Thread by @ValueSituations

Market Risk & A Buffett Special Sit🧵- Of all the coverage of the Berkshire $BRK annual meeting over the weekend, what I found most interesting was the news of $BRK 's ENORMOUS special situation trade via a merger arb play on the $MSFT / $ATVI deal –
bloomberg.com/news/articles/…

Is this one of the largest $ merger arb trades ever? – based on media reports, $BRK acquired an incremental ~7.6% or ~59.5m shares of $ATVI post-31 Dec-21, which at avg. price of ~$80 post deal announced = a ~$4.76bn investment -

Merger arb is a classic special sit strategy, and many are unaware that it was a key one for Buffett in his pre-Berkshire days managing the Buffett Partnership funds, when “Workouts” as Buffett called merger arb comprised 30%-40% of his portfolio;

- at the time he told his partners to expect the portfolio mix to tilt toward workouts when the market was rising. (H/T Jeremy Miller, "Warren Buffett’s Ground Rules")

Buffett estimated that over a 65 year period from his Graham-Newman days to $BRK through 1988, workouts produced an average unleveraged annual return of 20% (Buffett’s workout strategy generated a 53% return in 1988);

The usefulness of merger arb to investors is perhaps best summed up by Buffett in his 1988 $BRK Shareholder Letter, “Give a man a fish and you feed him for a day. Teach him how to arbitrage and you feed him forever.”

Back to the $ATVI arb - If the deal closes at $95/share, $BRK will earn a ~20% return on the arb portion of its investment or ~$900m; if it closes by 31 Dec this roughly equates to a ~24% IRR, in line with Buffett's historic average workout performance.

What is the significance of this insight today ?
Merger arb investments (and special sits strategies more generally) are market-agnostic, i.e. their success tends to be uncorrelated to the wider market and so can help insulate a portfolio from down markets -

I also find it very notable that of the net ~$41bn that $BRK invested in equities in Q1, a merger arb trade represents ~11.6% of this; I think this speaks to the current risk environment & Buffett's perception of it -

In the current market characterised by a host of macro uncertainties (slowing growth, inflation, rising rates, debt, war, geopolitical risk) and still-high valuations ($SPX only ~13% off ATH!) I see special / value sits, including selected merger arb-type plays, as offering -

the best risk-adjusted returns independent of where wider market ends up going. Special sits such as merger arb & spin-off situations are among the types of value situations that can provide actionable opps, as I've written previously in my newsletter valuesits.substack.com/p/between-untu…

Some recent special situations-related ideas I've featured in my newsletter are: (1) Alphamin Resources $AFM.V $AFMJF, a leading, strategically significant tin miner now in play - valuesits.substack.com/p/weekly-bulle…

(2) Wickes Group Plc $WIX.LN #WIX - a recent spin-off that has sold off for non-fundamental reasons - valuesits.substack.com/p/wickes-group…

(3) Hibernia REIT Plc $HBRN - an Irish office REIT that I wrote about in June-21 as a PE-RE takeover candidate - valuesits.substack.com/p/forced-purch…

- My $HBRN idea actually played out more or less as I expected when Brookfield announced a takeover of $HBRN in March for return on my idea of ~34.8% IRR / 1.35x MOIC -

https://twitter.com/ValueSituations/status/1507298306216820736

If these types of investing ideas are of interest to you, my newsletter covers undervalued public equity situations w/ special sits-type characteristics & catalysts - you can find my newsletter linked here, please sign up & subscribe today! - valuesits.substack.com