John Paulson on Playing Today’s M&A Game

Forget shorting mortgages. In a year when M&A is suddenly roaring, hedge funder John Paulson used his time on stage at Delivering Alpha in New York talking merger arbitrage, a business his firm, Paulson & Co., has been pursuing for years.

Paulson offered a quick tutorial of a business that’s growing for the first time since the financial crisis, with major deals breaking out daily, including the recently reported 21st Century Fox play for Time Warner. Paulson laid out the various strategies his firm uses to invest in merger situations: traditional merger arb; hostile deals; trying to anticipate M&A, particularly in a consolidating market; and strategic M&A, that is, investing in companies that are active — that is, strategic — acquirers.

On the strategic side, Paulson is a big fan of Valeant Pharmaceuticals and its CEO Michael Pearson, which is currently bidding for botox-maker Allergan in what’s currently a hostile deal. Paulson argued that Valeant has a strong track record of growth through M&A — 35 deals over the past few years — and the necessary discipline of cutting costs and integrating acquisitions. “They have a different approach to managing pharmaceuticals,” he said, and, he added, the stock is up 800 percent in that time.

But that’s just the start. Paulson also has stakes in both Shire and its pursuer, Abbvie, spun off from Abbott Laboratories last year. That sets up a variety of possibilities, all of which could make money for Paulson, particularly given the speculation that Allergan, eager to escape from Valeant, might make a bid for Shire, which is trying right now to elude Abbvie.

Paulson laid out the possibilities. Valeant wins Allergan and cuts costs and increases earnings. Allergan on its own decides to restructure. Allergan buys Shire. If Abbvie wins Shire — as he expects is likely — there is some overlap between the two operations, a tax inversion opportunity for Abbvie and by broadening Abbvie’s product line, a chance to boost the multiple. In each case, Paulson profits from the deal.

And that’s not including the merger arb play on the two hostile deals. In fact, the strategic considerations serve as a hedge on the risk of speculating on a hostile deal actually closing.

Paulson is anticipating a similar situation in the energy business, specifically a group of independent oil companies involved in fracking in North Dakota’s Bakken shale: Whiting, Kodiak and Oasis, each of which have reserves, innovative technologies, rapid growth and relatively low Ebitda multiples. It’s an anticipation play. “It’s not likely they’ll remain independent,” said Paulson.

Then there’s today’s big deal, 21st Century Fox and Time Warner. Paulson said he has a number of questions: Will it close? Will other bidders appear? And what will be the ultimate price?

So far, with Time Warner’s board rebuffing Murdoch, it’s a hostile deal, and that means high risk. Paulson argues that M&A deals generate the biggest premiums — and the biggest profit for arbs — when a big company buys a smaller one. But Time Warner and 21st Century Fox are roughly the same size, making it hard to pay a big premium. Two, the size of the deal makes it difficult to find competitive bidders. Three, a merger could provoke antitrust problems.

“We’re looking at it,” he said. “It could work out, but it’s not that exciting.”