July 16, 2020- Listen to special guest Mal Spink, a seasoned arbitrageur and creator of Merger Arbitrage Limited. In this podcast we discuss:

  • The current environment for M&A
  • Risk management in merger arbitrage
  • Where the best opportunities lie currently
  • Mal’s current top merger arbitrage investment

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Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at www.Accelerateshares.com.

Julian Klymochko: All right, Mal, how are things with you out in the UK?

Mal Spink: Hi, Jullian. Yeah. Things are, things are pretty good, actually. Yeah, it is looking good, looking good.

Julian Klymochko: It is nice to finally be past all that Brexit stuff that had been dominating the headlines over the past number of years. I remember that was a media favourite, but obviously with the current pandemic concerns have obviously moved and there is kind of always new risks and opportunities presented to investors with respect to all these macro issues that are happening.

Mal Spink: Well, absolutely. I do think it is a case of ‘be careful what you wish for.’ The Brexit, a lot of people are saying that they’re tired of hearing about Brexit and well, yeah, there’s no more Brexit. They got something else to fill that time with.

Julian Klymochko: Yeah, exactly and once we are past COVID. I wonder what the next drama will be? I guess we will see. Can never really predict these big macro events, but nonetheless, I guess an investor needs to be prepared and what better way to really be prepared from a diversified asset allocation standpoint is with merger arbitrage, which is an area of the market of investment management in which you are fairly experienced. Why don’t you tell our listeners a bit about your background in finance and how you got into arbitrageurs specifically?

Mal Spink: Sure, yeah. I started off actually as an options market maker. Some time ago, a few years ago. I actually, I was working for an American firm based in London, but we would trade on Swedish markets. We are quite advanced in a sort of a technological sense at the time. The OMX was the Swedish market, so run by OM Group, which I think might be part of NASDAQ now. Have I got that, right? 

Julian Klymochko: Yeah, I am not sure. 

Mal Spink: Yeah, I think that the world’s just going to go into one big, large exchange isn’t it? At some point, but so yeah, it’s an options market maker and we had a great advantage-technological advantage and we have computing power. The knowledge that we had in the office, but you could see that business model had had a limited shelf life. 

Julian Klymochko: Right.

Mal Spink: I think one of the things of traders or being a trader and having that longevity in the market is to be able to adapt. I have been that doing that for a couple of years. Ever since the U.S. and I helped set up an office there. We would trade in on the ISE, which is the U.S. stock exchange. And that was in 2000, and you could kind of see at that point, you’re going to have to adapt and adopt and learn new strategies or take advantage of new opportunities. That was the kind of person you are going to have to be. If you are going to stay in the market. That is how I started.

Julian Klymochko: Yeah that makes sense. Because many of the guys who didn’t, they kind of turned into dinosaurs. If you look at floor traders, which went the way of the dodo bird and others sticking with these antiquated strategies that kind of get competed out of the market in terms of the opportunity set. It really lends credence to your idea of progressing and developing and really learning new skills. And it’s a discussion that we’ve had time and time again, what many people refer to as style drift. I like to refer to as progression and improving as an investor because no trade, no type of investment strategy is great forever. And I mean, you definitely need to move on to greener pastures. It is like what Charlie Munger says, “you got to fish where the fish are,” and over time, some ponds get depleted of fish. Whether it be technological advances or over competition, that is something we definitely stress to readers, so it is nice that you live by that credence as well.

Mal Spink: Yeah, exactly. That kind of inherited strategy or that. I love being a market maker is it was great, I was thrown in at the deep end and you learn very quickly that the responsibility starts and it stops with you. And it’s a great lesson, as a trader to have. Where your subsequent career happens to take you. That kind of inherited strategy, you are doing something that you have been told to do and if that doesn’t adapt, then yeah, enjoy it while you can, because that will finish and then you’re going to go into a different field.

Michael Kesslering: As an investor, I think it is really important to have some of that background training and in something such as market making where you’re really working with such slim margins, right. In terms of the operational risk in something like that is quite substantial, and so I mean. It is a really interesting area to get our feet wet in investing. So when you moved on from options market making, what were some of your takeaways with that onto the arbitrage side? Is it some of the operational side, or are you literally doing some market making within some of these arb spreads or where have your takeaways be?

Mal Spink: Well, I think the one of the most important things is the discipline. You have to have as a trader. Knowing that you have that responsibility and you do have that sort of pressure on you a market maker. Because there is a number of people looking at the figures and you have that responsibility and you have to produce. So you have to stay disciplined or it will catch up with you. So in subsequently whatever area of the markets that you then go into. You all, well hopefully take that skill and have that with you. It’s like right, I can’t just do anything crazy here because you can’t get away with everything forever. It will catch up with you.

Julian Klymochko: Yeah, it is important to note that I agree with you. It really helps starting out on the trading side because you really get to understand the underlying infrastructure and plumbing driving markets, where a lot of investors start. They just look at the data, for example, closing prices. And no sense for, you know, the feeling of the market. How it is to trade? Understand the underlying liquidity trading without pushing market prices around and things of that nature and really best execution, which is a super important consideration, just given kind of slim margins of various business lines these days. And so you go from options market making to arbitrage. And what was the main thing that drew you to arbitrage as a strategy?

Mal Spink: Well, first of all, I’ve always been very mathematical in my approach. Was always very numerical and that’s what attracted me to the markets is hugely data, statistically intensive line of work. And I think at the time that coming from an options market making background. We were always market natural. 

Julian Klymochko: Right. 

Mal Spink: So there was not, we seen various ups and downs in the markets and as a new trader, you hear these stories. And there was always stories in the office, about who did this? Someone did this. But at the end of the day, the approach was to be market neutral and you think, wow, this is really interesting. So we can be market neutral, would not take a direction and still make a great deal of money.

I mean, it was profit. It was incredibly profit. So you kind of think, well, hold on, if this particular line is going to be, not exactly dry up, but become more and more difficult. It is going to become more and more accessible to a larger number of players. Then how can I develop a different strategy or what else is there? Or what can I take that’s already been done and add my sort knowledge as I accumulate to it and move that strategy forward, and then of course naturally that as a market neutral strategy you are almost there in arbitrage.

Julian Klymochko: Right. Yeah, I definitely feel the same way where investing is really moving. Kind of beyond that 60/40 equity bond portfolio, where investors are really clamouring for uncorrelated strategies, as you indicated. Market neutral strategies, such as merger arbitrage, can really present that to investors and it adds a ton of value. Especially in an environment like Q1, or when you have these big bear markets, that is where these types of strategies really shine by protecting capital. I always like to say, if you look after the downside, the upside will take care of itself and that is no more true than in merger arbitrage and so continuing on with that point. What are some key investing lessons that you have learned investing in arbitrage? Some wisdom that you have gathered over the years as a grizzled veteran.

Mal Spink: Some wisdom, well first of all, I appreciate those kind words to suggest that I might I might have some wisdom. I think the idea of definitely we touched on this already, but being able to adapt. Not just, be stuck trading one thing. If you are looking at arbitrage is something new then I would say, arbitrage is such a wide field; it can be as difficult as you sort of want to make it. Is statistically intensive or in terms of data mining, depending on what kind of skills you got or market experience you’ve got. I would say don’t bite off more than you can chew you. You start-off something that you are comfortable with and you work your way up. When I say up, I mean if that is what you interpret it, but you don’t need to be doing something maybe at the level of Renaissance Capital immediately. You need to do something, which you are capable of doing, and you are comfortable in doing. 

Julian Klymochko: Right. 

Michael Kesslering: I mean, both Julian and myself are initial trading background on the buy side in different time periods within the realm of closed end fund arbitrage, which is a very, very niche area of arbitrage. But nonetheless as you had mentioned, it’s focusing on something like that and then widening your sphere of competence, if you will. So, and with that, I think you could adapt that to really focus on risk management. So that can be as granular as individual position sizing or within the strategy itself, so that’s really interesting. So beginning your merger, arb background, back in the early two thousands. What have you seen change in those intervening years in this space? I mean, for myself, I have just been involved in merger arb since 2015-2016. How has that really changed from the early two thousands, whether it be spreads, competitors in this space? What have you seen? 

Mal Spink: Well spreads. Yeah, let’s start with that. Like most strategies of this kind of nature that become known and with the internet, they are sort of dissemination of ideas and knowledge, the lowering in trading commissions, the accessibility of trading software to the general public. It has become so accessible the spreads have obviously declined, I mean, significantly. I think that is one thing; also, there has been a change of who is actually doing the buying. I was just saying that the kind of the stories of old. You know, the eighties, you know, the corporate raiders. Have kind of evolved into a more subdued and the sort of the activists even which kind of evolved out of the corporate raiders have now sort of evolve again, into this kind of more of a social conciliate conciliar approach. Is like, hey, let’s work with management, so yeah. I think there has been a big change, not necessarily shift, but an evolution along those lines, definitely.

Julian Klymochko: It is a really interesting environment for M&A currently. Obviously, you know, quite volatile given what is happening with COVID and just wild effects on various companies and merger agreements. You are seeing elevated risk and really a dearth of deal announcements. However, that is kind of starting to turn around in July. First week of July, we have seen four new deals announced with National General-Allstate today. Vivint Solar and Sunrun yesterday. What are your thoughts on the current environment for M&A and what do you think is the new normal? Will it go back to normal or is this new environment kind of something that will continue going forward?

Mal Spink: Yes, I think there will be a new normal. I suspect, I am going to be leading a little bit and say that there is a certain amount of business you can do online. But if you’re a CEO or whatever level of executive, if you can’t get on a plane and go somewhere to make a deal, or at least that kind of interaction is restricted, then I think that is going to damp your deal activity, at least for the time being or sometime to come, so I can see things taking some time to recover on the deal-making front.

Julian Klymochko: Right and where are you viewing the best opportunities in the current environment?

Mal Spink: Oh, well, here we go. I have taken a position in in Tiffany. I was in Tiffany before and sold out fortunately and following the recent spike of articles and news regarding that deal. Then I bought back in, so I am, quite happy to be in Tiffany right now.

Julian Klymochko: Yeah, that is certainly an interesting position. Obviously, the market is quite concerned about that the buyer may try to walk. As we have seen on other deals, but for disclosure purposes were also long Tiffany and we like that deal, especially given where it is trading currently. Super, super wide spread and many investors, like I said, concerned about a potential buyer, but who knows? I mean its highly strategic dealer?

Mal Spink: Sorry, what I am just concerned about the traders and you know, these masters of the universe as we used to be called are now getting off financial news from Women’s Wear Daily.

Julian Klymochko: Yeah. Well, surprisingly, it is quite a legitimate source. You know, I have been following it for a number of years and they actually do break fairly reputable stories. Unlike other media sources out there. The Women’s Wear Daily is surprisingly accurate and you would not think that given the name of the publication, but yeah, I definitely put stock into what they say. So that’s something to keep in mind, but nonetheless, you know, speaking of deal risk and things of that nature. How do you think of risk management in the context of merger arb?

Mal Spink: Well I think one of the main points that probably doesn’t get enough coverage is the difference between and this comes from the sort of general populist articles that you might read on a given news site is the difference between a stock deal and a cash deal and how the risks are different about how there is broader market exposure to a cash deal. I don’t think that’s sort of investigated enough. I don’t think that’s reported enough. I think people need to understand that the spread is wider if the cash deal with the target stock decreases because it’s floor price, the under adjusted price that he goes to is going to be a lot lower. 

Julian Klymochko: Right. 

Mal Spink: And I think it is important that people do fully understand that point.

Julian Klymochko: Yeah. 

Michael Kesslering: So for each deal that you’re looking at, say for Tiffany’s you don’t have to give an exact number or anything like that, but in each deal that you’re looking at, are you going in and modelling in exactly what you believe the deal-break price would be on the downside? Or are you looking at it more generally?

Mal Spink: I got a pretty good modelling system for that. Yeah, I would definitely look at that because at the moment I’ve recently been concentrating more on cash deals and looking at what that that floor price would be.

Michael Kesslering: Julian…

Julian Klymochko: Sorry, go ahead. 

Michael Kesslering: Sorry, I was just going to say. What you have seen in say Tiffany’s in particular is just that floor price has come up substantially in the last couple of months as we have been working out the deal. I mean it is, de-risking slightly on that side where, you know, I had seen original estimates of a Tiffany deal break price in the seventies or eighties you know, with the recovery as it has been happening. You have to believe that has increased,

You know, quite materially. 

Mal Spink: Well, yeah absolutely. I suppose as a rough proxy, you could always just look at LVMH price and see how that has behaved.

Julian Klymochko: Yeah, exactly. It is near an all-time high.

Mal Spink: Just to make that absolutely clear. I am not suggesting people would necessarily do that but as a rough proxy, you could look at LVMH price and it is quite impressive actually. When Jeff, was it October, Julian that deal announced, end of October?

Julian Klymochko: That was announced in November 25. However, there was this public bear hug letter that came out and you know, the public negotiation prior to striking a definitive agreement in November. So yeah, I believe the initial bear hug letter that that process could have started you know, a month or two before that. 

Mal Spink: Right. 

Julian Klymochko: Because they started with a lower unsolicited proposal at 120 prior to striking a definitive deal at 135 and now obviously the stock at kind of 122 and, you know, pretty massive spread with respect to that. And the market not pricing in a huge odds of success, but thus far there have been talks of LVMH wanting to reprice, however they have not commence any litigation with respect to that. But for the focusing on risk and opportunity. Tell us about your most memorable merger arbitrage investment.

Mal Spink: Most memorable, ooh, there is a few. 

Julian Klymochko: Good or bad? 

Mal Spink: Whatever one I suggest, I think it is going to be a good one. It will go good. I think there was I can’t remember the exact name of it now. When I was in New York, it was one of the first M&A deal. I was trading because primarily I was an options market maker on the ISE and Hewlett was the market maker for Hewlett Packard. They took over a company; I think it was blue something. Maybe one of the listeners can help me out on this one, but the thing was, it was back when the market in the U.S. was trading in sixteenths and eights. 

Julian Klymochko: Right.

Mal Spink: Which was something sort of, obviously I was aware of, but new to me as a trader because I was coming from Europe. So it meant that as the target stock that you could almost be on the bid and then subsequently be on the offer and you’re making 12 and a half cents a spread. And I was doing that for quite a long time and I remember my boss saying to me once. He said, well, you are having a great month. What has been going on? And of course I kind of parlay into the options trading because I’m primarily an options market. All I needed to do was just buy a few thousand chairs on the bid and then subsequently putting up an offer and have that lifted and yeah, it was one of the most easiest things I’ve ever done.

Julian Klymochko: Yeah, certainly the fractional trading made for wide to bid, ask spreads and much more profitability from a market making perspective or buying the bid immediately offer it out on the ask and kind of do that over and over again. So what advice do you have for budding arbitrageurs listeners who are interested in the strategy, but are just kind of getting their feet wet and learning how it works?

Mal Spink: Yeah, good question. I think that touching on what you said obviously about Women’s Wear Daily and various news sources. I think research is important but there is always enough news. If you keep going looking for it and I think that could be a thankless task. You could spend your entire life just search around looking for news. I think it is important that you find some way or someone or something that you are comfortable with. You like the style of reading, you like the style of the writing, the quality of the news. And it’s something that you can understand and it’s something that you think you can use and then stick with it. I think there is a number of sources nowadays, especially in times like this, that maybe a little bit less scrupulous and simply writing copy for the sake of it. 

Julian Klymochko: Right. 

Mal Spink: So I think it is important that you do your research, but when you find somewhere that, you are comfortable with, that is something that you should maybe stick with on a longer-term basis.

Julian Klymochko: Yeah, this sounds like a good plug for Merger Arbitrage Limited. Why don’t you tell our listeners about what you do online and some of the content that you produce?

Mal Spink: Yeah, sure, mergerarbitragelimited.com website dedicated to merger arbitrage. We have a number of articles written about trading merger arbitrage. There is a number of resources, a number of news feeds, news sources on the website. There is a number of additional sources, academic articles, relevant books, weekly commentary. Hopefully a whole sort of investors’ toolkit of resources that’s required to trade merger arbitrage.

Julian Klymochko: Interesting, so Mal before we wrap things up here, why don’t you tell people where they can follow you and where they can get your content?

Mal Spink: Absolutely, Thanks Julian. Yeah, mergerarbitragelimited.com by all means. Sign up, register, weekly email, seeking alpha. There was a frequent publication on seeking alpha. Twitter, the handle is @MergeArbLimited and of course LinkedIn. Yeah, Mal Spink on that, LinkedIn.

Julian Klymochko: Okay. Perfect. Well, thanks so much for your time today Mal. We love hosting other investors on this podcast, and it is great to have another merger arbitrage practitioner on the show to discuss the current state of the union. So thank you very much. 

Mal Spink: Thank you. 

Julian Klymochko: And to all our listeners, hope you enjoyed the show. We will chat with you soon, cheers.

Thanks for tuning in to the Absolute Return Podcast. This episode was brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at www.AccelerateShares.com. The views expressed in this podcast to the personal views of the participants and do not reflect the views of Accelerate. No aspect of this podcast constitutes investment legal or tax advice. Opinions expressed in this podcast should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information and opinions in this podcast are based on current market conditions and may fluctuate and change in the future. No representation or warranty expressed or implied is made on behalf of Accelerate as to the accuracy or completeness of the information contained in this podcast. Accelerate does not accept any liability for any direct indirect or consequential loss or damage suffered by any person as a result relying on all or any part of this podcast and any liability is expressly disclaimed.  

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