Comments on: 3Com Merger Arbitrage Idea

By: Leslie Schwartz

Leslie Schwartz — Fri, 09 Apr 2010 22:10:22 +0000

All of these comments seem to be correct. Except, did HP buy 3Com to run as is (e.g., the $5.50/per share company) – or for its potential, such as in China, organizationally (Chinese engineering / manufacturing, etc., and for whatever potential it may have for HP server and SAN clients?

So, my guess is they must see some potential to put about 2.7 – 3 $B USD for the acquisition.

By: Jae Jun

Jae Jun — Thu, 04 Feb 2010 21:41:08 +0000

I could have used the following formula
An = 0.25 An-1 + 0.45 Bn-1 + 0.40 Cn-1 + 0.25 Dn-1 + 0.15 En-1

But I don’t know what it is…

By: Paul

Paul — Thu, 04 Feb 2010 21:01:37 +0000

Fair enough.
I just see people who use a probability in their analysis of special situation investing and wonder how they come up with it.
It seems to either be a highly complex formula, which reminds me of something either Buffett or Munger said (or both), that successful investing requires no more than basic math skills.
Or it’s a gut thing, which you seem to use.
Usually a gut feeling beats out a complex formula. Less variables.

By: Jae Jun

Jae Jun — Thu, 04 Feb 2010 08:35:13 +0000

@ Paul,

No real mathematical formula to the 85%. I figured 90% is too high and 80% is too low. As simple (and flawed) as that haha

By: Jae Jun

Jae Jun — Wed, 03 Feb 2010 08:01:59 +0000

@ Chris,
I didn’t think about that part. I clearly see where you are coming from. I’ll try to dig up some more stuff on MOFCOM and its history and share if it is useful. Appreciate your point of view.

@ Dean,
Thanks Dean. I did get your email. I’ll send you a reply.

By: Dean

Dean — Wed, 03 Feb 2010 04:29:53 +0000

Nice article Jae and I like your use of Scribd. Those who use Kelly criteria in the stock market often use half Kelly for position size.

I tried to leave you a request on your contact page the other day and wasn’t sure if it worked. Can you reply to this or my email, just so I know either way. Thanks – Dean
.-= Dean´s last blog ..Day Eight: Ten of the Biggest Mistakes in Option Trading =-.

By: Chris

Chris — Wed, 03 Feb 2010 03:03:08 +0000

Hi Jae, I agree with 100% you that that MOFCOM is the sole reason behind the 5% premium for the reasons you listed above. The terms seem straightforward enough and the potential synergies are readily apparent; it is, however, a very high profile transaction–anybody who has ever dabbled in risk arb has heard about this deal. Given that (at least on the surface) the numbers are simple to crunch, I find the 5% premium a bit troubling. I am no specialist in international law, nor do I believe in totally efficient markets (as no value investor does), but 5% is a very significant figure for a transaction that is on everyone’s radar and with such simple deal terms. This would imply to me that there is something askew with the uncertainty surrounding Chinese regulatory approval, and it is the breakdown of this uncertainty (risk, for lack of a better term) where the profit lies in successfully investing in this transaction. Personally, given that I am not a lawyer (helpful in breaking down and quantifying all regulatory risks) nor a soothsayer (helpful in breaking down and quantifying all risks related to dealing with the Chinese government), I will leave this transaction to those rocking both aforementioned feathers in their cap. Long story short, anything that seems too good to be true (and a 5% premium in a widely-followed acquisition is most certainly that) usually is. Just my $.02.

As an aside, I do very much enjoy your site/spreadsheets/blog. Keep it coming.

By: Paul

Paul — Wed, 03 Feb 2010 01:58:03 +0000

Hi Jae, just wondering how you arrived to an 85% probability?

By: Jae Jun

Jae Jun — Tue, 02 Feb 2010 17:37:14 +0000

@ Chris,

I disagree that the spread is huge. Definitely more work required to learn about MOFCOM but for the small guys, there is no point in dealing with arbs where the spread is less than 1%. The only factor here between a 0.1% arb and 5% arb is MOFCOM.

Will do some more digging around though as I’m sure it isn’t the first time MOFCOM had to approve something, and since it is for anti-monopoly purposes, I dont think it’s as big a threat as you state. There are far many and bigger companies with bigger market share that HP has to be concerned about monopolizing the industry.

@ Alex MacKinnon,
It all depends on your asset allocation. Remember it says allocate “up to 27%”.

By: Alex MacKinnon

Alex MacKinnon — Tue, 02 Feb 2010 17:30:04 +0000

“I then plug the numbers in a Kelly formula calculator with the above stats and the result is a Kelly Percentage of 27%. Meaning, you can allocate up to 27% of your portfolio to this particular investment. I’m not 100% convinced with the Kelly formula but in this case, I would have to agree.”

You be confident putting 27% of your portfolio into this position ?

That’s seem quite high.

By: Chris

Chris — Tue, 02 Feb 2010 17:19:04 +0000

The spread on this transaction is huge–much larger than just about any other deal currently in the works–due solely to the fact that MOFCOM is a black hole of information. There is absolutely zero transparency, so gauging the likelihood of regulatory approval is extremely difficult. Additionally, the size termination fee is standard (about 3.5-4% of the total deal value) so do not put any stock (pun intended) into its size as a determinant of the transaction being completed. Investing in the deal may turn out to produce some great returns (as stated, the spread is HUGE for a merger arb transaction–the small spreads that are the current standard and are why merger arb funds are generally leveraged to the hilt), but the potential risks from the lack of regulatory transparency is inherent in size of the spread.

By: Jae Jun

Jae Jun — Tue, 02 Feb 2010 16:00:33 +0000

thanks for pointing that out. I misread it as 990,000,000. Fixed.

By: Old School Bro

Old School Bro — Tue, 02 Feb 2010 12:25:41 +0000

Sicne when is $99,000,000 equal to 1/2 of $1,000,000,000?