Long Medco/Express Scripts Arb

Last week I was able to purchase Petrohawk at a 2.5% gross spread on a deal that was as close to a sure thing as one could get (I bought at $37.85 and the deal is closing tomorrow at $38.75). I never wrote about it because I was only filled on about 15% of my desired position. Quibbling about a few pennies sure seems silly now but when the deal was available a week ago when the market was tanking it felt scarier.

The point of this anecdote is to point out that there are some good deals available in the merger arb world. Wall Street prop desks and European banks are the major players in merger arbitrage. Wall Street has scaled back proprietary trading and European banks are in risk off mode. There is simply not enough capital to close these spreads as many hedge funds do not have this expertise.

Today, I entered the Medco/ Express Scripts merger arbitrage play. This is not nearly as low risk as the Petrohawk deal but there is a 27% gross spread available. The  downside seems protected as Medco is trading lower today than where it was before the deal was announced. I believe the risk/reward is very favorable in this spread and have taken a position. However, because there is some risk in this trade it is smaller than the position I wanted to take in Petrohawk.

7 comments:

Anonymous said...

i am sorry for pleading ignorance but could you explain how you set this up and what you mean by 27%gross spread.. if this is too basic for you, then just direct me where i could read up on arbitrage 101

Tsachy Mishal said...

ESRX is purchasing MHS for $28.80 a share in cash plus .81 shares of ESRX. For every share of MHS that one purchases one has to short .81 shares of ESRX. The return if the deal closes would have been 27% of the price of MHS.

The deal has tightened by 1.5% since I posted this so the spread is now 25.5%. Meaning I am up by 1.5% on the trade. The reason I put on this trade today that I forgot to mention was the closing of the HK deal. I figured some of that money might come to close this spread.

marketfolly said...

Good to mention this as I think more investors will take a look especially since the spread is so wide.  There's obviously anti-trust risk but after MHS popped on the news initially, it's literally been a waterfall of selling due to the market turmoil. Unlucky 'timing' on the merger announcement, if you want to call it that. But obviously an interesting development for arbs & others.

Tsachy Mishal said...

I rarely invest in arb situations except in times of severe market stress when there are juicy returns available. Before Petrohawk the last time was Pfizer/Wyeth and Merck/Schering Plough.

It even rarer for me to invest in arb situations where there is a real risk but 27% was just too much for a very moderate risk.

Anonymous said...

Thanks for the post.  I love the reward but what about the risk?  What happens if the deal isn't approved?  The worst of all worlds for the deal would be if esrx went up with the news that the deal feel through and MHS fell because of the news.  What do you see happening if the deal doesn't happen?

Thanks!

Tsachy Mishal said...

The spread had come in and I took profits. I am no longer in the trade.

Tsachy Mishal said...

I have not kept up with the details since I exited the trade. I cannot answer the questions.