Re: Good Deal or Bad Deal?
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We like to think the markets are efficient, but in merger situations it seems that they often aren't. Since the target stock has a price ceiling, analysts often seem to stop covering it and it goes off the radar. Irrationality can also take over, take a look at JNJ-GDT. GDT had their problems and there were rumors of a reduction in price, but now things seem stable and we're just waiting for October FTC approval.
Risks, yes. But how many people are investing in high flyers with incredible risk, hoping they'll hit that 10 bagger? It's all relative.
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Well the merger markets can be more rational than you realize, especially in the larger cap mergers. The first key is to avoid the doggy deals. Assume the best deals have a 5-10% chance of blowing up. Lower quality deals have even more risk. Estimate the value of the target if the deal falls apart, i.e. your loss. Early on I made the mistake of investing in a deal where the target went immediately into bankruptcy when the deal collapsed.
Once you estimate the success rate, do the math. Does your gain the percent of times if the deal goes through outweigh your losses the percent of times it doesn't?
Merger arb is a great way to earn a fat annual return, but the other trick is, as in poker, in bankroll management. You'll consistantly make 3-10% in a few months on each deal, until you lose 50% in a day like I once did (thankfully on a small position). So if you want to do them, do more than one, and keep each individual deal to a manageable portion of your portfolio. If I was doing them full time a reasonable goal would be 10-20 deals and each deal no more than 10% of my portfolio. More deals and smaller percentages would be better.
If you are doing them as a sideline to regular investing, just try to keep it to a small portion of your portfolio.
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