Risk arb update

Anheuser-Busch Cos. | BUD
InBev SA

Deal value $50 billion

Spread 09/30/08 $5.12, or 7.9%

It's a tough investment environment out there, and risk arbitrage funds are hardly immune. September returns are not expected to look pretty, and some risk arbitrageurs are concerned about investor redemptions. That has put them in a tough spot, given market volatility, political uncertainty and credit concerns. By standards of the last decade, arb spreads have been far out of whack with any rational assessment of deal risk. But, then, how can deal risk be assessed in this environment?

There are inherent contradictions to this predicament. Take the $50 billion merger of Anheuser-Busch Cos. with InBev SA as an example. The Anheuser transaction is large enough that it is both highly liquid and a part of most or all arb portfolios. That makes the spread a likely target for unwinding as arbs look to raise cash and absorb mark-to-market pain during these troubled weeks of dramatic plunges in the Dow Jones Industrial Average and commercial bank failures.

This also means that as markets snap back, so should the spread.

InBev shareholders last week approved the Anheuser deal, including a $10 billion increase in InBev's allotted share capital, which it intends to tap to cover bridge financing for the merger, which is not conditioned on financing. InBev has recently characterized the financing as fully committed, and last month it increased its bank syndicate to 19 banks from 10. The group includes Fortis SA/NV, which was bailed out last week by Belgium, Luxembourg and the Netherlands. Even if Fortis cannot participate in the funding, InBev's broad bank group could absorb that piece of the debt.

Another large food and beverage deal -- safer recession plays -- that has been buffeted by the bank crisis is the $22 billion merger of Mars Inc. and Wm. Wrigley Jr. Co. But Mars expects to close the Wrigley deal this week. The financing, which includes equity from Berkshire Hathaway Inc., has been in place, and the likely close of the transaction may provide a shot of confidence to the market for other pending deals with credit concerns.

Fording Canadian Coal Trust |FDG
Teck Cominco Ltd. |TCK

Deal value $13.4 billion

Spread 09/30/08 $6.13, or 7.4%

Teck Cominco Ltd. and Fording Canadian Coal Trust initiated the required trading period leading to the close of their merger, which is as near a guarantee of a deal close as possible. The completion date should be Oct. 30.

Under the deal, Teck is buying 60% of the metallurgical coal miner for cash and stock. Teck owns 19.6% of Fording and is selling those shares before the close to avoid a tax hit and use the proceeds to fund the deal. The deal payment could be taxable to many Fording shareholders as ordinary income, but the agreement requires Fording and Teck to certify that conditions have been met so Teck can get a good price in selling its shares to tax-advantaged Canadian funds. Teck and Fording confirmed Sept. 30 that the $9.8 billion funding agreements are definitive and all conditions have been met.

The certification of the deal and purchase of Teck shares by Canadian funds provide a high degree of certainty that should narrow the spread and enable arbs to cash out before the close to avoid a tax liability. So in the midst of the storm, the Teck deal has become what rarely exists: a done deal that is still trading, albeit with tax risk.