Chit Chat Stocks - A Merger Arbitrage Inflection With Andrew Walker

Episode Date: October 26, 2023

Andrew from the "Yet Another Value Blog" joins the show to discuss merger arbitrage investing and why he thinks now could be a great time to be using this strategy. Listen as Brett and Ryan ask Andrew questions about his experience in merger arb. Enjoy the show! ***************************** Chit Chat Money is presented by Interactive Brokers. Switch to the best brokerage in investing today: ⁠⁠ibkr.com/info⁠⁠ ****************************** Want updates on future shows and projects? Follow us on Twitter: ⁠https://twitter.com/chitchatmoney ⁠ Subscribe to our Substack to receive free show notes and charts for our Tuesday episodes: ⁠https://chitchatmoney.substack.com/⁠ Want more from Andrew? Check out the Yet Another Value Blog on merger arb: ⁠https://www.yetanothervalueblog.com/p/the-antitrust-inflection Contact us: [e-mail] Timestamps Merger Arbitrage | (3:00) Examples | (14:35) Fundamentals | (26:48) Disclosure: Chit Chat Money hosts and guests are not financial advisors, and nothing they say on this show is formal advice or a recommendation. Brett Schafer and Ryan Henderson are general partners and portfolio managers at Arch Capital. Arch Capital and its partners may hold securities discussed on this show. Learn more about your ad choices. Visit megaphone.fm/adchoices

Welcome to Chit Chat Money. This is our Thursday deep dive episode where we interview an analyst or another investor to discuss typically either a single stock or in this case, more of a concept or a field. And today we're talking about merger arbitrage investing. For those that aren't familiar, we go through what that means with Andrew Walker. And I should say, Andrew's really bright. He's a great investor. He does fantastic work and he has a great blog called the Yet Another Value blog, also has a podcast called the Yet Another Value podcast. I listen to that. It's a great show. But we go through all things merger arbitrage investing. We go through a few specific examples that are outstanding right now, including Spirit Airlines

and JetBlue, as well as we talked briefly about the Microsoft and Activision deal, but basically cover all the basics on merger arbitrage investing. Brett, do you think I'm forgetting anything there? i don't think so yeah anyone interested in jet blue and spirit i think that was a great case study and there's also other ones here where we kind of go through how you look at either what's a maybe uncompelling opportunity when evaluating the total you know your upside downside chance of how it goes through and stuff like that we run through how the math will work how it's different than a fundamental investment and then what i think is interesting is when it's hit on it

specifically, but there's just kind of tidbits throughout the episode, is how you're going to research this stuff, which is looking at the public filings from these core cases, which can be quite interesting. And I don't think a lot of investors really know to start there. All right. Well, without further ado, here's our interview with Andrew Walker. Welcome to Chit Chat Money. On this show, hosts Ryan Henderson and Brett Schaefer interview industry experts, and riff on the world of investing. As a quick reminder, Chit Chat Money is a CCM Media Group podcast. Ryan and Brett are also general partners at Arch Capital, and Arch Capital may have positions

in the securities discussed in this podcast. Anything discussed on Chit Chat Money by Ryan or Brett or any other podcast guest is not formal advice or a recommendation. Now, please enjoy this episode. All right. Welcome in. Today, we are joined by first-time guest, Andrew Walker. If you are a regular listener to Investing Podcast, you might be familiar with him. He is the host of the Yet Another Value podcast and the author of the Yet Another Value blog. Today, we are talking about usually we do company-specific shows, but we wanted to focus more on a sector. You just

wrote a really interesting piece about this and it's merger arbitrage. For people that don't know what that is, it's kind of an intimidating sounding thing. Can you maybe explain just what is merger arb investing? Yeah. Yeah. Okay. So merger arb, this is classic stuff. You can find stories of Ben Graham and Warren Buffett doing... Some of them could be a little more exciting back then. But no, merger art was basically company X agrees to buy company Y for $10 per share. The stock trades to $9 per share. And if the deal goes through, you're going to make $10 per share. People, it can be really attractive, especially to kind of mathematical odds oriented people, because there is a definitive catalyst, right? The deal closes,

you get $10 per share. The issue with it is if the deal doesn't close, you can get a lot less than $10 per share. Normally, company Y in this example would have been trading for $5 or $6 per share. And then they announced the deals get bought out by $10 and the stock goes to $9. Well, if the merger breaks, it's probably going back to $5 or $6. You're not getting that premium. But normally, mergers break because something terrible has happened. So you're actually not going back to five or six, you might be going to three or four or two or one or zero. So it is a very, on the upside, you make 10 or 20%. On the downside, you can be talking about huge losses. So it's a very odds-oriented game where you're looking at it and saying, one up, four down,

what are the odds I think this is going to close? That fits really well into a lot of mathematical formulas for a lot of mathematical people. But it can, again, because if I am right and a deal closes. It doesn't matter if the market has gone up 50% or down 50%. I get my 10% spread that can be very attractive for a lot of different reasons. Right. And we'll talk about maybe some of the uncorrelated or the lack of correlation to the market, which you mentioned in your piece, but the sort of the crux of your article here was that you think merger ARB is at this inflection point. So can you maybe expand on that? Why do you think it's in sort of this inflection point? And why has it changed in recent years? Yeah. So let me back up a little bit. So merger,

company X agrees to buy company Y, the stock trades to $9 and you'll get 10. The reason an arbitrage generally breaks is obviously the deal falls through, but there's a contract, right? As Elon Musk learned with Twitter, and we'll probably talk about this later. Just because the market goes against you and you realize you're overpaying for a company, you can't just walk away. There's a contract and you have to honor that contract. If you don't, you will go to Delaware court and the company will sue you and you will be forced to honor that contract. Plus you'll pay a whole bunch of legal bills. The way a merger generally breaks is the government comes and says, hey, this is anti-competitive. We have antitrust laws.

We're not, you know, think about all the oil monopolies of the early 20th century. We have antitrust laws. We're not going to allow monopolies to get formed. So, you know, if tomorrow Google, Microsoft, and Amazon announce the massive three-way merger, guess what? That's not going to go through. So the way a deal normally breaks is the government comes and says, hey, this is anti-competitive. And anti-competitive can be a lot of different things.

It really depends on the market. You know, like there can be very small markets that the merger between two people is anti-competitive. About 20 years ago, Office Depot and Staples tried to merge. And, you know, today you think of Office Depot and Staples trying to merge and it's an absolute joke. But at the time, you know, the online shopping was there, but it wasn't as big. Office Depot and Staples said, hey, we compete in the retail sector, right? The retail sector is huge. Walmart, Kroger, you know, there's Superstore, there's retail. all this. And the government said, no, we're defining the market as corporate office products.

And when you define the market as corporate office products, Office Depot and Staple were two of the three largest players. That was a huge antitrust problem. So anyway, the reason a merger normally breaks is antitrust. And traditionally, antitrust was very hesitant to pursue cases that they would So I provided this stat. From 2010 to 2019, of the thousands of mergers that were out there, the DOJ only actually pursued a case against 100 of mergers. And of those cases they pursued, and I'm doing this off the top of my head, 94 of the cases they announced the settlement. So the deal went through with kind of conditions. A classic settlement would be, Brett and I own, we're a nationwide grocery chain, but in St. Louis, there's only two grocery chains. I own one, he owns the other. The government says, hey, this merger is fine, except for in St. Louis, that would be an antitrust problem. So we agree, all right, government, Brett will give his St. Louis grocery chain to Ryan, and then you don't have to worry about that. So the government was very hesitant to take cases all the way to court and then see them all the way through. And we can talk about the reasons why in a second. Of all the thousands of cases, they only take six cases all the way through court in 2010 to 2019. Of those six cases,

they only lose one, AT&T Time Warner, which is actually important. We might come back to that. In the Biden administration, I think they've completely changed their minds. They've said, hey, we like to take cases all the way to trial. It shows our constituents. It shows these companies. We're serious. We main business. And they are racking up L's at an astronomical rate. You know, the big one this year was Microsoft Activision. That wasn't the DOJ. That was the FTC. But they went to court. And if you listen to the court proceedings, the judge was kind of like, what are we talking about here? And, you know, we can go as deeper as there is one. We can start talking vertical versus horizontal mergers, all this sort of stuff. But my basic thought is,

in merger arbitrage, your big worry has always been antitrust. And if the DOJ announced the case against the merger, the stock would drop a lot because people say, oh, the DOJ only brings cases that they are very likely to win. And the past few years when the DOJ has announced cases, stocks have dropped a lot. And my contention is something has changed. We have hit an inflection point and the DOJ has started to bring cases that they are likely to lose. And the market has not picked up on that. And investors who have picked up on that have the opportunity to generate a lot of risk-adjusted alpha by kind of looking at these cases, taking the other side of the DOJ stances, and betting that the DOJ will lose in court. So I have covered a lot of antitrust

and merger arm in that little five-minute spiel. I'm happy to go into specific examples. We can talk overall, wherever you guys want to go. Yeah. So we want to hit specific examples later uh we can talk i have two that were set up just as a little teaser the jet blue and spirit one which you think is maybe a little more attractive than the irobot and amazon one which you think is a little bit less compelling but i want to i think as maybe a novice to merger arb investing you get a little bit nervous dealing with the legal system if you don't have that background so as someone who's been studying this for many years i know you had a lot of good good podcasts and then discussions with, I forget the name of the person, the Twitter,

the expert on the Twitter deal. You can maybe say the name there, but where do you get the information on the stuff? You mentioned JetBlueSpirit. So I had Lionel Hutz, who is a lawyer. He came on and we talked about JetBlueSpirit recently, which is my favorite of this style of cases currently. He also came on and I mean, I had a lot of lawyers on to talk about the twitter case last year but yeah yeah so i guess maybe even if where are you looking at kind of the the information on this stuff are you kind of reading you know what the ftc is reporting in like the wall street journal they're saying like hey we changed our tune here yeah the great thing about these cases and i think this will come into play when we talk about irobot amazon is

the u.s has the best systems of laws like we are really lucky that we have codified laws we have precedent. The courts are very serious. And there's a system for this. When the DOJ doesn't like a merger, there are some cases like in the UK, they have what is called the CMA. I believe it's the Competition and Markets Authority. If they don't like a merger, they can basically just say, we don't like the merger. Can't do it. That's Microsoft Activision. When the CMA ruled against Microsoft Activision in April, I thought that merger was dead. The CMA had never overturned reverse the merger. Microsoft, through some clever lobbying, some clever restructuring, managed to save that deal. And that's what you expect from one of the biggest companies in the

world. They have the best lawyers. They're very creative. But the CMA, if they decide they don't like a deal, dead. Nothing you can do. The US, if the FTC or DOJ decide, hey, this is an antitrust issue, the companies can go and say, we don't think it is. The DOJ has to go to court and the onus is on them. The burden of proof is on them to go to court and say, hey, this deal is anti-competitive. Here's why. And we're going to have a whole court case where we, the government, are going to hire expert witnesses who are going to go on the stand, who are going to say why this deal is anti-competitive. And generally, anti-competitive has come to be defined as it will harm consumers. And generally, harm consumers has come to be defined as

it will raise prices for consumers. And then the companies can go and they can hire experts and they can say, hey, here's why this deal isn't anti-competitive. The government is wrong. and both of them can present their sides to a case and a judge will rule and the judge can say, yes, the deal can go through or no, the deal can't go through. And what's great about this for people who are willing to do the work is most, not all, but most, because these are court cases, all the filings are public. They're all in the government. So you mentioned JetBlue, Spirit, DOJ. That's my favorite case right now. You can go, that's in Massachusetts District Court. you can go to the massachusetts district court and you can read the doj's original complaint

why they think jet blue and spirit is anti-competitive you can read jet blue's response why it's not anti-competitive and then they just filed the trial was set to start about two weeks from today when we're talking i believe it says start october 30th after uh it was going to be it was actually going to start yesterday they delayed it twice it's going to be october 30th now but uh on last thursday they filed their pre-trial briefs which summarizes everything that they've kind of found in the pre-trial process and it says, hey, we're about to have this court case. Here's exactly what we're going to argue in court. So it's great for investors because both sides are so clearly laying out their theses and you can read it and you can say,

hey, I believe this thesis, this makes more sense to me. Based on precedent, this makes more sense to me. I can go talk to lawyers and say, hey, you guys do this for all your lives. What side do you think makes more sense? Chit Chat Money is brought to you by Interactive Brokers, but we like to call them by their ticker symbol IBKR. Designed for active traders and sophisticated investors, Interactive Brokers offers trading assets in 150 markets with 27 different currencies, charges USD margin loan rates from 5.83% to 6.83%, rated the lowest among margin fees, the ability to trade stocks, bonds, options, futures, commodities, and more with high interest rates paid on instantly available cash balances and the ability to lend your eligible stock shares

to earn passive income all on one single unified platform. Restrictions may apply. For more information, visit IBKR.com. Member SIPC. Open an account with IBKR today. Yeah, that totally makes sense. Now, before we go into, again, these specific examples, but I think are quite fascinating because they're going on right now. Can you run the math as an example of how you calculate the risk reward for a merger opportunity? Because it's so different than a classic fundamental investment. Yeah. Yeah. It's actually pretty, it's pretty simple. It's a pretty easy mathematical formula. So you would take, let's see if we can use something. So let's go back to the example I used earlier, right? Hey,

company A is getting bought out by company B. The stock is at five before the announcement, the deal is for $10 per share, and the stock trades up to $9 per share on the announcement. So I'll just go put those into my little formula right now. And so you would generally assume you need to figure out the downside and the downside is the key, right? As I said, most things when they break, the other way things break than the government suing to block and saying this can't happen is, you know, company X goes into complete distress, something terrible happens and asteroid hits their headquarters. And, you know, the company who's, who's about to buy them says, Ooh, I don't think I want to buy you anymore. And generally you would go to court and have an MA,

but you know, like during COVID there were all these cases, uh, Tiffany was getting bought out by Louis Vuitton. And when, you know, for, from, from March, 2020 to June, 2020, like all of retail shut down. And Louis Vuitton sued and said, hey, this was an MAE, material adverse event. We don't have to buy you anymore because basically act of God, the world has changed. So you could go to court on that. And you could imagine if Tiffany was trading for, in our hypothetical example, $5 before and that deal broke, it would not be going back to five. We're in the depths of COVID. It's going way lower. Anyway. So if you do a stock is trading at nine, the offer is 10 and the downside is five, that would imply 80% chances of the deal going

through. And the way you get that is you take the $9, you subtract $5 from it. That's your top, that's your numerator. If I'm remembering my sixth grade math class or fourth grade or whatever it is. And then your denominator would be, you take the deal price 10, you subtract five. So you divide the top by the bottom and that would get you to your 80%. All right. And basically you're saying, hey, I have to be confident that it's greater than 80% likelihood. That means it's maybe an opportune or a good opportunity that you- Yeah. And again, this is why a lot of people with poker backgrounds, a lot of mathematically minded people like this because you can go and again, the question is the downside, right? We

know the market price and we know what happens if the deal goes there. There is some assumptions of the downside, but you can generally get pretty good at estimating the downside here. You really need to understand the deal and go and look at it and say, hey, the market's offering me an 80% chance of this going through. That is pretty much hard facts at that point. Do I think it's 80% or not? And people love it because with Merger, there's probably a hundred deals announced every year. You're not going to play all of them, but if you can find 10 mispriced deals a year and you're right on them, that can create a lot of uncorrelated alpha. Right. And speaking of uncorrelated, how do you think about it from a portfolio management

perspective and counterbalancing other investments? Because I think it's perfect to pair it with, say, a long-only strategy, trying to buy, quote-unquote, compounders or whatever your strategy is. I think pairing it with other stuff makes a lot of sense. Is that how you look at being a merger arbitrage? Yeah. So look, I'm a journalist. I try to do it all. If you're a merger org focus, you have to play like all of these deals and you can get into what's called rate of return i don't do rate of return merger where you know the deal is at 10 the stock's trading at 980 and you're betting hey you know if this closes in two months my irr is going to be i'm going to make two percent gross but my irr is going to be great because two percent gross in two months is great but if it

closes in four months i don't do that like i tend to we'll talk about spirit twitter i tend to do Rocky ARP, where there's real doubt, there's real uncertainty, you can really dive into it. And if you're right, you will get paid quite a bit because the stock will go up 20%, 30%, 40%. Of course, if you're wrong, that is the chance. But if I can find three or four of those a year and be right on a few, the great thing is, again, it's uncorrelated. I think you generate a lot of alpha and I think it works really well. It seems like, as you mentioned earlier, more and more and i you know we haven't been doing merger for a long time but it seems like there's a lot of these opportunities that are popping up like you said because uh the ftc or

the doj is pursuing blocking them how do you think about situations where it requires clearance from other governments does it make it too complicated or does it just kind of factor into your analysis So Brett mentioned iRobot, iRobot Amazon. I think iRobot Amazon. So in merger ARB, and again, I'm flipping through a lot of things, but there's vertical versus horizontal mergers. Horizontal merger is, Ryan, you are the largest brake manufacturer in the country. I am the second largest brake manufacturer in the country. We decide to merge. That's a horizontal merger. Those are very difficult under antitrust, right? Now, if you're the number one player and you have 2% market share and I'm the number two player and I have 1.9% market share, that's fine. That's going to go through. That's a very fragmented market. But if you're the number one player with 40% market share and I'm the number two with 30%, that's probably going to be a problem. Horizontals, the market knows how to adjust that.

Vertical merger is – Brett is Toyota, a car company, and they're buying Ryan, a brake company. So Ryan's a supplier. vertical merger because you're going from one step of the supply chain into a completely different step. That has generally been, I think in the 80s, one vertical merger was blocked, but there's no case for vertical mergers to get blocked in the US, right? Because you're not eliminating or changing competition. You're just taking a supply in-house. So why do I mention that? Amazon is buying iRobot. And if you think about it, Amazon is a retailer, right? And we can online retailer, whatever. We can talk about all the definitions, but they're a retailer.

They're buying a supplier, a vacuum cleaner. There is no precedent for a retailer not being able to buy a supplier. The US is suing them to block... Sorry, the US has not sued. Everybody thinks they're going to sue. The FTC is already suing Amazon as a monopoly. It's not a far throat to think that they're going to sue Amazon for buying iRobot as well. And the basic case there is Amazon, you're too big. We don't want to let you get any bigger. That is not an antitrust case. Too big, we don't want to let you get any bigger. Too big in your market, we don't want to let you get any bigger in your market. That's an antitrust case. But there's no, you're too big, we don't want to let you get bigger. However, in Europe, and particularly the UK with the CMA, they've got

more powers. Not that those aren't countries that operate on laws, they do, but the regulatory bodies there do have a lot more powers. I am not as familiar with them. So when I say I'm less interested in iRobot Amazon, it's not because I don't think Amazon has a great case against the government on iRobot if and when that comes to happen. It's because now the CMA has already cleared Amazon iRobot. And the CMA is probably the most powerful where they can just say this murder isn't happening. It's death sentence. But the EU has not cleared it. And I am not as confident in my read of EU antitrust. I'm sure some people are. You guys, me, whoever might get email saying, oh, I know the EU really well. Amazon, if they try to block Amazon, it's got

this route, this route, this route. Cool. I just, I'm admitting, I don't know it as well, but foreign mergers are an issue. And that's one of the reasons. So JetBlue Spirit, one of the great things there is they really don't need any foreign. Like those are two almost exclusively domestic operators. If the US allows it, it goes through. If the US doesn't, it doesn't. Another big area for antitrust historically and for merge ARBs has been pharmaceuticals in general, not always, but in general, pharma has only needed US approval or it's been largely US-based. So what else?

Retail, a lot of retail. I mentioned Office Depot, Steeple earlier. Right now in the market, there's Albertsons, Kroger. That will probably get sued by the FTC. That's retail, almost exclusively US-based. So I'm familiar with US-based. It's one of the things,

a lot of times people come pitch me foreign investments. And I was talking to someone earlier today and he was like, look, foreign investments are great, but you're pitching something to the UK. If you wanted to go buy a hammer, could you name two places to go buy a hammer in the UK? Could either of you?

No. No. And I bet you guys would say, oh, I probably know the UK market. Like, oh, they speak English. The income's probably the same as here. The rule of law is kind of the same. I could name seven different places off the top of my head I could buy a hammer in the US. I can't name a single place in the UK. And not that you need to know where to buy a hammer, but you tend to internalize the domestic market a lot easier than international markets okay i'm rambling i don't know where i'm going okay i have a kind of a follow-up to that so you mentioned the cma and like you said we've seen a number of times where they kind of block it on whatever grounds they justify i think they blocked meta or

facebook from buying giphy a couple years back um they tried it sounded like to block the activision microsoft deal what can can microsoft just be like or even in like this amazon i robot case can they just say like all right fine we just won't sell i robots in the uk or do they become like an illegitimate operation or something in the eyes of the uk how can they is there any remedy that has been an interesting question so when microsoft so microsoft activision the cma in April came out and said, we're not going to allow this deal to go through. And the reason they weren't going to allow it to go through was they said cloud gaming is an issue and cloud gaming is a nascent market, but they were worried that Microsoft buying Activision was going to influence

cloud gaming and Microsoft would be incentivized not to sell to competitors. Microsoft ultimately got around that by, I think there was a lot of lobbying. I think the CMA, they had a court case where I think the judge let the CMA have it a little bit. And ultimately Microsoft said, hey, We'll sell the cloud gaming stuff too. I think Ubisoft bought it and that. So that's what happened with Microsoft Activision. But yeah, in general with the CMA, they are a regulatory body. If they decide that they don't want something to happen, yes. Sorry, to go back to your point. If the CMA decides they don't want something to happen, they're not going to let it close. We have seen in the past, very small markets, like New Zealand, right? If New Zealand said, hey, we're not going

to let Activision, Microsoft go through. Cool. Microsoft might hive off Activision's New Zealand operations and operate it completely separately and try to sell it or something. That's completely possible. Could they do that in the CMA? Yeah. I heard some people saying, hey, all right, we're just not going to sell Call of Duty in the UK. The UK is not a huge market. It's less than 5% Activision sales. Technically, I think they could do that. It's tough. If it was a retailer, would actually be easier right if it's walmart and walmart's merging with target and that everyone says okay cool except for the uk cma walmart could just say cool we're divesting all the targets in the it's a little harder with the video game that you're downloading but there i you are on something

like you probably could try to hive it off for microsoft to do it you know also you're pissing off your regulator for this like windows is a big business there are if microsoft had closed Activision. And this assumes that they didn't try to hive off the Activision business. And then the CMA ruled that that was anti-competitive. There could be potentially really large fines. So I don't know. It's possible, but we haven't really seen it happen. Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad. I get it. I'm Siaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned.

And today, I'm still figuring it out. Somehow, things usually get worse before they get better. Apparently, that's how I roll. So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem. How much do fundamentals matter? Because I'm looking at, you know, you think of Activision Blizzard, decent business.

They might have bought it at a pretty, you know, expensive multiple, but not a crazy multiple. versus iRobot, whose business doesn't seem to be doing very well. It's almost like getting saved. How much does that matter when evaluating the downside? Because Activision Blizzard back when it was in kind of the 70s, you almost thought like, hey, this is a pretty fair value if the business just stays intact. Do you factor that in a lot when evaluating these merger ARPs? Fundamentals are huge, right? Because in my case, $9 to $5. A $5 stock gets bought out for 10, right? And it's trading at 9. So if the downside is 5, then the market is implying the

odds that's going through at 80%. If I change the downside to 8, the market's implying that as a 50% to go through. If I change the downside to 2, the market's implying approaching 90% to go through. So the downside is huge. And that is one of the things, if you read the piece that talks about how antitrust is changing, I mentioned that Activision's downside was hotly, hotly contested during the entire sea of Microsoft buying them out. Because if you think Microsoft and Activision announced their deal in January of 2022, and when they announced it, Activision is right in the throes of there's a corporate harassment scandal. The business isn't doing very well. I think the last call of duty was kind of poorly reviewed, hadn't done great.

So the downside looked pretty big. And then run it through 2022, January 2002 to October 2022. The NASDAQ is down like 25% or 30%. The NASDAQ is Activision's index. So a lot of people were saying, oh, Activision was trading at 60 or 65 beforehand, run it to the NASDAQ and the downside here is 50. A lot of other people were saying, oh, the fundamentals have actually gotten better. So yes, the NASDAQ is down a lot, but Activision's fundamentals are better. So maybe the downside should stay 60 or 65. Come to this year and by March of 2023, it's clear that Diablo 4 is about to come out and it's going to be an absolute smash hit. By June of 2023, it is a smash hit. So Activision was trading for around 75 at the time. And you would hear a lot of people

saying, hey, the downside here, if you run and also March 2023, the NASDAQ has a huge bounce from October tomorrow. So you would hear a lot of people say, oh, Activision's 75. I think the fundamental downside here might be 70. It might be 75. I'm getting all upside if this deal closes and no downside. And one of the things I think can be a little overplayed in merger art, but sometimes these situations can take a long time to play out. Microsoft Activision deals announced January of 2022. It closes in October of 2023. That's over 18 months. A lot of times what you will find is once a deal is announced, fundamental investors do not want to touch that stock because they say, I'm not here to be a merger arbitrager. I don't have the expertise. I don't know how to

do the odds, all this sort of stuff. So a lot of merger arms will say over 15 months, look, I think the fundamentals have gotten better. Sure, the stock was trading at $5 before, but this business has done great. The stock's at $7.50 currently. I think if this business was standalone, it would be trading $8. So they kind of call it the double play, right? If the deal goes through, I'll get a premium. And if the deal breaks, fundamental investors will do more work and they'll say, oh my God, this is the cheapest stock in our sector. And they'll come in and buy it and the stock will go up. There are some historical examples. Like there was one, it was a utility company, right? And they announced the deal, the stock was 50, the deal was 60,

stock kind of traded 55, the deal was outstanding for 18 months. And in that time, the utility index went up 30%, right? So the deal was to take them out for 20 times PE and all of the peers by the time the deal was kind of at the knife's edge, all the peers were trading for 25. So a lot of people would say, hey, if this deal goes through, great, I make 10%. If this deal breaks, I might make 30%. Now, there is something to that, but I will tell you, I do think that gets overblown. So there was another situation in 2016, 2017, Qualcomm was buying NXPI and every merger arm had a huge position and the deal broke and every merger arm said, oh, the semiconductor index is up like 50% since this deal got announced. NXPI,

the downside is higher than the current trading price. And this stock was trading at like 125. and I think it went to $75 in two or three months. So it is a popular theory. It's just, it's really hard to know, but happy to talk about any of that. Right, so one factor there. Now, I do want to let you go through the whole JetBlue and Spirit opportunity,

but I do want to give one more context question here. And it's around the political landscape. Do you pay attention to that a lot where, okay, a new administration might be in, okay, we got a new FTC chairman or or in this case it absolutely matters and the companies think it matters too right so when the trump administration came in in 2016 i remember a lot of people were saying comcast and charter the two biggest cable companies in the united states shouldn't

the fact is republicans tend to lean more free market and they tend to let more uh let more go through the democrats tend to lean not that they're not free market but they tend to lean a little more big as bad. And particularly the Biden administration has been much more, you know, so Lena Kahn, who heads up the FTC, she came to fame. Her Yale, I think it was her Yale PhD was Amazon's too big, antitrust is outdated, Amazon should be broken up, right? And she's put in charge of the FTC. I'm going to let you guess what one of her signature achievements was, right? So you politics definitely matters. And this administration, you know, the DOJ and FTC both have taken a lot of cases that I think prior administrations would not have pursued. And that's presented a lot of opportunity. However, so you have to pay attention to it. Yes, if a Republican administration comes in, I think this changes. However, I do think if you're paying any attention to politics, I think Republicans do not have the same relationship with big business that they used to have. Like, you know, the next Republican, if a Republican wins in 2024, I would not be surprised if their head of the DOJ came into the office saying, hey, let's stamp out big tech, right? Let's break up big tech. Big tech's too powerful. I would not be surprised if they said, hey, we need to go against all the media companies. The media companies are biased against us.

And one of the things that I mentioned in it, the only loss the DOJ took in 2010 to 2019 was in 2018, they tried to block a vertical merger, AT&T Time Warner, and that was a 100% political driven decision. So I talked a lot about right now the opportunity set is the Biden administration. It's what they're regulating. But this started, a lot of this starts in 2018 when the government makes a very political decision, in my opinion, and I think that's widely reported. There was no antitrust case to block AT&T, Time Warner. That was a vertical merger of a television and wireless company buying a media company. Absolutely no antitrust reason. But because Donald Trump doesn't like CNN, he let it be known he wanted that merger to be blocked and the DOJ sued to block them and they kind of got laughed out of court. yeah let's talk about a couple specific examples i think maybe we can start with the jet blue and spirit merger uh i guess can you give a little bit of context around this and then why do you think it's uh an attractive opportunity yeah so jet blue is buying is in the deal to buy spirit and the doj has sued to block this deal and i think this is the only administration that would have brought this suit. JetBlue is the sixth biggest airline, and Spirit is the seventh

biggest airline. And combined, they will be the number five biggest airline with about 10% market share. The big four, which is Southwest, Delta, American, and United have about 80% of the market between them. So it's kind of crazy on the face of it to say, oh, you're combining a 4% player with a 5% player. And that's an antitrust issue when there's 20 or 25% players out there, right? So again, there's antitrust standards. The antitrust standard is, does this harm the consumer? And one way it could harm the consumer is antitrust is actually a local game, right? I mentioned before, if Brent and I are merging our grocery stores and nationwide, we would have 1% combined market share. So we'd be like a little pimple compared to Whole Foods, Walmart,

all these guys. That's great, but it doesn't matter if we would have a monopoly in a local market, St. Louis, right? Now we could agree to the best, St. Louis. So in airlines, one of the big issues would be, hey, JetBlue and Spirit are merging. It doesn't matter if they're pimples, if they would have a monopoly on what they call city route payers, right? So if Spirit and JetBlue are the only people who fly from, choose your market, from Boston to Orlando, that could be an antitrust problem, right? Not guaranteed because the airline industry is extremely dynamic, right? If they thought they were going to get monopoly power on Boston to Orlando, guess what? Unlike with grocery stores where it's St. Louis, you can't take a grocery

store from Chicago and move it into St. Louis. Well, with an airline, if there's monopoly profits being generated on the Boston to Orlando route, another airline could look at that and say, why don't we take one of our planes and just have it go back and forth between Boston and Orlando? So it's a dynamic industry, but that could be a problem. Particularly if there are some like an airport, Austin Airport, I'm just pulling one out. Tons of space, tons of gates, they can build more slots there. That has a lot of slots. It's pretty easy for a competitor to go there. Whereas a LaGuardia, that is a gate limited market. If you have a monopoly problem in LaGuardia or Boston, in some of these bigger Northeastern cities, it might be more difficult for a competitor to get

in there. Anyway, I'm rambling a little bit. So these two are merging. Under every traditional antitrust standard I've seen, I can't see any reason why this would be an issue. But the DOJ is suing to block it. And the DOJ sued to block it in March. And this is going to get a little technical. But when they sued to block, JetBlue had this thing called the Northeast Alliance. And the Northeast Alliance was JetBlue and American had merged all of their operations in the Northeast into a JV. And you heard me mention a second ago that there are some gate-limited markets. Newark, Washington DC, I think is one of them. Boston is one of them. LaGuardia. Guess what? These were the markets that JetBlue and American merged in the Northeast

Alliance. And at Boston, Logan Airport, JetBlue had, I think it was 30% market share, and American had 40% market share. So when they merged, they created a literal titan in the Northeast. So in March, when the government sued to block this, the Northeast Alliance was still on. In June of this year, a court ruled that, hey, the Northeast Alliance is anti-competitive. We should break this up. And if I was the judge, I would have made the same decision. There were a lot of issues with this thing. That's been dissolved. So the government sues, and if you read their initial case, there is so much talking about the Northeast Alliance in there, it is unbelievable. The Northeast Alliance has been broken up. So it's now no longer,

hey, JetBlue, who's in this very anti-competitive Northeast Alliance, who controls a ton of the Northeast markets because of their partnership with American, that's gone. Now it's just the number five and number six players merging. And again, I think that is a, I don't see an antitrust problem there. I've never seen an antitrust problem where a number five and number six player play. We can talk more about it, but that's the overview. Before you guys ask questions, I'll just say, you mentioned Lionel Hutz. I had Lionel Hutz on the podcast, not to pitch my own podcast, but we went into all these questions in super, super depth a few weeks ago. So people can go to Get Another Value podcast and find that episode. It's one of my favorite episodes I've

done, but happy to ask questions or talking to all complexities of the case. Yeah. Let's go a little deeper on that one. So I guess on the non-legal side of things, what's the spread like there? And then how are you measuring the downside there? Is there anything that's happened since the deal was announced? Two great questions. So as you and I are talking, the spirit stock trades for about $16 per share. And if the deal goes through, by the time the deal goes through, there's this weird dividend structure, which we don't need to worry about. It doesn't really change anything too much. But if and when the deal goes through, let's just say you'll get $30 per share to make the numbers nice and even. So 16 to 30, that's a lot of upside.

right uh the downside as we've talked about can be a hotly contested topic you know the first place you want to go to for the downside is what was the stock trading for before the deal was announced well spirit was trading for like 20 or 24 before the deal was announced uh the operations have not been fantastic since this deal was announced you know the deal was announced january of 2020 sorry july of 2022 jet blue first kind of started bidding and we can talk about spirit was in a different merge before this. In March of 2022, well, fuel prices have been really volatile since then. Domestic travel in particular has been tough. Spirit in particular has had trouble with some of the engines that they get. So the downside has fallen a lot. It is a hotly

contested topic. A lot of people think the downside is about $10 per share. Spirit's book value is actually higher than that. So they're thinking Spirit would trade below book value, but Spirit's got a lot of debt, a lot of leverage. So the difference between 10 and 17 is not huge in terms of book value. But a lot of people think the downside is $10 per share, which would imply 30 up, 10 down, the stock's at about 16. That would imply the market's got Spirit about 30% to go through. I've kind of been using about $7 as the downside. That would imply about 40% to go through. So those are kind of your range of odds. And the next question would probably be, hey, what do you think? I mean, I think this is at worst a coin flip. If you kind of ask me,

I think Spirit Jet Blue or like 75% to win would be my personal odds, but reasonable people can disagree. That's just my personal opinion. I've talked to people who do disagree with me, but I think this is a really unique case. And I think the odds are very high here. And that's not a investment advice, right? I'm not a financial advisor. I'm just letting people know what I think. yep of course all everything we discussed here is all just everyone do their own research but one other thing i think that's important there is what's the timeline to any decision on this yeah that's another great question so we're talking october is it 15th or 16th today i can't remember october 17th i'm completely off so the trial is set to start october 30th it the it is going to be a two-week trial now. And I think it's two weeks. Previously, it had been set to start October 16th. They delayed it to October 23rd. They delayed it against October 30th. It was originally going to be a three-week trial. Now it's going to be a two-week trial. It might be

too much inside baseball. So it's going to start October 30th. It'll be a two-week trial. And the judge has said, hey, I understand that you guys are under a merger contract that can time out. I'm aware of that. I'm aware that both sides will likely appeal if they lose. So I am going to try to rule before the end of the year. So I think we're going to see the trial start in two weeks. I think we'll have a ruling before the end of the year. There may be an appeal on the heels of that ruling. We'll see. But I think we'll know by the end of the year. Whoever wins, 90% of the time is going to win. An appeals court is very unlikely to overturn this, especially to stop the merger to overturn it. They might say, okay, we'll hear the appeal,

but the merger can close and we'll worry about unscrambling they give them when we get there but i i think we'll know by the end of the year okay and ryan do you have another follow-up on jet blue or i was going to go to a bad example no uh an unfavorable one but yeah i have a more of a general question it's kind of speculative but i don't think it really applies to the jet blue spirit situation but do you think in the in the event of a deal break just in general, for a lot of merger ARBs, do you think it ever impacts the actual business itself? So I'm thinking of Activision here. If they didn't get acquired by Microsoft, do you think there's employees that would have been like, I'm out of here?

So it's difficult to know. I think it does. So there's two ways it does. First, when you are in a merger contract, the merger contract lays out what you can and can't do. so you know one of the issues i mentioned louis vuitton tiffany's earlier during which happened during covid right and one of the issues with during covid is your merger contract said it really restricts you from what type of financing you can take on the type of layoffs you can and can't do all that type of stuff right so the merger happens during covid you can't lay off you might now it was covid so i think a lot of judges said it's the ordinary course like This did get litigated. And 80% of the time, the judges said you can. Tiffany's could lay off all

of their retail staff because every other peer of theirs did. So if they didn't, they'd actually be operating outside of what's called the normal, ordinary course of business. But that gets litigated. But you can't do financing. There's a lot of things you can't do. VMware Broadcom are getting a buyout right now. And that got announced, if I remember correctly, right before the big tech, the year of efficiency with Facebook and everything. So one of the things a lot of people have pointed to with VMware is, hey, every other tech company has laid off 10% of their staff. VMware has not done that because they're under a merger contract.

If they laid off 10% of their staff, that would be against the merger contract. So if VMware broke, the first thing they'd do is probably fire 10% of their staff and they'd come out and say, hey, guys, our margins are going to be a lot higher. So it does impact the business. You can't do a lot of finance. You can't do a lot of strategic things. Your top brass is, they're probably looking at yachts or they're not really thinking about driving the business. Absolutely can. But at the same time, you're talking Activision.

If you're the game developer for Call of Duty, that's the real driver of Activision's business and value. Are you really getting caught up on, hey, the CMA just blocked us? It really doesn't impact your job or your lifestyle. So I think the answer there is yes and no. yeah no there's always gray areas yeah with that type of stuff now we already talked about amazon irobot so maybe we could use a different example if you have one that comes to mind but what's one maybe at the moment or maybe that was recent that was less compelling to you as a merger arbitrage opportunity and why was it less compelling oh well you know all these are individuals. So let's use Albertson's broker. We have not seen a suit yet. I think we are going

to see a suit at some point. But right now, the stock trades for 22. I think there's a real case there. They do have a lot of local monopolies. If you look at the history of a lot of antitrust right now is there were several grocery mergers in the mid-2010s that went through where bread and Andrew were merging. There was going to be a monopoly in one market. And they said, hey, we'll sell it to private equities. We'll sell the source of private equity firm XYZ, right? Private equity firm XYZ was a fly-by-night private equity shop that threw a ton of leverage on it. The stores went to shit the moment that they got bought out from the other brand, and they went bankrupt. And it was just a huge issue all around. I think Albertson's Kroger's

is an example. I don't know. We haven't seen a suit, but I think there's a good antitrust case there. I don't know if it's a good investment or not. I guess what I more want to say is any of these could be good or not at any price, right? Like Spirit is my favorite currently. As I laid out the odds of that going through, the market odds are probably 30% to 40%. I think the odds are a lot higher. But if Spirit was trading for $29 per share right now, and the deal was at 30, I mean, no chance would I be touching that, right? That would be the implied probability of it going through would be way too high. So it's kind of tough for me to say, what's a good one? What's a bad one? Because everyone could tell you, hey, this thing's likely to close. It's trading 99%

to close. Cool. Yes, I don't disagree. Where you kind of make money and make alpha is when something is offered at 30% odds and you think it's 50. Or last year, Twitter was consistently traded 50% to 60% implied to go through. And when I read the case, I thought it was 99% to go through. And I would make the joke all the time. I'm sure most of your listeners are familiar with Kelly Criterion. I could talk about it in a second. But if I put my implied probabilities into a Kelly Criterion and showed what the market supply probability was, Kelly Criterion would be like, hey, Andrew, put all of your money into Twitter, then leverage as much as you possibly can and put all of that into Twitter, then go and sell your kidneys and put all of that into

Twitter, and then put online photos of your feet up and take that money and put that into Twitter as well. That's how mispriced it was. So it really depends on the odds. There are cases like, I don't know, Albertson's Kroger. Again, we have not seen a case. And the details of the case are so important. But let's say they sue. I think the government, based on my understanding, the government would be probably 50-50, maybe 75-25 to win. If Albertson's traded 1%, well, hell, I'd have a position there, right? Because at 1%, when the merger inevitably breaks, you're talking basically no downside. And if you hit that 25% or 50% chance, it's the moon.

Yeah. Go ahead, Ryan. How do you think about managing, like you talked a little bit about this earlier, but managing a portfolio of a bunch of merger arms? So like the situation here, you talked about the Twitter thing, right? It's a high probability this thing's going to go through.

It is not reflected in the price. You should bet a whole bunch on it, But on the half chance or the little tiny chance that it doesn't, if that's your whole portfolio, that's kind of a big issue. So how do you manage that? Do you like to have a diverse book of these, or are you willing to have big concentrated bets? You know, I don't do tons of these.

So I tend to be concentrated when I think the odds are. I think historically, I wish I had been more concentrated, but maybe that's resulting. Because again, if you don't do any, if you don't do a lot, like you can have five that work really well. And then Twitter, the downside there was massive. One thing a lot of people do, and I've just got to reiterate, this is not financial advice. This is super risky, but a lot of people like to play these with options because you can really define your upside downside with options, right? So you know, Hey, I've got a 1% position in the option. If this plays out, the option will go up

three X. So I will make 2%. And if it doesn't, I lose the 1%, but I have clearly tightly defined Now, one of the issues with options is court cases can get delayed. I just mentioned the JetBlue case that got pushed back two weeks. That probably doesn't super matter in the grand scheme of things. But if you were playing with November options, you're probably not going to enroll before November. Those December options start looking a little worse, right? So you worry about court cases.

The other thing we haven't talked about is settlements and price cuts, right? There was some rumors that Twitter would take a... So Twitter got bought out for $54.20 per share. There were some rumors that they had offered Elon, hey, we'll settle at $49, right? Well, if you had bought a bunch of $50 call options and he settles for $49, you were right that you were very likely to win the case, but you were wrong because the price cut and those $50 call options are worthless. So yeah, it's tough. I just think, look, nobody runs to Kelly Criterion in the stock market. The reason is you can use Kelly Criterion at a blackjack table. That's where I think most people started doing it because there are no fat tails in a blackjack table. You know the next card

is coming. The next card can only be one of what, like 12 different values. So you know it's next coming. You know when it's coming. You can bet it's very defined. The stock market has much thicker tails, right? I can't think of any right off the top of my head, but the court case can be delayed. That can impact your option. The merger can time out, like all sorts of different things. So you really, you would blow up if you ran with Kelly Criterion in the stock market. And the odds, I've given you odds, but these are my best estimates, right? I'm saying 75%, maybe the odds are 67%. You just don't know the odds. So nobody runs a full Kelly in this. Okay. Do you ever short the acquirer or do you go both ways if you think the probability is less

than what's the market's stating or is it strictly? This is a hotly... So a lot of merge arms do. The thesis is, hey, if you're saying you're good and you can identify things that are trading at 50% that should be 75, well, you should be able to identify things that are trading at 90, that should be 50. In general, I have not because again, the market is full of fat tails. And I find when you're dealing with probabilities, the shorting fat tails can really rip your face off. For example, you could be short of stock because you think the deal's unlikely to go through and then another acquirer comes in and all of a sudden you've got a bidding war, right? That's rare. But if you're short, that's going to hurt a lot more than if you're

long. So in general, I just personally, I don't do tons of shorting in general. On the odd side, I mean, we have thought about it. I know a lot of people kick themselves because for a while, iRobot originally was getting bought out for about $60 per share. And the stock was trading at like $59 per share for a long time. I'm using rough numbers, which implied almost 100% that was going to go through. This was basically rate of return. People thought it would close in six months, 59 to 60, that's what, about 2%. At the time, Fed funds would get you about 2%. So people were pricing at rate of return. And I know a lot of people came to themselves like, hey, this FTC was so clear they wanted to sue Amazon for everything. Why would I not short this? My

downside was I basically get my margin cost and my upside was it goes from 59 to straight at 38. And I'll just remind everyone, shorting risky, options risky, not financial advice, but yeah. All right. Well, this was a great discussion. I think if we can sum it up, your thesis is that merger ARB is getting much more interesting and could have a great next three to four years. We will link to that specific article on your sub stack in the show notes for anyone who wants to read any of the details here. But we always like to close out with a pre-mortem. So what are the risks you're looking at maybe from a broader perspective of why this thesis about a merger arb inflection could be incorrect well i mean look i could be wrong on any individual court

case for sure i think there is you know most of these uh merger cases get overseen by a judge so it's one person and you could have one judge who wakes up on the wrong side of the bed you know there are there are famously judges who there's a judge in texas who if a conservative viewpoint gets around, he rules against the government every time, right? There's a judge in Seattle who rules for the government every time. You could just get a wrong judge drawing and that could take a great case and make it terrible just because the judge will rule against it. Now, there's always the appeal process, but in general, companies don't like to go to the appeals process. So there is the judge factor. Congress could change the laws, right? I do

think there are issues that we've never considered before where I mentioned at the beginning, consumer price is generally defined as consumer welfare and antitrust. I do think there is something to, hey, Facebook, Google, all these things are completely free. I like them. I enjoy them. I could see antitrust arguments for, hey, it's just the scale. Maybe we shouldn't have Facebook buying, I don't know, Instagram. I could see arguments for that. I'm not saying I believe them, but the government could change the antitrust laws. That would be a huge thing. or your thesis could be wrong. I don't know.

But, you know, in general, that's the nice thing. We I for spirit, which we've talked about, we've read the court case. We have the judge. Could I be wrong? Absolutely.

But we know the odds. We've got the court case. I've read it and we'll see in a few months. And if the court case comes out against us, I'll probably come on here and say, hey, look,

I said it was 70 percent, but I was we got 30 percent of the time I was wrong. So I wasn't wrong. Just a bad roll of the dice. But yeah, I think it's one of the nice things about these outcome was wrong, but the process was right. Yeah. And that's what I say for every, every investment I have that's wrong. Let's not have any

intraflection, please. I don't want to look. I was always right. It was just a bad, bad drop. All right. Well, I think that's all the questions we have, I guess, for anyone that is unfamiliar with your work and wants to see more of it. What are the best resources to follow you? Yeah. Yetanothervalueblog.com. Blog there. Yetanothervaluepodcast. You can find it on Spotify, YouTube, iTunes, wherever else you're going to listen to podcasts. If you go YouTube, you'll see the mustache one day, beard the next day, clean shave the next day. But yeah, look, they're all a lot of fun. I talk about these. And I think in particular, if you're interested in the Spirit deal, not financial advice, but the Lionel Hutz podcast was really, really good.

Now, we did that before the pretrial briefs came out. I'd encourage you, again, the nice thing about these is these pretrial briefs, the motions and everything, I would just go read them, man. You want to talk about, you will never get details on companies, even if you're not interested in merger arb or antitrust, you will never get details on companies like you will the Amazon FTC case. Go read it. It's like an initiation on the entire online space. They talk about Amazon's network effects. There's so much interesting information. You've got to remember that they get access to all of Amazon's internal documents, all of their emails and everything when they do

it. So they can go and they'll have quotes from the insiders and they'll have strategies. He's like, if you're not at least reading some of these antitrust things, not that you can't be a great fundamental investor. You absolutely can be. But I think you're doing yourself a disservice because these are like industry primers on steroids. There's so well-researched. There's so much interesting stuff there. So you should just go read those. But how to follow me.

Get another value blog and get into the value podcast. All right. Well, before we sign off, we want to throw a disclosure on this. We should remind listeners that Brett and I are not financial advisors. Anything we say or discuss here on Chit Chat Money is not formal advice. I was going to say, I'm not a financial advisor as well. Our guests, nothing they say is formal advice, and Andrew is not a financial advisor either. We are, however, general partners at Arch Capital, so clients may have positions in

the securities discussed in this podcast. Thank you all for listening. Thank you, Andrew, for coming on the show, and we will see you all next time. Don't you wish you could just hit skip on the worst parts of your life? You know, the same way you can skip an ad. I get it. I'm Siyaya and I live in Ice Cove. I've made some questionable decisions that didn't end up the way I planned.

And today I'm still figuring it out. Somehow things usually get worse before they get better. Apparently, that's how I roll. So bundle up and come along for the bumpy ride. Stream a new episode of North of North Tuesdays on CBC Gem.