New: Buffett, CASB, SHMR. Old: NGAS, TCM

I learned that Buffett practiced merger arbitrage extensively early in his investment partnership days. The float generated by his insurance companies was placed into risk arbs rather than safe T-bonds. I read his 1988 annual letter for some of his thoughts and case studies. I always thought of him as being a pretty vanilla stock picker. Not anymore.

Anyway, recall our thesis: small merger arb deals are a source of alpha for the small investor with free trades (i.e., me).

Small premium, short timeframe

NGAS and TCM have “closed”, but I just finally got the NGAS shares today after a long wait. TCM closed a week ago, and I still don’t have the cash. This impacts the real return of these positions a great deal.

I can see why the outsize premiums in these deals (1-4% spread over short timeframe, <30 days) exist. The absolute size of the deals are too small for hedge funds to exploit. On the other hand, the razor-thin premiums are cut by transaction costs for small investors, and the annualized premiums as a whole are smaller because of delays between closing and getting money. See example below.

Medium prem, med timeframe

CASB, and SHMR represent a different opportunity. For some time, they were putting out 8% spread for a 2Q (June 30) close, i.e. over three months. On a straightforward calculation, this was less than I was getting on the other deals.


However, consider this: a 2% spread over 2 weeks opportunity reps 1.02^26 = 67% annualized, while 8% spread over 10 weeks reps 1.08^5.2 = 49% ann. But let’s say that it always takes another week past closing for money to get to your account. In this case, the 2%: 1.02^17.3 = 41% and the 8%: 1.08^4.72 = 43%. So the tables have turned, Dr. Evil.

Anyway, I really didn’t get enough of either of these stocks before they started to move up. Although I did get about 8% portfolio into SHMR. But certainly I see how “absolute spread” is a number worth looking at on top of “annualized spread.”


Finally, Brazil stocks shot way past my limit prices and I’m obviously caught in a “what do I do?” situation. I firmly believe in Brazil (or in holding reals instead of dollars), but to get in now, I have to pay a lot more.

I’m thinking about how both value guys and traders are right. And about how you can only be one or the other. Value guys would say I never established fundamental value as an anchor for my buying decisions. Traders would say that “If you think something’s going up 60%, why quibble over 5% on the limit order?”


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