Friday, November 30, 2007 3 comments ++[ CLICK TO COMMENT ]++

Risk Arbitrage: BCE

One of the risk arbitrage plays that I have mentioned before is BCE of Canada (BCE; TSX: BCE). BCE is the largest telecom in Canada and it is being taken over by a consortium. The payment is in cash and is supposed to close early next year. Fabrice Taylor of The Globe and Mail has written a good column summarizing the details and the risks. Note that everything mentioned is in Canadian dollars. BCE also trades on NYSE.

f all goes well, BCE shareholders will get their money some time in the first quarter of 2008. Let's assume the last day of the quarter, March 31, to be conservative. The offer is $42.75 a share while the stock is quoted today at $39.20. The four-month return, then, is a little more than 9 per cent - and even more if investors get a dividend before the deal closes.


As the author suggests, you are looking at around 9% in 3 or 4 months. This is a low-risk arbitrage situation so that's a good return. If you are an American and are bearish on the US$ (I am not) then you may also get some positive return from currency gains if the US$ weakens further.

In terms of risks...

One risk is that more wireless competition will prompt the buyers to change their offer. BCE shares slipped yesterday on news that Industry Canada was making it a lot easier for new entrants to compete. Another is that BCE's bondholders are trying to thwart the deal in the courts. And finally, there's the risk that the buyers won't be able to raise the debt because of the credit crunch.


Some message board commentator on the site also points out a risk with the CRTC, which is the government agency responsible for media oversight in Canada. I think the CRTC issue is likely low risk given that owners are still mostly Canadian and nothing much is changing with the media structure.

If you do the calculation the way Warren Buffett looks at risk arbitrage, you will get:

probability of success (my guess): 90%
probability of failure (my guess): 10%
potential gain with successful closure: 9%
potential loss with deal collapse (my guess): -20%

Expected return = prob_success * gain - prob_failure * loss = 0.9*0.09 - 0.1*0.2 = 6.1%

If you annualize that, you are looking at around 20%+. Of course, I am guessing on the probabilities but that's how I see things.


I find this deal very attractive but I will likely pass on this for a few reasons. Firstly, the return is a bit too low for me. I am willing to take higher risk for higher return. Secondly, I don't have enough free capital (my portfolio is small) and I want to buy something around the tax-loss selling season. I am seriously thinking of Ambac (ABK); given that Owen's Corning (OC; OCWAZ) has dropped a lot, I'm also starting to look at it again. If the potential return increases to, say, 14%, I'll consider investing. (Having said that, I will likely take a position with my mom's portfolio :) ).

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3 Response to Risk Arbitrage: BCE

Anonymous
February 10, 2008 at 3:08 PM

You can look at all of the risk/return calculations at www.madmgergers.com too.

Guest
August 28, 2009 at 12:40 AM

I would have guessed 50/50 prob loss/gain.  Hope you didn't put real dollars down.  :(

Sivaram Velauthapillai
August 28, 2009 at 10:10 AM

I did invest real money and lost around 30% so far. Dissapointing but I think if you are playing the risk arbitrage game, you have assume that you will post some losses. My goal is to invest in many and keep the failure scenario low. I also try to invest in cases where the downside is somewhat limited (say max 50%) or I am comfortable holding the company if the merger fails.

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