1. Adventures of a Risk
Arbitrageur

2. Trade # 1

3. Trade # 2

5. Trade # 3

6. From Nirma’s Annual Report of FY1997-98

9. Trade # 4

10. Trade # 5

11. Trade # 6

15. A Special situation
is one in which a
particular
development is
counted upon to
yield a satisfactory
profit even though
the general market
does not advance.

16. Buffett’s
Case on
Arcata
Corporation

17. 28 Sept, 1981: KKR agrees to buy
Arcata
printing and forest products
business and a contingent claim.
10,700 acres of Arcata timberland
acquired by govt. in 1978.

18. Arcata Timberland

19. $97.9 mil compensation over many
installments deemed inadequate; plus
co got 6% simple interest- claimed
more, compounded
Value of the stock = value of the
business (less debt) + the value of
contingent claim

20. KKR offered Arcata’s
shareholders $37 plus two-
thirds of contingent claim if
materialized.

21. How did HE
Analyse this
situation

22. How likely is it that KKR will
go through with this
transaction?
Deal subject to “satisfactory
financing”
Given KKR’s credentials, low
probability of deal failure

23. What will happen if the deal
with KKR fell through?
Other buyer likely to emerge

24. What is the Redwood Claim worth?
Somewhere between zero and “a whole lot.”
Why did Mr. Buffett not value this claim?

25. Started buying at $33.50. offer price
was $37 plus two-thirds of the claim.
Started buying on 30 September.
Payment expected by next January.
Heads I win a little, tails I win a lot
Not counting the value of contingent
claim, expected return = 40% p.a.
annualized.

26. Financing glitches appear.
(“Shit Happens”)
The stockholders’ meeting was
postponed again, to April.
Such news usually treated by
the arbitrageur community as
bad bad news.

27. Stock declines, Mr. Buffett
buys more.
On March 12 KKR revises offer,
first cutting it to $33.50, then
two days later raising it to
$35.00.

28. March 15: Arcata Board Rejects
KKR bid and accepts rival bid of
$37.50 plus 50% of contingent
claim.
Stockholders approved deal, $37.50
paid on June 4.

29. BRK received $24.6 mil versus its
cost of $229 mil.
average holding period close to 6
months.
Annualized return came to 15%
return excluding any value for the
redwood claim.

30. What about the contingent
claim?
The trial judge appointed two
commissions:
One to look at the timber’s
value

31. The other to consider the
interest rate question.
January 1987: Timber valued
at $275.7 mil compound
interest @14% p.a. awarded!
Wow!

32. August 1987 the judge upheld
these awards
Total value of claim = $600 mil.
Government appealed. In 1988,
claim settled for $519 million.
BRK received an additional $29.48
per share, or about $19.3 million.

33. Risk Arbitrage Teaches
Probabilistic Thinking

34. Risk Arb: Pursuit of profits
from an announced corporate
event such as sale of the
company, merger,
recapitalization, reorganization,
liquidation, self-tender, etc.

35. In most cases the arbitrageur
expects to profit regardless of
the behavior of the stock
market. The major risk he usually
faces instead is that the
announced event won’t happen.

36. To evaluate arbitrage situations you
must answer four questions:
1. How likely is it that the
promised event will indeed
occur?

37. 2. How long will your money be
tied up?

38. 3. What chance is there that
something still better will
transpire - a competing
takeover bid, for example?

39. 4. What will happen if the
event does not take place
because of anti-trust action,
financing glitches, etc.?

40. Annexure to 3rd Edition of Security Analysis

41. Trade # 7

42. The commercial vehicle business of
Eicher Motors Limited along with the
related components and design
services businesses will be transferred
to the joint venture company which is
a step-down unlisted subsidiary of
EML on slump sale going concern
basis at a value of Rs202 crores

43. Volvo will contribute Rs 1,082 crores in cash and will
also transfer its Indian truck distribution and
service network to the joint venture. In lieu of cash
and the service and distribution network, Volvo will
be allotted 45.6% equity shares in the joint venture.
EML will consequently hold the balance 54.4%
equity and thus the joint venture will be a subsidiary
of EML and its financials will be consolidated with
the financials of Eicher Motors.

44. Volvo will also buy 8.1% equity stake in Eicher
Motors Limited from the promoters of Eicher Motors
Limited at a consideration of 157 crores which
equates to Rs.691 per share. Now taking into account
it’s direct and indirect holding, Volvo’s economic
ownership of the joint venture will be 50%.

45. The joint venture will have exclusive distribution
rights in India for all present and future Volvo truck
products. All future Volvo group truck projects in
India will be routed through this joint venture
subject of course to agreement on the terms and
conditions.

46. EML and promoters have also entered into a
separate non-compete agreement with the joint
venture for not getting into trucks and buses
business in India. Volvo shall pay a non-compete
consideration of Rs.39.4 crores each to Eicher
Motors and to the promoters.

47. Post-closing Eicher Motors will receive a
consideration of 202 crores from the joint venture
and it will be debt-free. In addition there will be the
39.4 crores of non-compete fees which will come in.
So both put together this will be around 240 crores.

48. “Eicher Goodearth (promoter of EML) intends to
propose to the EML board to consider a buyback of
shares from the public shareholders in the same
proportion as the promoters have sold to Volvo. So
the promoters have sold 8.1% out of 58.2% stake and
that equates to around 13% of the promoter holding.
So we are recommending to the EML Board to do the
same to the public shareholders and at the same
price of Rs.691.”

49. Buy 100 shares at 225
Tender 13 shares at 691
Effective cost of 87 shares = 13,517 or Rs 155 per
share.

52. Capital Structure Arbitrage
Exploiting relative valuation gaps
between different securities which
form part of the same capital
structure.

53. Network 18 PCCPS
1 pccps = 1 stock + 1 warrant + 1 preferred
=
1/2 stock
Buy Spot Sell in Futures Create cheaply!
Trade # 8
Market neutral returns of 23% in 3 months

54. http://fundooprofessor.wordpress.com/2011/03/01/
ben-graham-framework-36/

60. Example Capital Structure Arb:
ISPAT INDUSTRIES

61. http://fundooprofessor.wordpress.com/2011/02/19/
bfbv-examination-question/

62. http://fundooprofessor.files.wordpress.com/2011/02/
ispat_pa_22122010.pdf

69. Subsequent Developments

70. 24 Feb 2012

71. 3 Sept 2012
13 Sept 2012

73. EXAMPLE
CONVERTIBLES ARB
TATA STEEL
CCPS
Trade # 9

75. 26.8 x 6 = 160.80 which is 12% cheaper than Tisco Stock

76. Current Discount is 12%

79. Rs 2 per share dividend
on Rs 26 dividend yield (tax free) = 7.7%

81. Update as on 29 October 2012

82. EXAMPLE
CONVERTIBLES ARB
TATA MOTORS DVR
Slides from a presentation made on 13 october, 2011
Trade # 10

83. DVR enjoys
1/10th the
voting right of
Equity but gets
5% extra
dividend rights.
Discount of
46%

84. Post Split Equity shares = 269 cr shares @ 186 ≅ Rs 50,000 cr.
Post Split DVR = 48 cr DVRs @ Rs 101 ≅ Rs 4,800 cr. (Almost $1
billion)
Discount of Rs 85 per DVR x 48 cr DVRs = Rs 4,100 cr.

85. http://breport.myiris.com/ICICISL/TATENGLC_20110530.pdf
Why No Mention of “DVR”?
Price is before stock split

86. Why don’t they
switch?

87. Why the discount?

88. Is corporate
28% discount
governance at
Pantaloons better
than at the house
of Tatas?

89. Month Promoter Stake in DVR
Jun 2011 9%
Mar 2011 19%
Dec 2010 19%
Sept 2010 36% Is there a technical
Jun 2010 36% reason for the
Mar 2010 53%
Dec 2009 57%
discount?
Sep 2009 80%
Jun 2009 84%
Mar 2009 84%
Dec 2008 84%

90. 1,500 Class B = 1 Class A (Economic Rights)
10,000 Class B = 1 Class A (Voting Rights)
74x1,500 =111,000
No Discount in Class B

91. Why do Tata
Motors Futures
trade at a
discount to
spot?

92. Update as of
29 Oct 2012

94. 1500:1

96. Thank You