Professional Documents
Culture Documents
EYQUEM
1.
Manne,
H.G.
Mergers
and
the
Market
for
Corporate
Control,
Journal
of
Political
Economy,
Vol.
73,
No.
2
(Apr.,
1965),
pp.
110-120.
2
Han,
Ki
C.;
Suk,
David
Y.;
Sung,
Hyun
Mo.
The
evidence
of
bidders'
overpayment
in
takeovers:
the
valuation
ratios
approach,
The
Financial
Review,
May
1,
1998.
3
Data
are
for
the
period
1980
to
2005,
as
recorded
in
the
Handbook
of
Corporate
Finance:
Empirical
Corporate
Finance,
Vol.
2,
Chapter
15,
pp.
291-430.
Eckbo,
ed.,
Elsvier/North
Holland
Handbook
Series,
2008.
2
EYQUEM
hedge
funds
and
the
lull
in
merger
and
acquisition
(M&A)
activity,
which
has
been
sluggish
in
the
first
half
of
2012,
with
17,562
deals
at
a
value
of
approximately
$1.1
trillion.4
This
is
a
temporary
period
of
cyclical
weakness
likely
to
reverse
soon.
Past
periods
of
persistent
undervaluation
have
been
followed
by
a
steep
increase
in
M&A
activity.
Typical
companies
in
the
investment
universe
have
the
customary
defensive
mechanisms
in
place.
Absent
the
attention
of
activist
hedge
funds,
some
very
attractive
targets
are
unlikely
to
be
acquired
other
than
on
a
friendly
basis.
Coercing
these
companies
into
a
change
of
control
will
mean
a
full
proxy
fight
or
tender
offer,
which
is
an
activist
hedge
funds
bread-and-butter.
The
other
participants
in
the
market
now
have
unprecedented
levels
of
firepower.
American
corporations
hold
$2.2
trillion
in
cash
on
their
balance
sheetsmore
than
at
any
time
in
the
last
half-century,5
and
private
equity
firms
hold
record
levels
of
capital
for
buyouts
at
approximately
$3
trillion.6
Activist
hedge
funds,
quiet
after
a
period
of
success
in
the
early
2000s,
are
likely
to
re-emerge
as
the
stars
move
back
into
alignment
for
activist
investing.
The
economic
climate,
shareholder
sentiment
and
opportunities
available
have
the
potential
to
create
a
new
golden
age
of
M&A
activity,
like
the
hostile
takeovers
and
leveraged
buyout
wave
in
the
1980s
and
the
private
equity
boom
in
the
early
2000s.
A
clear
opportunity
exists
for
patient
investors
to
systematically
capture
the
control
premium
by
identifying
likely
targets
before
a
bidder
announces
a
transaction
or
files
a
Schedule
13D
notice.
Such
a
strategy
has
a
number
of
attractive
qualities:
4
Abnormal Returns: it has consistently beaten the market, the investment universe, and a comparable passive value index Asymmetric Risk:Reward Profile: target stocks have limited downside, and the potential for an asymmetrically elevated upside Embedded Catalysts: target stocks have high-probability, latent catalysts Scalable: the investment universe is large, and liquid
Primack,
D.
M&A
Cliff:
Deal
activity
falls
21%
in
2012,
CNN
Money
Term
Sheet,
July
2,
2012
(http://finance.fortune.cnn.com/2012/07/02/ma-cliff-deal-activity-falls-21-in-2012/)
5
Pinkowitz,
L.,
Stulz,
R.M.,
Williamson,
R.
Multinationals
and
the
High
Cash
Holdings
Puzzle,
NBER
Working
Paper
No.
18120,
Issued
in
June
2012
6
Financial
Times
June
30,
2012,
Private
equity
assets
hit
record
$3tn
(http://www.ft.com/intl/cms/s/0/9e9e2ae8-da65-11e1-a413-00144feab49a.html#axzz25trEdDES)
3
EYQUEM
2.
2.1
The return available to investors in the market for corporate control is the differential between the marginal publicly traded market price prior to the bid, and the final acquisition price, which includes the companys intrinsic value and the control premium.
MARKET PRICE
2.2
EYQUEM
company
changes
control
in
a
takeover
or
proxy
fight
imposed
on
the
company
by
an
activist
hedge
fund,
private
equity
firm,
or
strategic
buyer.
While
the
size
of
the
discount
from
value
is
the
ultimate
determinant
of
return,
the
investor
reaps
the
return
as
the
stock
price
rises
to
the
value.
The
faster
the
price
rises,
the
more
rapidly
the
investor
benefits.
The
market
can
spontaneously
remove
the
discount,
but
the
evidence
suggests
that
reliably
identifying
such
companies
a
priori
is
difficult,
and
it
is
unlikely
to
generate
a
control
premium.
Catalysts
bring
immediate
whole
or
partial
closure
between
market
price
and
value.
In
the
absence
of
a
catalyst,
value
can
erode,
or
the
gap
between
price
and
value
can
widen.
The
attraction
of
catalysts
is
that
they
reduce
the
impact
of
market
forces
on
investment
profits.
By
precipitating
the
realization
of
underlying
value,
catalysts
reduce
risk,
and
augment
the
margin
of
safety
achieved
by
investing
at
a
discount
from
value.
Bids
from
private
equity
firms
or
strategic
buyers
are
important
catalysts.
Researchers
find
the
magnitude
of
such
a
catalyst
is
on
average
around
43
percent
over
the
prices
at
which
target
companies
shares
traded
immediately
prior
to
the
takeover.
The
filing
of
a
Schedule
13D
notice
by
an
activist
hedge
fund
is
another
catalytic
event.
Recent
confrontational
activist
campaigns
generated
significantly
positive
market
reaction
for
the
target
firm
around
the
13D
filing
date
and
significantly
positive
returns
over
the
subsequent
year.
The
immediate
abnormal
return7
upon
filing
is
in
the
range
of
7
percent.8
Target
companies
then
earned
10.2
percent
average
abnormal
stock
returns
during
the
period
after
the
13D,
and
an
additional
11.4
percent
abnormal
return
in
the
following
year.
9
We
seek
to
invest
prior
to
the
filing
of
the
13D,
or
the
bid,
and
so
capture
the
full
abnormal
return.
Companies
with
the
conditions
in
place
for
a
catalytic
change-of-control
event
offer
asymmetric
returns,
with
limited
downside
and
elevated
upside.
By
targeting
companies
with
an
embedded
near-term
catalyst
prior
to
the
emergence
if
the
catalyst,
we
can
capture
the
full
control
premium,
expect
a
more
rapid
resolution
of
holdings,
and
reduce
risk.
7 8
The abnormal return is the difference between a stocks actual return and the stocks expected return. Klein, April and Zur, Emanuel, Entrepreneurial Shareholder Activism: Hedge Funds and Other Private
Investors (September 2006). AAA 2007 Financial Accounting & Reporting Section (FARS) Meeting Available at SSRN: http://ssrn.com/abstract=913362 or http://dx.doi.org/10.2139/ssrn.913362 9 Brav, Alon P., Jiang, Wei, Thomas, Randall S. and Partnoy, Frank, Hedge Fund Activism, Corporate Governance, and Firm Performance (May 2008). Journal of Finance, Vol. 63, p. 1729, 2008; Available at SSRN: http://ssrn.com/abstract=948907
EYQUEM
3.
3.1
Source: CRSP/Compustat
Range: $250 million to $22 billion Mean: $3.2 billion Median: $1.4 billion
EYQUEM
Exhibit 3.1 demonstrates the scalability of the investment opportunity. The median market capitalization is $1.4 billion, meaning more than half the opportunities are between $1 billion and $22 billion. Exhibit 3.2 shows the distribution of investment opportunities by enterprise multiple (enterprise value10/EBITDA) in Fall 2012.
Source: CRSP/Compustat
3.2
Enterprise
Value
includes
equity
market
capitalization,
net
debt,
preferred
shares,
minority
interests,
and
after-tax
under-funded
pension
liabilities,
and
asbestos
liabilities
(if
any).
7
10
EYQUEM
4.
4.1
Investment
Criteria
The
investment
criteria
for
target
selection
are
as
follows:
1.
Market
Price
Discount
to
Change-of-Control
Value:
Uses
acquirers
valuation
metrics
to
identify
undervalued
public
company
targets,
and
then
rank
on
the
discount
to
total
change-of-control
value
(intrinsic
value
plus
hidden
control
premium).
The
change-of-control
value
ignores
a
firms
current
bottom-line
profitability
and
business
quality,
and
examines
the
companys
potential
under
an
effectual
management
team.
Probability
of
Change-of-Control
Event:
Identifies
features
likely
to
attract
strategic
buyers,
private
equity
firms
or
activist
hedge
funds,
including:
Lower
payout
ratio:
Often
accompanied
by
other
latent
examples
of
inefficient
employment
of
capital.
Enhanced
takeover
defenses:
Removal
of
which
enhances
value.
Higher
CEO
pay:
Enhances
effectiveness
of
public
campaign.
Higher
institutional
ownership
and
trading
liquidity.
Lower
insider
ownership:
Enhanced
potential
for
successful
hostile
takeover
bid
or
proxy
contest.
Concentrated
insider
ownership:
Enhanced
potential
for
MBO.
Lazy
balance
sheet,
legacy
business:
Creates
an
unstable
relationship
between
balance
sheet
strength
and
business
strength,
which
attracts
activists
seeking
special
dividends,
return
of
capital,
sale
of
a
major
asset
or
outright
sale.
Weaker
balance
sheet,
underappreciated
business
strength:
Private
equity
firm
acquirers
are
indifferent
to
a
companys
capital
structure
because
they
will
substitute
their
own
mix
of
debt
and
equity
after
acquisition.
8
2.
EYQUEM
4.2
4.3
Portfolio
Management
The
portfolio
is
constructed
to
accommodate
the
behavior
of
the
target
stocks.
The
median
holding
period
is
approximately
20
months,
calculated
from
the
Schedule
13D
filing
date
to
the
date
when
the
fund
no
longer
reports
a
stake
in
a
target.11
If
a
position
does
undergo
a
change-of-control
event,
the
price
movement
may
be
rapid.
The
portfolio
is
constructed
to
maximize
the
probability
of
capturing
such
a
move.
To
this
end,
the
portfolio
contains
a
maximum
of
50
positions,
each
sized
at
inception
at
~2
percent
of
the
portfolio
value.
The
portfolio
is
managed
for
long-term
capital
gains.
4.4
11 12
EYQUEM
stocksbehind first-ranked Kensey Nash Corporation (formerly NASDAQ:KNSY), which was taken private May 2012 for a 64 percent gain over 24 months, and second-ranked Dish Network Corporation (NASDAQ:DISH), which is still public, but up 44 percent over the period. On July 14, 2010 the Carlyle Group bid $55 per share in cash, representing a market capitalization of $3.8 billion ($4.1 billion enterprise value), trailing enterprise multiple of 8.3, and P/E of 14.6. The bid represented a 57 percent premium over the trading price in approximately two months.
Figure
4.4:
NBTY,
Inc.
(NYSE:NTY)
Quantitative
Buy
Signal
and
Bid
Chart
July
14,
2010
Bid
Price
$55
57%
Source: CRSP/Compustat/WikiInvest.com
Table
4.4:
NBTY,
Inc.
(NYSE:NTY)
Quantitative
Buy
Signal
and
Bid
Detail
Date
Price
Enterprise
Multiple
Price-to-Earnings
Ratio
Buy
Signal
Expectations
Buy
Signal
May
17,
2010
$35
(Market)
5.3x
9.3x
Change-of-Control
Event
Announced
July
14,
2010
Closed
December
2010
$55
(Bid)
8.3x
14.6x
Change-of-Control
Value
(Est.):
$53
(8x
EM,
14x
P/E)
Minimum
Upside:
~50%
Change-of-Control
Event
Probability
Ranking:
3
10
EYQUEM
5.
5.1.
Eliminating
Stocks
with
Elevated
Probability
of
Financial
Distress,
Earnings
Manipulation,
and
Fraud
Reduces
Risk
We
eliminate
from
our
investable
universe
companies
at
high
risk
of
financial
distress
(including
bankruptcy),
earnings
manipulation,
and
fraud.
These
companies
have
the
potential
to
cause
a
permanent
loss
of
capital
because
they
have
no
intrinsic
value
to
stockholders,
and
can
provide
no
margin
of
safety
at
any
price.
Table
5.1
shows
the
impact
of
eliminating
these
stocks
from
our
opportunity
set
by
comparing
our
scrubbed
investment
universe
to
the
full
index
of
stocks
(which
includes
the
high
risk
stocks):
Table
5.1:
Comparison
of
Investment
Universe
to
Full
Index
(1964
to
2011)
CAGR
Standard
Deviation
Sharpe
Ratio
Sortino
Ratio
(MAR=5%)
Scrubbed
Investment
Universe
11.04%
15.31%
0.42
0.62
Full
Index
10.80%
15.49%
0.40
0.59
Source:
CRSP/Compustat
Table 5.1 demonstrates that our scrubbed investment universe slightly outperformed the full index, but, importantly, did so at reduced risk. By eliminating the small number of companies at high risk of financial distress, earnings manipulation, or fraud (approximately 5 percent of the full index at formation of each annual portfolio), we expect to see reduced risk over the full index.
5.2.
Concentrating
on
Stocks
Trading
at
the
Largest
Discount-to-Change- of-Control
Value
Substantially
Improves
Returns
We
rank
each
stock
in
the
investment
universe
in
5.1
above
according
to
the
size
of
its
market
price
discount
to
its
change-of-control
value
(intrinsic
value
plus
control
premium).
Table
5.2
below
shows
the
performance
for
the
period
1964
to
2011
of
the
value
decile
(the
cheapest
10
percent)
of
stocks
ranked
in
this
way
against
the
investment
universe
described
in
5.1
above:
11
EYQUEM
Table
5.2:
Performance
of
Change-of-Control
Value
Decile
and
Investment
Universe
(1964
to
2011)
CAGR
Standard
Deviation
Sharpe
Ratio
Sortino
Ratio
(MAR=5%)
Change-of-Control
Value
Decile
15.95%
17.28%
0.64
0.96
Investment
Universe
11.04%
15.31%
0.42
0.62
Source:
CRSP/Compustat
Table 5.2 demonstrates that the stocks most discounted from their change- of-control value significantly outperformed the investment universe on both absolute and risk-adjusted measures. By concentrating on the decile of stocks at the lowest market price-to-change-of-control value (approximately 285 stocks), we expect to see substantially improved performance over the index.
5.3.
Selecting
Stocks
with
Higher
Probability
of
Undergoing
a
Change-of- Control
Event
Beats
the
Passive
Value
Decile
We
can
compare
the
performance
of
undervalued
stocks
with
high
and
low
probabilities
of
changing
control.
Table
5.3
informally
compares
a
hand- collected
dataset
from
1999
to
2012
of
two
portfolios
formed
by
dividing
the
value
decile
into
two
half-decile
portfolios
(approx.
143
stocks
in
each)
with
higher
and
lower
probabilities
of
undergoing
a
change-of-control
event.
Table
5.3:
Returns
to
Higher
and
Lower
Probability
Change-of-Control
Event
Value
Portfolios
(1999
to
2012)
CAGR
Standard
Deviation
Sharpe
Ratio
Higher
Probability
Lower
Probability
Value
Decile
Change-of-Control
Change-of-Control
16.58%
17.96%
0.67
14.97%
16.22%
0.61
0.91
15.57%
16.87%
0.63
0.95
Source: CRSP/Compustat/Riskmetrics
12
EYQUEM
Table 5.3 demonstrates that stocks in the value decile with a higher probability of undergoing a change-of-control event substantially outperformed those with a lower probability. Figure 5.3 below shows a performance chart of the higher and lower probability change-of-control portfolios over the more recent period 1999 to 2012.
Figure 5.3. Chart of Value Decile Divided Into Higher and Lower Probability Change-of-Control Event Half Deciles (1999 to 2012)
Source: CRSP/Compustat/Riskmetrics
Figure 5.3 demonstrates that separating stocks in the value decile into higher and lower probabilities of changing control better identified the winners and the losers. While a more formal study over a longer period is required, over the periods examined, the higher probability change-of-control portfolio had a persistent advantage over both the full value decile and the lower probability change-of-control portfolio. By selecting the stocks with the highest probability of changing control from the tranche of stocks at the greatest discount from the change-of-control value, we can expect markedly improved performance over the raw value decile. Eyquem Fund LP seeks to hold the 50 best opportunities, combining the largest discount from the full change-of-control value and the highest probability of a near-term catalytic change-of-control event.
13
EYQUEM
6.
6.2.
Contact
For
more
information
about
the
Eyquem
Fund
LP
or
the
strategy,
please
contact:
Tobias
(Toby)
Carlisle
Managing
Member
Eyquem
Investment
Management
LLC
IARD/CRD
Number:
157310
Direct
telephone:
+1
646
535
8629
Email:
toby@eyquem.net
14
EYQUEM
IMPORTANT DISCLAIMER: The information in this document is not intended to be an offer to buy or sell, or a solicitation of an offer to buy or sell, any securities and has been obtained from, or is based upon, sources believed to be reliable but is not guaranteed as to accuracy or completeness. Eyquem Investment Management LLC is under no obligation to disclose or take account of this document when advising or dealing with or on behalf of customers. The views of Eyquem Investment Management LLC reflected in this document may change without notice. In addition, Eyquem Investment Management LLC may issue other reports that are inconsistent with, and reach different conclusions from, the information presented in this report and is under no obligation to ensure that such other reports are brought to the attention of any recipient of this report. To the maximum extent possible at law, Eyquem Investment Management LLC does not accept any liability whatsoever arising from the use of the material or information contained in this document. This research document is not intended for use by or targeted to retail customers. Should a retail customer obtain a copy of this report he/she should not base his/her investment decisions solely on the basis of this document and must seek independent financial advice. The financial instrument discussed in this report may not be suitable for all investors and investors must make their own informed decisions and seek their own advice regarding the appropriateness of investing in financial instruments or implementing strategies discussed in this document. The value of securities and financial instruments is subject to currency exchange rate fluctuation that may have a positive or negative effect on the price of such securities or financial instruments, and investors in securities such as ADRs effectively assume this risk. Eyquem Investment Management LLC does not provide any tax advice. Past performance is not necessarily a guide to future performance. Estimates of future performance are based on assumptions that may not be realized. Investments in general, and derivatives in particular, involve numerous risks, including, among others, market, counterparty default and liquidity risk. Trading in options involves additional risks and is not suitable for all investors. An option may become worthless by its expiration date, as it is a depreciating asset. Option ownership could result in significant loss or gain, especially for options of unhedged positions.
15