Paulson Goes Old School After Billions in Losses: Street Whispers

NEW YORK ( TheStreet) -- After earning Wall Street fame by betting against subprime mortgages in the 2008 financial crisis, John Paulson has gone cold -- his financial and gold investments have lost clients billions of dollars.

But Paulson's roots in merger arbitrage -- the art of guessing which companies will be taken over -- is standing out as the biggest success for his hedge fund Paulson & Co. and its attempt to regain glory.

Three of Paulson's investments, a new stake in engineering specialist Cooper Industries ( CBE) and increased positions in Quest Software ( QSFT) and Gaylord Entertainment ( GET ) -- the owner of the Grand Ole Opry in Nashville -- were M&A targets last quarter.

Cooper Industries was sold to Eaton Corp. ( TN ) in May for $11.8 billion, the largest U.S.-based acquisition of 2012. Quest Software was sold to Dell ( DELL ) just after the quarter's end for $2.4 billion. Meanwhile, Gaylord Entertainment, an oft-speculated M&A target, sold rights to operate its hotels to Marriott ( MAR ). In each instance, the shares soared.

In the second quarter, Paulson & Co. bought 1 million shares in Cooper Industries worth $68 million, and he raised his holdings by 47% and 60% in Gaylord Entertainment and Quest Software, respectively, according to 13F filings submitted to the Securities and Exchange Commission and compiled by Bloomberg after the market close on Tuesday.

Although disclosures on Paulson's investments are imprecise because filings don't specify when the hedge fund made the purchases, share gyrations of the three companies indicate a classic merger arbitrage. That's because in all three investment instances, the shares have gained significantly even after each company disclosed M&A activity.

The investments show that amid a poorly timed bet on financials -- highlighted by Paulson's sale of Bank of America ( BAC) and Citigroup ( C) stock ahead of a 2012 rally and a $142 million-plus investment in JPMorgan ( JPM) -- Paulson may be wise to revert to merger arbitrage, the strategy he used before he shorted the U.S. mortgage market.

In the three arbitrage investments, Paulson appears to have backed conventional M&A plays. Cooper Industries was widely considered a takeover target after Swiss engineering giant ABB ( ABB) bought electrical systems specialist Thomas & Betts ( TNB) earlier in 2012, and both Quest Software and Gaylord Entertainment were the focus of consolidation speculation within their respective cloud computing and hotels sectors.

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