James Dinan had profound experience in risk arbitrage before he founded his event driven strategy fund, York Capital Management in 1991. He had started working for the merger arbitrage firm Kellner DiLeo & Company in 1985 and before that he was employed at the stock research firm, Donaldshon, Luftkin & Jenrette (DLJ). In the interview series ‘The New Capitalists Shaping Our World’, Dinan talked about how the new world of risk arbitrage is significantly different from back in the days when he started out. Since technology has facilitated the instant availability of company’s filings to investors around the world, the informational advantage in the form of a one or two days headstart that firms like that of Dinan’s used to have is erased. According to him it is more of a ‘judgement’ game now, and considering his net worth of $2.4 billion as of January this year according to Forbes magazine, the 55-year-old’s judgement seems to be in tip-top condition.
Earlier in his career Dinan worked 100 hours a week as an investment banker, but hard work wasn’t all that he claims shaped his investment prowess. He suffered from hearing disability as a child and he often had to ‘guess’ what was being asked of him. With time he got much better at it. In fact, he attributes his rare ability to make the right decisions in the face of incomplete market information to that childhood disability. With Dinan’s background in mind, we have compiled a list of his top risk arbitrage picks according to his fund’s latest 13F filing, which are Actavis plc (NYSE:ACT), NXP Semiconductors NV (NASDAQ:NXPI), DIRECTV (NASDAQ:DTV), Comcast Corporation (NASDAQ:CMCSA) and Family Dollar Stores, Inc. (NYSE:FDO).
Most investors don’t have enough time to do in-depth analysis on each stock they want to include in their portfolios. Professional investors like Dinan spend weeks conducting due diligence on each company and spend millions obtaining information and paying the salaries of Ivy League-educated analysts. That’s why we have always believed that imitating the stock picks of hedge funds and billionaires is an excellent shortcut we can take, if done properly. To that end, we analyzed the historical stock picks of these investors and our research revealed that the small-cap picks of hedge funds performed far better than their large-cap picks, as well as the market as a whole. A portfolio of the 15 most popular small-cap stocks among hedge funds outperformed the S&P 500 Total Return Index by 95 basis points per month between 1999 and 2012. The exceptional results of this strategy got even better in the forward testing since the end of August 2012, when the strategy was launched. The most popular small-cap stocks among the hedge funds in our database beat the market by more than 82 percentage points (see the details).
The first holding in our list is represented by Actavis plc (NYSE:ACT), which acquired Botox-maker Allergan for $219 per share late last year. The transaction was a mixture of $129.22 in cash and 0.3683 of Actavis shares for each unit of Allergan stock. Shares of the botox-maker were trading around $200 before the deal was announced in mid-November. The deal, which was closed in mid-March, resulted in annualized merger arbitrage returns of 72.8%. Actavis plc (NYSE:ACT), on the other hand, rose by 24% during this four-month period.
Towards the end of 2014, York Capital held 2.02 million shares of Allergan valued at $429.84 million, while its stake in Actavis plc (NYSE:ACT) amounted to 1.35 million shares valued at $348.64 million. Andreas Halvorsen’s Viking Global increased its exposure to Actavis by 80% during the fourth quarter to 4.59 million shares valued at $1.18 million. Actavis was also among the best performing stocks for the first quarter of 2015.
Next in line is NXP Semiconductors NV (NASDAQ:NXPI) of which Dinan held some 4.09 million shares valued at $312.22 million in his fund’s portfolio at the end of the fourth quarter. NXP entered into a definitive merger agreement on March 2 with Freescale Semiconductor Ltd (NYSE:FSL), under which the latter will receive $6.25 in cash and 0.3521 of an NXP share for each of its own ordinary shares. The transaction is expected to close in the second half of 2015, and assuming an early October close, the annualized arbitrage returns stand at about 21%.
Among the billionaires that we track, eight had invested a total of $1.12 billion in the company. David Tepper of Appaloosa Management LP was one such billionaire, as his fund held some 2.35 million shares valued at $179.75 million according to the latest 13F filing. NXP Semiconductors NV (NASDAQ:NXPI) has benefited considerably from the overwhelming success of Apple Inc. (NASDAQ:AAPL)’s iPhone 6, as it provides the $726 billion company with high performance solutions relating to radio frequency.
Dinan initiated a stake in DIRECTV (NASDAQ:DTV) during the third quarter after the announcement in May last year that the company was going to be acquired by AT&T Inc. (NYSE:T) in a cash and stock transaction that valued DIRECTV at $95 per share at that time. The price included $28.50 in cash per share and a collar agreement which could pay between 1.724 and 1.905 of AT&T shares, depending upon AT&T’s price at the closing of the deal. Although expected to close within 12 months at the time of the announcement, it could take the deal significantly longer as the FCC paused the 180 day “shot clock” in mid-March to evaluate if sensitive information regarding the two merging companies should be shared with the other media companies taking an active role criticizing the marriage of these two companies. The annualized arbitrage returns stand at 17% assuming the $95 closing price and the deal reaching completion by this May.
DIRECTV (NASDAQ:DTV) was held by 63 hedge funds at the end of the fourth quarter among those that we track, with an aggregate investment of $10.66 billion, as compared to 57 funds with $9.67 billion invested a quarter earlier. Warren Buffett’s Berkshire Hathaway held the highest stake among these with 31.35 million shares valued at $2.72 billion. The company was also among the top picks of billionaire Tom Sandell at the end of 2014.
The Comcast Corporation (NASDAQ:CMCSA) – Time Warner Inc(NYSE:TWX) merger has met the same fate in terms of FCC intervention. Comcast is set to acquire TimeWarner in a stock for stock transaction that valued the latter at about $158.82 per share based on the stock prices at the time of the announcement. The deal was expected to close towards the end of 2014, yielding annualized merger arbitrage returns of nearly 199%, but has been marred by delays owing to regulatory reviews.
Paul Ruddock and Steve Heinz’s Lansdowne Partners held a significant stake in the media and technology company amounting to 24.77 million shares valued at $1.44 billion, according to its latest 13F filing. York Capital also held some 3.74 million shares of Comcast Corporation (NASDAQ:CMCSA) valued at $216.97 million towards the end of the fourth quarter.
Family Dollar Stores, Inc. (NYSE:FDO) was another of Dinan’s risk arbitrage picks. The company is set to be acquired by Dollar Tree, Inc. (NASDAQ:DLTR) in a cash and stock transaction that values Family Dollar at approximately $76.50 per share. Family Dollar shareholders approved the merger in January and the deal could close this month, but it is still awaiting the FTC’s approval. Based on Family Dollar Stores, Inc. (NYSE:FDO)’s current price, the annualized arbitrage returns stand at about 34%. Nelson Peltz’s Trian Partners and Paul Singer’s Elliot Management are two other significant stock holders of Family Dollar, with their respective stakes standing at 8.37 million shares valued at $662.70 million and 8.10 million shares valued at $641.78 million respectively.
Disclosure: None
