Arbitrage With John Orrico

Is this a good climate for deals?

I think it may be the best climate in five years. There has been a significant pickup in domestic and foreign deal flow. There is a long list of reasons for the great environment: strong global economies, a booming China, strong stock markets worldwide, record levels of private equity funds, record levels of cash on corporate balance sheets, low long-term interest rates and an improved environment in boardrooms following the wave of scandals in recent years.

How do interest rates affect what you do?

Merger arbitrage is one of the few investment strategies that actually benefits from rising short-term rates. Our spreads track off of short-term rates, with a risk premium attached. All else being equal, rising short-term rates lead to higher spreads -- and therefore greater profit potential. With short rates up over the last 18 months, we are seeing that show up in the returns available to us in the deals in which we invest.

Are you seeing more international deals? And if so, are these deals harder or easier to navigate?

Yes, we are seeing more international and cross-border deals. There has been a global pickup in deal flow because of factors like the single currency in the E.U., and the migration of regulatory structures in the E.U., Japan and Far East closer to what we see here in the U.S. and Great Britain. That is very positive for deal flow and consolidation in parts of the world that up until recently have witnessed quite low levels of deal flow relative to the U.S. and Western Europe.

Would you rather have cash or stock deals?

The ideal scenario is a mixture of each type of consideration, as they each have their pros and cons. Cash deals tend to have a higher return on capital, but spreads on those deals experience higher levels of volatility and are harder to hedge. Stock deals are less volatile but employ greater capital due to the fact that we need to short shares of the acquiring company. However, stock deals have no financing risk but do have other issues with regards to the structure of the deals. Also, for diversification purposes, we like to have a mix in the portfolio in terms of consideration received, as well as a good diversification among industries and market caps.