New York-Integrity Research recently completed an assignment which illustrates the heterogeneity of the investment research marketplace. We were asked to identify providers of risk arbitrage research which are not affiliated with investment banks. Risk arbitrage research??? This had all the makings of a “stump the chumps” exercise.
What is Risk Arbitrage Research?
Risk arbitrage, which is also known as merger arbitrage, is a form of event driven investing. Investors seek to profit from pending M&A transactions by capturing the takeover premium in an announced takeover. Generally, risk arbitrage involves establishing a long position in the stock of the acquisition target and an offsetting short position in the acquirer stock.
If a merger attempt is successful, the target’s stock price will increase to the offer price and the spread between target and acquirer will move to zero as the closing date approaches. Risk arbitrage is almost always profitable when the merger offer succeeds. If the merger attempt fails, however, spreads will not close to zero, and risk arbitrageurs usually end up with losses. Therefore, predicting which announced merger efforts will be successful and which will fail is an important task for arbitrageurs.
This is where the research comes in. Ideally, risk arbitrage research offers analysis relating to the likelihood of a transaction, risks to the transaction, comparables with similar transactions, and the potential timing of the transaction.
Integrity has developed a formalized search process as part of its ResearchSelectSM service. It starts with a Research Needs Assessment to identify the requirements of the institutional investor requesting the search. In this case, the client wanted actionable advice on pending transactions, and ideally the research service would include an historical database of merger transactions (both successful and failed) to allow the client to do their own analysis. Geographic coverage was primarily North American, with an interest in cross-border transactions. Preference would be given to research firms with limited client bases and distribution.
Armed with the client requirements, our first stop was our proprietary database of research providers, where we confirmed that there is such a beast as an ‘independent risk arbitrage research provider’, and found three that we had already catalogued and evaluated. Our next step was to look for other similar research firms. This can be a sensitive process-some research providers don’t want to be found-so we can’t go into too much detail here except to say it partly involves our extensive industry rolodex. The end result was we came up with six providers in all, including one based in Europe.
Bringing it Home
The next step was evaluating the newly discovered firms, including their research product offerings, the quality of the analytic staff, the viability of the firm (i.e. if you develop a relationship will they be able to continue it), any conflicts/risks associated with the research, related products and services (in this case, information on transactions), and client feedback.
Based on this, we recommended two firms with a strong runner up to be considered if time and cost permitted. The next step is up to the client. They contact the research firms directly and initiate the service. To maintain our objectivity and to allow us to cover the entire research waterfront, we don’t distribute research, we don’t take “sales commissions” from the research firms we recommend, we don’t arrange soft dollar payments. We are hired by the institutional investor and they pay us for our work.
Even though we do this every day, we continue to be amazed by the extraordinary variety of investment research. So much of what is written about research talks about what is broken, and yet there is a vibrant ecosystem of research providers who are out there doing their thing. How broken can the system be?
Comment by David Trout:
See website for details. M & A research, analysis, data compilation. Contact for free report samples.
Comment by David Miller:
“Stump the chumps” exercise? I love it! Any of us who have got “that call” form a client (“What do you know about XXYX?”) know exactly what you mean…