering a possible cash offer.

The European Event Driven fund, which Cheyne plans to close to new investors at $750 million, gained 20.5 percent in 2010, 2.7 percent last year and 1 percent in January, according to an investor letter seen by Reuters.

In February so far it is up 2.4 percent, said a source familiar with the matter. Last year the average merger arb fund made 1.48 percent, according to Hedge Fund Research.

Davies sees more M&A ahead after the European Central Bank's long-term refinancing operations (LTRO) in December, which flooded markets with 489 billion euros ($655 billion) of cheap cash to try and head off a second credit crunch.

"Many observers underestimated the power of LTRO -- that's set the fundamentals of the market rally, driven volatility down and indirectly helped M&A," he said.

"The pipeline for M&A is pretty big. In the last six months M&A volumes were very low, so there's a lot of targets that managements have wanted to acquire but haven't because of uncertainty over the eurozone."

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