LONDON United Parcel Service's decision to abandon its 5.2 billion euro bid for TNT Express has left hedge funds nursing potential losses of more than $700 million, as the Dutch delivery firm's shares slid.
So-called merger arbitrage funds - which make money betting on the outcomes of corporate events including takeovers - are estimated to have owned around 30 percent of TNT shares before Monday's news European anti-trust regulators would veto it, several sources familiar with the sector said.
With TNT shares losing half their value when the market opened and ending the day down 41 percent, funds collectively could have lost more than 540 million euros.
"This was one of the only large, liquid, all-cash deals in Europe right now. It's going to have been really painful across the street," one merger arbitrage manager who owned TNT shares before selling them on Monday morning told Reuters.
Funds had been buying shares in TNT ever since UPS (UPS.N) made a 5.2 billion euro play for the company last February.
But UPS and TNT said on Monday European Union officials had told it that the EU executive Commission would veto the deal, leaving them no choice but to drop it.
It is impossible to calculate exactly how many shares were held in the hands of hedge fund because Dutch regulations stipulate that investors must only detail a stake larger than 5 percent in a company.
Among the biggest hedge fund holdings in TNT was Water Island Capital's.
According to Thomson Reuters data, the $3 billion U.S.-based firm owned almost 14 million shares, or 2.56 percent of TNT TNTE.AS, in September, making it the Dutch firm's fifth biggest shareholder.
Merger arbitrage funds have struggled in recent years amid a sharp slowdown in the deals they thrive on, as companies hold off from spending their cash until the euro zone debt crisis eases and the economic recovery looks to be on firmer ground.
The UPS-TNT deal was among the top five biggest plays for merger arbitrage funds in the last six months, along with commodities trader Glencore's (GLEN.L) $33 billion takeover of miner Xstrata XTA.L.
Competition commissioner Joaquin Almunia said last week that UPS would need to create an equivalent rival to TNT before he would approve the deal. In the end, the U.S. firm seemed not to have done enough to help France's DPD expand its challenge.
Funds were convinced that because the Commission was remedy testing DPD as a third rival in the market, the deal would most likely go ahead, resulting in some hedge funds switching out of short bets in the last month or so, one source told Reuters.
This week's losses also highlight the risk for merger arbitrage funds in betting on deals subject to huge regulatory and political risks for which managers are often unprepared.
"In what has been a time of very few deals, funds have been driven towards this one," one London-based prime broker said, asking not to be named.
Last year the average merger arb fund gained less than 3 percent, according to Hedge Fund Research, less than half the average fund's 6.16 percent.
Several merger arbitrage funds said that while losses were big, some funds had mitigated the damage by reducing their positions in TNT late last year amid growing worries Brussels would intervene in the deal.
A common way to hedge against the risk of a failing deal was to short - bet on a falling price - shares in PostNL (PTNL.AS), which had been counting on using proceeds from the deal to pay investors a dividend and is TNT's biggest shareholder.
PostNL shares closed down a whopping 36 percent, but this was less than TNT's and means even hedge funds who hedged their position are likely to have lost money.
(Editing by David Cowell)