VH Standard Merger Arb Fund - Quarterly Letter (Q1 '25)
- Robert von Hoffmann
- May 17
- 6 min read
Transactions Mentioned In This Letter: Discover Financial (DFS)/ Capital One Financial (COF).
Although this is a letter about the first quarter, you probably want to know how we managed during April, as well. Our results were (1.08)% for the first quarter of the year. For April, we had returns of +3.41% to start the second quarter, bringing us to +2.29% for the year-to-date, as of April 30, 2025. We will discuss more in detail below; however, this is a one-off situation where we felt it was necessary to include the first month of the next quarter. Obviously, the returns were excellent, and we wanted you to know.
During this first quarter, we experienced less drawdown than the market, as the S&P 500 was down approximately (4.6)% year-to-date. From the presidential inauguration date to March 31, 2025, we were down approximately (1.9)%, while the S&P 500 was down approximately (6.4)%. After that, we outperformed.
Here’s a chart of how our daily returns looked vs. the S&P 500 during the first four months of the year:
If there was ever a chart that displayed what we wanted to provide in terms of value-add to portfolios, this would be it. However, it’s important to note that in these times of uncertainty we will be affected in the short term (as you can see in the chart above). It’s inherent that positions, even in transactions on solid footing with cash compensations, will sell off as investors look for liquidity. In the past, I’ve talked a lot about our approach to leverage and how it offers us a competitive advantage during tough or volatile times. It’s during these recent months when I think that advantage becomes a little more apparent (barring our ability to act in the face of a downturn and not freeze up). Some funds are forced out of positions. While I felt compelled to realize our loss from our COF puts, due to a mistake I’ll talk about below, we were in a position as a portfolio to take advantage of the downturn by buying several names, including BRDG and APO, HEES and HRI, BECN, SWTX, HHH, PLYA, PDCO, and a few smaller purchases (GB, WBA, BHLB, FLIC, FFNW, CMRX, JWN), as well as buying back into DFS/COF around the $165 range.
I have also initiated a position in the 180 Degrees Capital Corp. (TURN) transaction with Mount Logan. My fellow Montclair investors, you might be familiar with this one.
With the strategy being self-liquidating, we were able to be net buyers throughout this whole year while also growing our portfolio cash. Seems contradictory, but it’s true. During the first quarter, 24 of our invested transactions were completed, providing us with ample liquidity. As of March 31, we had approximately 30% of our portfolio in cash earning short term rates, not including the 5 cash compensation deals that closed on April 1st & 2nd. In our strategy, this can happen at times when business leaders are more cautious and M&A activity slows down. Although I wasn’t anticipating this exactly, I am okay with a strategy that tends to build cash automatically as the market turns over. It’s somewhat inherent in the process, regardless of my views.
MISTAKES & FLAWS
At the end of February, I made a miscalculation of risk (i.e. a mistake) in our Discover-CapitalOne (DFS/COF) position. I decided to sell what I believed at the time to be extremely short term (4 day) puts at strikes that I thought were well out of the money. It turned out to be the exact wrong time for this approach, and while I felt it was a de minimis position, it actually was not. This cost us about 0.50% of our equity. And if I had been right, it would’ve barely made a dent to the good side... That’s not a winning strategy, and I won’t be returning for more.
Fortunately, however, market volatility around the tariffs offered us a better opportunity to buy back into DFS/COF in a meaningful way, and we were able to recover those losses during the month of April. I continue to believe that COF is creating tremendous value for shareholders through their acquisition of DFS.
FUTURE OUTLOOK
We remain steadfast in our belief that M&A activity is set to pick up, and that this will likely result in a period of increased overbids. While 2024 was muted in terms of overbids and heightened in terms of deal failures, we look for this to revert to the mean and even flip in the years ahead, leading to excess returns above our expectations. We may be wrong, and are always looking to challenge our assumptions, so please reach out to discuss if you disagree with our assessment. We’d love to talk.
“Competition skews people’s assessments; as buyers get competitive, the demand for assets inflates pricing, often beyond reason.” - pg. 88, Sam Zell, “Am I Being Too Subtle”
This quote is from Zell’s 2017 book, not too long ago. I’m expecting this to happen again in public market transactions at some point over the next 5 years, resulting in overbid situations where acquirers pay above reasonable prices for assets they believe will be worth every penny in the future. It can have a profound effect on merger arbitrage returns; something that’s been missing in recent years.
I know right now it doesn’t seem like this will be happening any time soon for those hopeful in merger arbitrage land; however, I believe it’s closer than the current consensus view sees.
To lay out the current environment, consider these points that have been in the data over the last couple of years:
•Minimal Overbids. There have been minimal overbids. Much less than a normal environment. A few situations are Sculptor (SCU), Everbridge (EVBG), and maybe one or two others that I can’t think of.
•Where are the White Knights? When an acquirer launches an opportunistic takeover, it’s been rare to see interlopers feeling compelled to come in and pay a fair price for control.
•The Go-Shops are Quiet. Go Shop provisions haven’t performed well in recent years, with many finding no alternative interest, and not many instances of the beautiful blind auction.
•Auctions Have Few Buyers. Strategic reviews and pre-deal rumors have a few suitors, but nowhere near the normal with many potential acquirers given the offering materials and choosing to pass.
•Subdued Optimism in M&A Markets. The current enthusiasm for deals seems to be a wait and see approach. There’s a lack of FOMO and generally less competitive spirits on the acquirer side, while the lender side is competitive for solid balance sheets.
•Who’s Out There Saying “These Purchases are So Overvalued”? It’s not often right now that I look at a deal and think, “why would they be paying these prices?” In a heightened environment for deals, you hear all types of rationales for overpaying and most of them act like it’s conservative underwriting.
If this is the current environment, I feel comfortable saying “it’ll get better than this.” And we can find some historical context for feeling this way.
The 1960s and 1970s are known for some high profile anti-trust cases and an incredibly challenging environment for acquisitions. That period saw the famous 1962 Brown Shoe case, the 1966 Von’s Grocery case (where the Supreme Court overruled a court approval and blocked a grocery store merger with 7.5% local market share), the U.S. vs. AT&T, IBM, & Xerox, and the regulatory block of a vertical merger between Ford and Autolite in 1972. Does any of this sound familiar?
If it doesn’t, what about Brown Shoe co. sounds like Capri/Tapestry? What about Von’s Grocery sounds like Kroger/Albertsons? AT&T, IBM, & Xerox or Amazon, Meta, & Google? Not to
get too detailed - regulators over the last decade picked up where 1976 left off.
However, towards the end of the 1970s, things started to become more lenient as the Chicago School of Economics started to gain influence. Then the 1980’s happened. Below is a direct quote from Warren Buffett’s 1988 Letter to Shareholders, basically describing merger arbitrage as easy money. Things change. Environment’s ease. And the pendulum swings again.
“In recent years, most arbitrage operations have involved takeovers, friendly and unfriendly. With acquisition fever rampant, with anti-trust challenges almost non-existent, and with bids often ratcheting upward, arbitrageurs have prospered mightily. They have not needed special talents to do well; the trick, a la Peter Sellers in the movie, has simply been “Being There.” In Wall Street the old proverb has been reworded: “Give a man a fish and you feed him for a day. Teach him how to arbitrage and you feed him forever.” - Warren Buffett, 1988 Berkshire Hathaway Letter to Shareholders
If you’d like to have a conversation, please feel free to reach out.
“Great things are done by a series of small things brought together.” – Van Gogh
Please see the attached document for more details about our portfolio and fund.
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