Tom Steyer is the founder and co-senior managing partner of Farallon Capital Management LLC. The main investors of the fund are college endowments and foundations. Founded in 1986, Farallon is now the 14th largest hedge fund in the world with about $20 billion assets and eight offices worldwide. We like Steyer. He is not only a successful money manager, but also a great philanthropist. In 2010, Steyer and his wife, together with Warren Buffett and Bill Gates, donated half of their fortune to charity. Steyer has also agreed to establish a non-profit organization called the Center for the Next Generation, which is aimed at solving the issues related to children and the environment.
Recently Farallon Capital released its latest holdings in a 13F filing. We are going to take a closer look at the most bullish bets and decide whether it makes sense to imitate these stock picks.
Goodrich Corp (GR): During the fourth quarter, Steyer largely increased his stakes in GR by 180%. At the end of last year, Farallon had $424 million invested in GR. We like GR too. We think the passenger air traffic is trending up and we believe that the growing demand will have a positive impact on GR’s profitability. Additionally, GR is a takeover candidate. Earlier in September last year, United Technologies Corp (UTX) agreed to acquire GR for about $16.5 billion. According to UTX, about 75% of the acquisition will be financed by debt and the rest will be facilitated by stock issuance.
Investing in takeover candidates is tricky. Joel Greenblatt explained the risks in merger arbitrage in “You Can Be A Stock Market Genius”. According to Greenblatt, the merger deal may not be able to go through a variety of reasons, including regulatory problems, financing problems, etc. It is possible that the candidate’s price falls back to its pre-deal price or even lower, resulting in big losses for the investors. Therefore, for individual investors, we think imitating prominent hedge funds’ merger arbitrage plays is a better option. Hedge funds have access to experts, lawyers and other professionals who can judge more accurately which mergers will go through and which ones are more likely to fall apart.
GR seems to be a good candidate as it is popular among hedge funds. Besides Farallon, there were another 46 hedge funds with GR positions at the end of the third quarter. For example, Tiger Cub Stephen Mandel’s Lone Pine Capital had $323 million invested in GR at the end of September. James Dinan and Andreas Halvorsen were also bullish about this merger. Currently GR is trading at a 1.29% discount to its merger price. The deal is expected to close at the end of the second quarter. This implies that if the deal closes buyers of GR will achieve an annualized return of 3.5%.
El Paso Corp (EP): EP is also a new merger arbitrage play by Farallon. The fund did not report owning any shares of EP at the end of September. As of December 31, 2011, it disclosed to own $387 million worth of EP shares. EP was also quite popular among hedge funds. There were 35 hedge funds with EP positions at the end of the third quarter. The most bullish hedge fund manager about EP was Carl Icahn. At the end of the third quarter, Icahn Capital LP had over $1 billion invested in this stock. Barry Rosenstein, Dan Loeb, and Eric Mindich were also bullish about EP.
Similar to GR, EP is also a takeover candidate. The company announced in October that Kinder Morgan Inc (KMI) had signed an agreement to acquire all of its outstanding shares for a total of $38 billion. The transaction is expected to be completed in the second quarter. EP was closed at $27.19 per share on February 15. This is a more than 7% discount to the merger price. This isn’t a sure bet for investors. The implied annualized return in this merger arbitrage play is more than 19%.
Another new position of Farallon is Pharmasset Inc (VRUS). The company was acquired by Gilead Sciences Inc in January. The stock was closed at $136.97 per share on January 17, up 5.13% since the beginning of this year. During the same period, the S&P 500 index returned 1.44%. A few other large positions in Farallon’s 13F portfolio are Motorola Mobility Holdings Inc (MMI) and Owens Ill Inc (OI). MMI was another merger arbitrage play. On the other hand OI is a value stock pick we have come across in other hedge funds’ portfolios as well. OI is relatively undervalued. The glass manufacturer has a forward P/E ratio of 7.69 and is expected to grow at 7.86%. So its 2014 P/E ratio is only 6.6. We rate the stock as a long-term buy.