Street Capitalist: Event Driven Value Investments

The credit market is extremely important for investors in the event driven space because easy access to credit fuels private equity acquisitions and leveraged recapitalizations. These have been easy ways to create value for investors but have slowed down over the past couple months. This in conjunction with the J.C. Flowers uttering “MAC” against SLM, the abandoned buyout of Acxiom, and the fat arbitrage spread on the Tribune Company all seems to affirm the certainty of a PE slowdown.

Today we saw the CreditForecast.com release numbers. The following graph is a measure of credit quality, measured on a YoY basis:

As you can see, credit quality is diving. To make matters worse, mortgage delinquencies are on the rise. We’ve seen a steady rise in delinquencies from 2% in Q4 of 2005 to 3.3% in Q3 of 2007. Additionally, with house prices falling, variable rate mortgages resetting from teasers, and poor employment prospects the problem continues to pose a threat. Delinquency rates rise carried over into two other credit sectors, a 0.2% delinquency rate rise for auto loans and a 0.5% rise in consumer finance. These measures are at their highest levels for the past 2 years, and I believe that we’ll see a slow but sure rise in both of them.

What does that mean for event driven investments? If you read the Wall Street Journal, you know that deals are still happening. I don’t think that there will be a standstill. What I suggest is looking for plays that point towards industry consolidation. Normally value investors shy away from drug company stocks, but Daniel Loeb and Carl Icahn have made some great moves here. It seems like the idea is to go after smaller companies that own good patents / have a good portfolio of drugs, and agitate for larger industry players to come in and acquire them. The strategy benefit is easy to see, many of the existing drug patents from the larger players have expired, leading to a wave of generics. They need new drugs to fuel their margins, and the pipeline from companies like Biogen and PDLI seems to fit the bill perfectly. Other areas with strategic acquisition potential would be the IT sector, Oracle is already going after BEA Systems (another Icahn pick) and SAP announced a planned takeover of Business Object.

Most of the IT companies I’ve looked at are holding tremendous amounts of cash on their balance sheet and now that they don’t have to compete with private equity funds on buyouts, they should be ready to open their wallets and start spending. When looking through these companies, I’d be cautious on ones domiciled in India. Not because of governance concerns but currency risk. The rupee’s rapid appreciation will definitely take a toll on these companies’ US business and justifies their lower stock prices right now.