Intersection of

Value Investing &

Special Situations

Special Situations

• Mergers & Acquisitions

• Shareholder Activism

• Financial Restructuring

• Spinoffs

• Regulatory & Policy Shifts

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2014 M&A Activity Announced Deals With Market Value of $2.0 Trillion

Source: Bloomberg | Public North American transactions 3

Increased M&A Activity

Source: Bloomberg | Public North American transactions 4

Spins & Recapitalizations2014 Announced Activity With Market Value of $74.4 Billion

Source: Bloomberg | North American Spinoffs 5

Growing Influence of Activists

Source: 2014 Annual Report of Activist Investing produced by Activist Insight & Schulte Roth

Activists Funds Companies Publicly Targeted

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Why are Activists Growing in Influence?

Higher Rates of Success• Activists are more successful than ever. 73.8% of Activists demands were met in 2014 up from 66.6% in 2013

Good Returns Uncorrelated to the Market• Attracting more institutional investors to the strategy

Assets Under Management Has Increased• $237 billion in aggregate holdings in worldwide stocks controlled by activists

Institutional Shareholder Support• Activists interests increasingly aligned with large institutional shareholders

Larger Companies Being Targeted • For example, Apple, Dupont, eBay, Walgreens

Source: 2014 Annual Report of Activist Investing produced by Activist Insight & Schulte Roth 7

Activist Strategies & Impact

2014 Breakdown by Type

• Remuneration 3%

• Other Governances 5%

• Balance Sheet 11%

• Business 13%

• M&A 21%

• Board Related 47%

Source: 2014 Annual Report of Activist Investing produced by Activist Insight & Schulte Roth

Potential Impact

• Leveraged Recap

– Buyback

– Special dividend

• Spin of Business Unit

• Sale of Company

• Management Change

• Bylaw Changes

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Event Driven Investing

• Event driven investing has reoccurring themes that apply across

industries and security types.

• It requires detailed research of complex issues that may be

outside the purview of the typical Value Investor.

• The analysis is designed to estimate the success or failure of a

particular event.

• The goal is to find investment opportunities when comparing the

estimated probability versus the market implied probability.

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Event Driven Investingrequires detailed research and understanding of the following:

M&A

Mergers &

Acquisitions • Merger Contracts

• Proxy Statements

• Financing Risk

• Potential Interlopers

• Material Adverse Changes

• Antitrust Implications

–DOJ, FTC, MofCom, European

Commission, etc.

• Other Regulatory Approvals

– CFIUS, Federal Reserve,

State Regulators, etc.

Activist Situations• Corporate Bylaws

• Consent Solicitations

• Proxy Fights

• Activist Assertions

• Management Claims

• Litigation

• Institutional Support

Trading Implications• Collars

• Hedging

• Spread Trading

• Short Interest

• Averaging Period

• Election Considerations

• Crowded Trades

Regulatory & Policy Shifts• Regulatory Process & Decision Dates

• Industry Implications

• Lobbying Efforts

• Scope of Authority of Regulators

• Position of Administration

• Political Influence of Parties Involved

Spinoffs• Spin Structure

• Pro Forma Financial

• Strategic Rationale

• Tax Implications

• Investor Base

• Ongoing Relationship

• Potential for Post Spin Takeout

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Value Investing Principals

Distinguishing Features of Quality Companies

• Strong Balance Sheets

• Wide Economic Moats

• Market Dominance

• Durable Franchises

• Proven Business Models

• Highly Visible Revenues

• Compelling Products

• Quality Management

Investment Process

• Screening for Opportunities

• Finding Misunderstood Assets

• Adhering to Valuation Discipline

• Minimizing Behavioral Errors

• Being Patient - “don’t have to swing”

• Buying Cheap Assets– Margin of Safety

• Recognizing that Prices & Intrinsic Value

Regularly Diverge

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Event Driven Perspective

Complements Value Investing

Event Driven investors have a different perspective and investment

constraints than Value investors.

• Risk Arbitrageurs will short the acquirer regardless of price as long as

there is an adequate spread to capture.

• Event players will typically exit a trade indifferent to price if the event

doesn’t play out as expected.

• There is significant cross ownership among Event investors. When a

significant loss occurs in one situation it may cause forced selling in

unrelated but commonly held securities. Event funds tend to be levered

with strict risk limits imposed on them.

• Long-term Value Investors can capitalize on the short-term bias of Event

investors

Value investors can position themselves to take advantage of forced selling

and obtain securities at a steep discount to intrinsic value.12

“Arbageddon”

Wall Street Journal: Aug. 6, 2014

On a day some traders dubbed "Arbageddon," hedge funds who bet on big

corporate takeovers, known as arbitragers, suffered their worst rout in years

after two deals fell apart and regulators indicated they may take steps to

stymie others.

In a rapid-fire series of moves over the course of 24 hours, 21st Century Fox

Inc. dropped its $80 billion bid for Time Warner Inc., and Sprint Corp.

abandoned its plans to acquire T-Mobile US Inc. Walgreen Co. wrong-footed

other traders by deciding not to move offshore to lower its taxes once it buys

Alliance Boots GmbH, sending its shares tumbling. And President Barack

Obama said his administration was taking a close look at the controversial

tax-driven mergers that helped fuel the recent mergers boom.

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Positioning for Forced Selling

• There are quality companies that meet all the criteria of a

Value investor with the exception of price.

• “Arbageddon” and other deal breaks are examples when a

Value investor can purchase assets below intrinsic value.

• The insight of a Event investor can help the Value investor

know when those opportunities may occur.

• This is accomplished by

– recognizing crowded trades

– knowing the consensus Arb downside

– being aware of the next data point on the path to deal / event conclusion

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Recognizing Hidden Risks

• The Value investor will view a particular company in the context

of its intrinsic value and may be unaware of the transaction or

regulatory risks the company may encounter.

• An Event investor will have a distinct view of those risks based

on a different set of experiences.

• The Event investor will have an information network dissimilar

to that of the Value investor (special situation publications,

antitrust attorneys, lobbyists, proxy solicitors and other event

driven investors).

• The combined techniques will help recognize risks and

opportunities.

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Conclusion

• Frequency and magnitude of corporate events continues to

grow.

• Complexity and impact on valuations is increasing.

• Both Event driven and Value investing require intense

detailed research.

• The differentiated perspective of an Event investor can help

generate excess returns.

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Ira Gorsky ira.gorsky@gmail.com 732-740-5872

M&A

Shareholder Activism

Financial Restructuring

Regulatory & Policy ShiftsSpinoffs

Investable Universe

Value Investing Screening Process

Quality Companies

Screen: Price vs. Intrinsic Value

Value Investment Set

Event Driven Investor Perspective

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Appendix

Hillshire Foods (HSH)

On 5/12/14 HSH announced the acquisition of Pinnacle Foods (PF).

• HSH shareholders believed that Hillshire was a takeout candidate and sold indiscriminately when they believed their

thesis no longer held. In addition, Risk Arbitrage investors setting up the PF-HSH spread were indifferent to what

price they sold HSH as long as they captured an attractive rate of return. HSH was down as much as 8% when the

deal was announced.

• The PF deal required approval of HSH shareholders, which put HSH in play.

• On 5/27/14 Pilgrims Pride (PPC) made an unsolicited $45 per share bid for HSH.

• On 5/29/14 Tyson Foods (TSN) enters the fray bidding $50.

• A bidding war ensues with TSN winning HSH, signing a deal at $63 per share

With a different investment approach, the opportunity to purchase HSH, a scare asset at a discount was recognized.

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Shire (SHPG) – Abbvie (ABBV): Deal Break

10/15/14 Day of Deal Break

• Abbvie had approached Shire on an unsolicited basis and pursued Shire aggressively.

• Abbvie paid a high premium, approximately 50% above Shire’s unaffected price.

• This was a crowded trade because Shire is a large liquid name with a big spread to capture.

• The market was aware of the risk to Tax Inversion trades but had the mistaken belief that Abbvie would complete

the transaction due to other considerations supporting the strategic rationale of the transaction.

• Abbvie’s withdrawal of board recommendation surprised the market triggering panic selling.

Shire overshot its fundamental value on the downside because Shire holders were selling regardless of price to stay

within risk limits.20

DirectTV (DTV) – AT&T (T): Regulatory Risks

On 5/19/14 T announced it was acquiring DTV for the equivalent of $95 in cash and stock, subject to a

collar.

• DTV is trading at a significant discount to deal terms due to regulatory risk and the negative option

value implied in the collar. Approval from the DOJ and FCC are still pending.

• The horizontal overlap of T’s U-Verse and DTV is potentially problematic.

• There does not appear to be a workable divestiture to resolve antitrust . If the DOJ believes

competition will be harmed and a behavioral remedy is unacceptable, the DOJ will sue to block the

transaction.

• The FCC reviews transactions on a “public interest” standard. If the FCC rules the transaction is not in

public interest the parties do not have a means to overturn that ruling within a commercially

reasonable timeframe.

• The DTV-T transaction may also be influenced by the Time Warner Cable (TWC) – Comcast (CMCSA)

regulatory approval process which adds an additional layer of uncertainty.

Owning DTV at current levels means the shareholder either believes that there is a reasonably good

chance of the parties will gain regulatory approval or that DTV is currently trading below its long –term

intrinsic value.

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DirectTV (DTV) – AT&T (T): Collar Mechanics

• Obtaining regulatory approval is the primary concern of the DTV transaction. In addition to that, the collar impacts the number of T shares received and the value of the consideration received.

• DTV Deal Terms: $28.50 in cash + T stock with an exchange ratio subject to a collar

• Upper bound: $38.58 Upper ratio: 1.724

• Lower bound: $34.90 Lower Ratio: 1.905

• DTV holders are effectively short 1.905 puts struck at $34.90 and long 1.724 calls struck at $38.58.

• At present the collar has negative option value.

• The value of the collar will be reflected in DTV’s discount to deal terms along with regulatory and timing risk.

• The AT&T price used for the calculation is based on a 30 day volume weighted average period ending 3 days prior to close.

DTV holders will not know when they are in the averaging period and will not know how many AT&T shares they will receive until the transaction is about to close.

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