Bidding Wars and Smart Beta

Matt Levine is a Bloomberg View columnist. He was an editor of Dealbreaker, an investment banker at Goldman Sachs, a mergers and acquisitions lawyer at Wachtell, Lipton, Rosen & Katz and a clerk for the U.S. Court of Appeals for the Third Circuit.
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Congrats Valeant.

After Endo's $175-ish cash-and-stock topping bid last week, yesterday Valeant raised its all-cash offer for Salix from $158 to $173 and Endo bowed out, leaving Valeant free to close its deal as soon as the beginning of April. (The tender offer is set to "expire at 12:00 midnight, Eastern time, on April 1, 2015 (one minute after 11:59 P.M., Eastern time, on March 31, 2015), unless extended," and don't you love how lawyers explain the concept of midnight?) Valeant is selling $1.45 billion worth of stock to fund the increased purchase price. And here is Ronald Barusch on the timing considerations: In exchange for bumping its bid, Valeant got an earlier deadline on its tender offer, making it harder for anyone to hold out for a higher bid.

It's sort of an odd bidding war, no? I mean, for one thing, it comes on the heels of "an accounting scandal, a failed merger and the departure of top executives." But also, here is Salix's recommendation of the ($158) Valeant deal to its shareholders, from earlier this month, which describes a long intricate strategic-alternatives process involving Valeant and seven other potential bidders (Parties A through G, surely one of which was Endo, right?), as well as "substantial market speculation regarding a potential sale of the Company, such that other parties would likely have already approached the Company if interested in pursuing a transaction." You'd think that that would do a decent job of flushing out best-and-final bids, but Valeant won with a $158 cash bid, beating out a $150 cash-and-stock underbid and not much else. But now, less than two weeks later, after a deal was signed (with a breakup fee), Valeant is at $173 with a $170+ cash-and-stock underbid. I guess this is good work by Salix and its bankers, but it feels pretty fortuitous.

Elsewhere, Skadden managed to represent both Valeant and Endo in the bidding war, which is a pretty neat trick for a law firm. The banks involved in the Holcim/Lafarge merger are worried about losing over $100 million of fees if the deal falls apart. And Credit Suisse is settling a dispute over its advice to Freeport-McMoRan by agreeing to give Freeport some free advice.

Smart beta.

The thing that people say -- I mean, I say it -- when criticizing active investment management is that, by definition, the total performance of everyone trying to beat the market will average out to the performance of the market, less fees and trading costs. So if you can't know in advance who will beat the market then, in expectation, you will underperform the market by trying to beat it. And, empirically, it is hard to know in advance who will beat the market; past performance does not predict etc. 

On the other hand, there are some factors that reliably beat the market, so much so that in the best financial-academic circles it's considered a little naïve to talk about, say, an active manager adding value just because she beats the S&P: You have to see if she outperforms after accounting for known "factors" like value and momentum. If she just beats the S&P by taking advantage of the well-known outperformance of value stocks, you can hardly give her credit for that. In Greek letters, you'd say that her alpha is really Fama-French beta, or whatever.

But that suggests that you could just directly take advantage of the known outperformance of value stocks -- by, say, investing in an exchange-traded fund that weights its stocks based on value factors rather than just market capitalization. So shouldn't you do that? Obviously if everyone did that then you couldn't outperform the market that way, but they don't, so you can. (Maybe?) And of course you have no sound theoretical basis to believe that these factors will continue to work just because they have (more or less) so far, though you know what Hume said about the sun. And of course even if some factors predictably drive outperformance, you have to pick the right people or algorithms to pick the right factors, and it is less clear that you can predictably pick people who can predictably pick factors that predictably outperform the market. It is unpredictable turtles all the way down.

Anyway here is a Bloomberg Markets story about the rise of smart beta that is full of interest. And here is an important xkcd about the limits of arbitrage.

Good activists.

While past performance in active investment management notoriously does not predict future results, here is a paper finding that past performance in activist hedge-fund investing does predict future results: Activist investors show persistence in their performance over time. (Though that performance seems to be measured by three-day returns around the announcement of an activist campaign, which seems like an odd way to measure persistence.) There is an efficient-markets story that would make this seem unlikely: If activism promises good returns, then more managers should become activists, competing down the returns to activism. How do successful managers avoid that?

We first show that as hedge fund managers gain experience in activism they allocate a larger proportion of their total portfolios to activism stocks, they increase the dollar amount that they invest in each activism stock, and they reduce the amount of time between activism events. These significant and aggressive portfolio changes indicate that hedge fund managers do not back down when faced with imitators and greater competition. Rather, they address the problem of a declining opportunity set by finding ways to expand this set.

They also "target larger firms," "expand the number of industries in which they invest," and "become more aggressive in their activism tactics with experience." It almost looks like a story of activist hedge funds increasing their risks to maintain the same performance. Elsewhere, companies are starting to allow proxy access.

Can there be negative CDS?

Yes? Two Citigroup credit strategists "put the question to the market in a 200-plus people survey and found almost a third of them thought CDS could technically go negative after yields went sub-zero on hundreds of billions of euros-worth of government bonds." Obviously a negative credit default swap rate -- paying someone to let you give them insurance -- is a negative-NPV trade and so strictly a bad idea, but there are always technicals: "A dealer may be willing to pay to offload an existing contract if the cost of keeping it was more expensive than the cost of unwinding the trade due to regulatory capital charges." Is that really true? It seems like a bit of a failure if capital regulation drives banks to do strictly idiotic trades like this. To be fair, no one expects negative CDS trades any time soon. Elsewhere, here are Izzy Kaminska on negative interest rates, Joe Weisenthal on "rates have nowhere to go but up," and economists on ECB QE

Name a VC firm.

Venture capital firm Atlas Venture's tech investing group has split off and now needs a new name. Of course it decided to crowdsource that name, because that is what the kids do these days. If you submit the winning name in their contest, you can win a free $25,000 stake in their new fund for each of you and the charity of your choice. If you submit the worst possible name on Twitter, you can probably win fleeting renown on Twitter, which, I mean, that is worth at least $50,000, right? Be sure to look at this picture of them for inspiration.

Things happen.

Anthony Scaramucci is a bike-share mogul now. You can sign up for Midnight Madness, an all-night puzzle scavenger hunt for charity that is somehow affiliated with Goldman Sachs. (Disclosure: I used to work at Goldman, like that sort of thing just fine, and once did a (daytime!) puzzle hunt with a team of former Midnight Madness participants.) Saudi Aramco is hiring workers fired from U.S. shale fields. The Securities and Exchange Commission is not too worried about the effect of ETFs on volatility. Blackstone bought the Sears Tower, or whatever it's called now. Alibaba has a lockup expiring this week. Peter Henning on the proposed insider trading bills (which we've discussed here and here). Alison Frankel on HP's lawsuit against Autonomy executives. Put bitcoins on Charlie Shrem's prison commissary account. "But then he started seeing a therapist about issues that had been tugging at him for years: his self-identification as a sapiosexual, or someone who is sexually attracted to intellect, and as a polyamorist, drawn to having more than one romantic and/or sexual relationship." Mitt Romney will fight Evander Holyfield. "A restroom at a Wal-Mart in eastern Indiana has been closed indefinitely after an employee discovered a working meth lab inside." Ten dishes that made Guy Fieri's career. Sad spaghetti monster.

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To contact the author on this story:
Matt Levine at

To contact the editor on this story:
Zara Kessler at