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UPS and TNTE failed merger counter arbitrage

January 15, 2013 Leave a comment

When mergers and acquisitions fail it turns to Murders & Executions for merg-arb desks. And when there is blood on the streets, even if it is your own blood, buy…

When the news of European Union anti-trust regulators blocking the potential UPS and TNT Express merger filtered through the newswire, the markets were not open. Prior to this, I have neither followed this industry nor the two respective companies. I brought up the charts of TNTE and noted the “undisturbed price” of TNTE, the target company that was being acquired, was around 6 Euros. The offer price by UPS was 9.5 per share. The shares of TNTE were last trading around 8.5 Euros. I made a mental note that if TNTE fell way below its undisturbed price – somewhere in the region of 20-25% below its undisturbed price of 6 euros, I would fade the trade and long it. This 20-25% represents my margin of safety. Implicit in this assumption and my trade rationale is that the market is fairly efficient in pricing-in information – that the undisturbed price represents fair value given TNTE’s prospects and outlook.   As it turned out, TNTE opened at 4.160 when trading resumed. I transmitted a market buy order (yeah, I know I just broke my own rule of never using market orders – but hey this is a “Special Situation” and rules are made to be broken) and got filled at 4.35. The following day, I closed the position out at 5.10. Although this is only a small stake and I made 17% return on capital with limited downside risk in one day, I never actively sought this trade out. Had TNTE opened down at 5 Euros or even 5.5, I probably would not have put this trade on. I did not have time to look at the fundamentals of either company. All I knew was, the merge-arb guys who believed the deal was going through would be crushed and had to dump their TNTE holdings in a market with no buyers thus depressing the stock way beyond its ‘fair value’. What is fair value? I don’t know. It is a subjective concept.  As the day wore on and I scanned the newswire, I noted that even though TNTE was trading at 8.5 before the announcement by EU regulators, the market was pricing in information that told me the market is not extremely optimistic that the deal would go through. Needless to say, this did not affect my rationale as I was already in the trade and my trade was based solely on a special situation and understanding of the dynamics of strategies pursued by merg-arb desks. Everyone knew TNTE would slump on the open, the question was by how much? And is that margin of safety something I was comfortable with? Was I willing to lose half my capital staked on this trade if it opened at 4 and traded down to 2? Compared to making 50% return if it traded back to 6? Which was a more likely scenario considering UPS made an offer of 9.5? As it turned out, it was a trade that I was comfortable with and made a quick profit. Why did I not buy pre-open with the chance of getting filled at a lower price say around 4.160 and maximise my profit? Well, I let the market tell me what to do. It could have easily opened at 4.16 and traded down to say 3.75. This would have messed up my conviction and trading psychology. Equally why did I take profits so early? Well, I recall a ‘market wizard’ once noted “the first 1/8 and the last 1/8 of a move are the most expensive ones”. I am not trading to be right and I am not great at timing the inflection point of the market. I am trading to be profitable and was happy with the return.

 

 

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