TWX Time Warner Inc. New

There is a new mantra for those who trade on difficult deals: 'Don't fight the president'

By Rob Copeland, Gunjan Banerji and Liz Hoffman 

The once-mighty merger arbitrager has been humbled.

Time Warner Inc. shares closed Tuesday some $20 a share below the price spelled out Saturday in AT&T Inc.'s $85 billion takeover bid.

The big discount in Time Warner's stock price means that an investor who buys the stock today and holds it would make around 17% annualized if the deal closes on schedule late next year.

Yet even at a time of ultralow interest rates and intense competitive pressure for investment returns, the tie-up is attracting little interest from Wall Street traders, thanks in part to concerns about potential regulatory action and lingering fear that the postcrisis stock-market boom could be on borrowed time.

It is the latest sign that the once-lucrative field of betting on mergers isn't the sure win it used to be.

Wall Street is giving the deal just a 28% chance of closing at the stated terms as of Tuesday's market close, according to Macro Risk Advisors.

The AT&T deal has "got a long, long road ahead," said Robert Zoellner Jr., chief executive of hedge fund Alpine Associates Management.

For years, merger announcements large and small prompted money managers to pile into shares of potential takeover targets while selling the shares of the acquirers, often reaping substantial profits when the deals closed later.

But that trade has broken down under pressure from several factors, hedge-fund managers and others say. Many are turned off by the perception that regulators are becoming more likely to block many large deals, particularly those that match firms in the same or similar businesses. Others cite risks associated with soaring company valuations as U.S. stocks head for their eighth consecutive year of gains, counting dividend payments. A substantial pullback could potentially raise the prospect that the deal wouldn't be closed on current terms.

Even when they aren't blocked, deals are getting bigger and taking longer to complete, a turnoff for fast-moving traders who look to make a quick buck employing merger- arbitrage strategies.

The average U.S. deal size hit an all-time high of $476 million last year, and there were a record 33 deals over $10 billion, according to Dealogic.

Over the same period, the total assets controlled by hedge funds dedicated to merger arbitrage have stayed roughly constant at around $23 billion, according to HFR, meaning their firepower hasn't kept pace with the mergers- and-acquisitions boom. Merger-arbitrage-focused hedge funds are up 2% this year, half the gain for hedge funds overall.

That has kept some company shares trading at big discounts, as hedge funds can no longer fill the holes created when risk-averse peers like mutual funds head for the exits following a deal announcement.

Hedge-fund managers like John Paulson, a longtime merger specialist, have shrunk by billions of dollars due to bad bets and client redemptions. Mr. Paulson's flagship merger fund is down more than 20% this year, a person familiar with the matter said.

For those managers who remain, much of their available cash is stuck in limbo. The average $1 billion-plus deal that has been agreed upon but not yet closed has been pending 144 days, the most since 2002, Dealogic said.

"Merger arb is the classic 'standing in front of a steamroller picking up nickels' business," said Roy Behren, who oversees about $5 billion at Westchester Capital. "And it takes a lot of nickels to make up for the dollars you lose" when a big deal goes sideways, he said.

AT&T and Time Warner are hardly the only dsytaeals under pressure, and many investors blame regulatory oversight.

AT&T Chief Executive Randall Stephenson has said the deal isn't the type that regulators take issue with because the combination of a content provider and distributor doesn't increase industry concentration. AT&T said the merger "will produce real innovation, better pricing for customers, a stronger competitor to cable companies and significant financial benefits for investors." A Time Warner representative didn't comment.

Shares of health insurers Cigna Corp. and Humana Inc., for instance, are trading well below the value of their mega-mergers with Anthem Inc., and Aetna Inc. respectively. The Justice Department sued to block the deals; litigation is continuing.

Antitrust officials have already succeeded in blocking several other deals, including Staples Inc.'s purchase of Office Depot Inc., and oil servicer Halliburton Co.'s proposed $37 billion takeover of rival Baker Hughes Inc.

Separately, tighter Treasury Department rules on inversions, meant to head off companies from merging to move their tax addresses out of the U.S., this year tanked Pfizer's $150 billion takeover of Allergan Inc.

U.S regulatory officials and rivals have expressed concerns about whether government restrictions were tough enough on Comcast Corp.'s deal for NBCUniversal, a marriage of content and distribution that is similar in ambition to AT&T's play for Time Warner.

AT&T brings its own particular baggage to bear in this arena, having abandoned its 2011 takeover of T-Mobile under regulatory scrutiny.

Hedge-fund manager Drew Figdor of TIG Arbitrage Associates, which specializes in merger bets, said all the government attention motivated him to increase his shorts, or bets on deals falling apart. He is wagering that Time Warner's stock will stay below the AT&T deal price for the extended future.

Mr. Figdor said he forecast a continued harsh regulatory environment, regardless of which political party takes the White House. That has him trying a new turn on the long time Wall Street axiom "Don't fight the Fed."

"If you're an arb investor, it's now 'Don't fight the president,'" he said.

Write to Rob Copeland at rob.copeland@wsj.com and Liz Hoffman at liz.hoffman@wsj.com

(END) Dow Jones Newswires

October 26, 2016 02:47 ET (06:47 GMT)

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