Wednesday, October 27, 2010
WSJ explains an swaps strategy for M&A arbs. The long and short of it: use credit derivatives - and not equity - to bet on an acquisition:
Take the acquisition of packaging manufacturer Pactiv, which is being funded mostly with debt. Pactiv's shares have risen 38% since news of a deal broke in May. But the company's credit-default swaps have more than tripled: Five-year insurance on $10 million of debt costs $425,000 a year, compared with $140,000 in May, according to Markit.
What I think is interesting about this strategy is that when you start buying CDS' you'll continue to have equity-like exposure to the company after it goes private. Of course, one motivation for going private is that managers is that once you're private you no longer have to worry about the public markets and the short-term activist investors. Well, if you are relying the debt markets to fund business or your acquisition, going private may not be quite the quiet have you expected.