VH Standard Merger Arb Fund - Quarterly Letter (Q4 '24)

VH Standard AM - Monthly Letter (12-24).pdf

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Wintery Road in December

Transactions Mentioned In This Letter: Capri Holdings (CPRI).

This is a painful letter, but it comes with a silver lining for us as M&A arbitrageurs. Despite the horrible performance surrounding the CPRI transaction back in October, we have had 33 deals completed between October 1st and the end of the year. In that same period, there were 4 failed deals coming to an end, which marks a period with an unusually high failure rate. However, the environment for M&A has dramatically shifted in tone since the election of Trump, and we have heard endless commentary discussing a pick-up in dealmaking activity both in the background and in the headlines. This is something we suggested might happen during our August letter as a reason for holding excess cash, when we stated, “going forward, we want to position ourselves to strengthen [our] advantages as much as possible, especially in a scenario with an increase in deal activity, which we believe is very possible in the months ahead.” With this somewhat anticipated, we turned to being a net buyer during November through the end of the year. Albeit maybe early, considering the market volatility in December, we believe we have planted the seeds for a productive period in the 1st quarter of 2025.

I won’t discuss all of the details with the CPRI transaction since I’ve covered my views on that extensively in previous letters. Overall, I think the judge got the economics of the marketplace incorrect; I believe that the marketplace for mid-priced handbags is actually highly fragmented and competitive, with competition from lower priced items and various imperfectly substitutable goods. The judge’s ruling essentially determined an entirely new class of economic good, establishing either an inferior-Veblen good or a luxury-Giffen good. This type of good has not been known to exist prior to this ruling, and in fact, I have not seen anyone discuss this oddity other than myself (so, I could be wrong). Effectively, she ruled that women’s affordable, luxury handbags are non-discretionary goods that are necessary to living in the modern-day world due to the reputational impact, which is the part we disagree with. Nonetheless, it’s the judge’s decision, which is why the risk management process of a merger arbitrageur becomes so important. Throughout the years, there will be many binary, one-way decisions of either failure or completion from a judge, a commission of regulators, or even shareholders. It’s my job to protect the portfolio in these situations, which is why we aim to never put significant equity at risk of permanent loss of capital in any single transaction.

Our position in CPRI had an unrealized loss contribution2 of approximately (1.99)% of total equity, as of December 31, 2024, after reaching a high of approximately (2.25)% of total equity when shares traded down to a low of $18.70 in the days following the judge’s decision. Prior to the ruling, we sold approximately 20% of our position for an average price of $40.40 a share. In hindsight, that should have been more, as we were considering selling 33% of our position after reading through the trial transcripts, but I ultimately felt comfortable from a risk perspective. As of January 24th, we continue to hold onto our shares of CPRI as we believe the shares are trading at a meaningful discount post deal break.

For perspective, this is on the high-end of our appetite for risk – I’m not pleased with the outcome, but the overall loss is palatable in relation to the overall landscape of all investments, which spans from the highly risky venture capital types to the lowest risk treasury securities. It’s painful when a deal falls apart, but even Joe Sewell struck out at times.

To update you on a few headline worthy transactions, we lost a negligible (0.04)% of total equity in the Albertsons-Kroger (ACI) transaction in call options that expired during October. We have also not been invested in the US Steel (X) transaction since March ‘24, due to the overall complexity of this transaction combined with the easy avenue to blocking the deal through the CFIUS approval process. Some commentators have since suggested that former President Biden blocking the transaction is discretionary on what might be considered national security. This has always been the case with CFIUS approvals and is nothing new, in our opinion.

At times, there are deals that I believe we do not need exposure to, regardless of the upside - these two deals met that criteria. In hindsight, we felt the same about IRBT and SAVE earlier in the year, but we hadn’t quite found our ability to stand apart from the pack yet. These headline worthy deals can be tough to avoid at times, especially if you fear lagging Behind your peers in performance. Unfortunately, so early in our track record, it was difficult to have the conviction to separate ourselves. This lesson was learned throughout the year many times, and it’s since become engrained in our makeup as we head into 2025.

Looking forward, I want to discuss two things: 1) our outlook for 2025, which we believe to have positive tailwinds, and 2) an update on both our operations and the monthly letter going forward.

OUTLOOK FOR 2025

2024 was easily the worst year in my almost 9 years as a professional merger arbitrageur. I could talk for hours on how the year was such an abnormal one. However, that would not do any good. The regulators were aggressive. I knew this and could have been more willing to avoid transactions heading down that path. My experience had taught me to trust that most deals will find their way to completion; that the parties involved want to close the transactions that they’ve agreed to. This wisdom is still important, but during 2024, it wasn’t much help. I could have done a better job recognizing that, as the portfolio manager of our fund.

Turning to the outlook on the year ahead, the consensus on M&A activity in 2025 is mostly geared towards favorable conditions. After a few years of declining M&A activity, there seems to be an incredible backlog of deals to be made. I’ve heard this anecdotally. I’ve read it in the papers. And I’ve listened to countless M&A bankers in numerous public interviews. Since November 4th, we are tracking 32 new signed transactions and monitoring 28 potential new deals that are rumored in the press.3 

This administration change from the U.S. election, however controversial, is likely to impact our strategy in a few areas. As with most things, it’s probably less impactful in practice than the common perception, but there are still a few factors that we believe will change and a few other factors we believe will remain mostly unchanged.

Factors that have the potential to change:

•M&A activity increasing substantially. With a change in the regulators, there’s potential for more M&A activity, as management teams feel the likelihood of success is increased.

•Overbids, overbids, overbids. If anti-trust regulations ease, strategic bidders are more likely to join the process and become willing to pay a higher price than financial buyers.

•The return of the mega deal. Deals above $15 billion have been quiet for a few years. It’s possible we see a return of transactions above $50 billion.

•Simplified information requests. Second requests for more information have been a stalling tactic under the previous administration (either due to restrained resources or to make the process of merging more painful). The possibility of this changing is high, but not a given.

•Shortened timelines for deals on average. Deals with issues from novel or vague anti-trust theories might not be tested as vigorously by regulators.

Things that probably won’t change much:

•The percentage of total deals completed. Historically, this percentage hovers around 95% over the broad spectrum of transactions. Give or take 1% on either side, it doesn’t change much.

•Total number of deals taken to court. Every regulator has their line you can’t cross. Some acquirers will challenge themselves to find where that line is.

•Percentage of deals failing for non-regulatory reasons. Deals fall apart for other reasons. It’s not all about regulators. Other reasons may include shareholder votes, financing troubles, and unknown information coming to light.

When the new administration releases their updated merger guidelines, we will have a better sense of the direction and stance over the next four years. I will share that information when it becomes available.

Looking forward, the change in administration following the U.S. election is likely to put some new winds at our back in the form of increased deal activity and, more importantly, decreased timelines on transactions. The outgoing administration had extended deals in a number of cases. This included even lawful transactions that were eventually given approvals with no issues. This made it much harder for us to establish a proper hurdle rate for investments as the annualized return got stretched out and diluted. Any deal with a historical average of three to four months could have been extended indefinitely through the “request for additional information” phase of the HSR filing process. If this changes, we believe we will benefit.

OPERATIONS/ MONTHLY LETTER

As much as I’d like to seem a hero, operating as a one-man team is incredibly difficult. I try my best to share with you everything that I feel is important (when CPRI news hit, I reached out to each of you directly to make you aware the morning after), but that isn’t always easy. VH Standard isn’t yet at a scale where I can offload any of the work. The little things. The tedious tasks. They are all mine. The fundraising primarily falls on me, and it must be done in order to grow the business to become at least sustainable. Unfortunately, merger arbitrage also happens to be a multi-faceted, information-intensive strategy that requires a lot of man hours to upkeep the data and manage transaction news flow. Not to mention, someone needs to make sure this partnership is fully compliant with legal requirements, which is just as important as the rest of the business.

I tell you all of this because I feel that it is important to know as an investor. I’d like to share letters and materials with you as much as possible - sometimes that’s not very feasible. If you reach out with questions about the portfolio or general conversations, I always make time. With that in mind, I’ll be switching the monthly letters to quarterly letters (you’ll still receive monthly statements, as always). Not only does this allow me to be more intentional with my messages, but it removes the dilution that I find creeping into my letters. When there’s nothing to say, nothing should be said.

Starting any business is a lot like untangling a wire. You can’t simply do it with brute force. Instead, you have to continually work at one wire at a time, patiently. When you get stuck, you move to another area and focus on that. Eventually, you start to feel that operations are becoming more efficient as each wire comes untangled with a little more ease. There’s no shortcutting this process. You might hire someone else to work in another area, but no matter how many people you hire, you can’t just pull the wire apart.

It takes patience to start a business. In 2024, VH Standard did a lot of untangling. At the end of 2023, I discussed a few questions that I had. One of them was looking at which tools would be helpful to build out and would they benefit the portfolio, and ultimately the investors. To check back in on that - during the year, we built out our internal database for deals. It was tedious, but now we have a database of deals going back to 2015, which includes almost 1,200 public M&A transactions.4 We’ve expanded our statistical analysis to include DMA vs. pre-deal, deal types (an internal list of types), deal size, compensation type (cash vs stock), second requests by regulators, regulatory issues, acquirer size, country, sector, subsector, transaction dates and years (political administrations), timeline to completion, deal outcomes, reasons for failed outcomes, and other factors that we still plan to integrate during 2025. That’s one wire that we untangled. Now it’s all about proper maintenance and storage there.

Furthermore, I built a transaction analysis tool that shows any current transaction and compares its details to our historical data. To keep it simple, if you have an insurance deal with an expected close date coming up at the end of March, this tool will show how closely that expected close date matches with the data for insurance deals. It’s a useful tool when looking for red flags. All of those factors in our database are connected to this tool, and I look forward to refining and building this out with a long-term vision of making sure all of our data is connected and clean.

Building these tools takes time, but once established, they become invaluable to the portfolio. It’s difficult to describe but these tools were all ‘time liabilities’ during 2024. Now they are assets going forward.

Hopefully, this gives you a little bit better understanding of the operations behind the scenes. It’s not a big hedge fund, and mostly a ‘hedge fund’ in structure, not culture.

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.