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June 2018 – Market Update

Event-Driven Update

On the evening of June 12, 2018, Judge Richard Leon determined that AT&T can proceed with its planned acquisition of Time Warner with no conditions. The decision supports decades of precedent antitrust law, and we expect the pending mergers between Aetna/CVS and Express Scripts/Cigna will be impacted positively.

We also see a high probability of a major bid to the media and telecom space. On June 13, Comcast bid $65 billion for 21st Century Fox. If a bidding war erupts between Comcast and Disney, with whom Fox has already agreed to a $52.4 billion deal, press reports suggest Comcast could go as high as $80 billion without putting its credit rating in jeopardy.

In another high-profile deal, NXP Semiconductor (NXPI) last week traded higher when a deal to remove US sanctions on ZTE appeared imminent. It seemed that a group within the Trump administration was pushing a quid pro quo deal to gain antitrust approval for the Qualcomm/NXPI merger from China, in exchange for relaxing the sanctions on ZTE. This week, however, NXPI traded lower, after it was reported that an amendment to the National Defense Authorization Act would include actions “to curtail the president’s ability to mitigate sanctions against ZTE.” While a more benign version is more likely to be passed, the news led to continued volatility in NXPI’s stock.

Corporate spin-offs also continue to be a focus for event-driven equity investors. These transactions often create valuation dislocations between the pre- and post-spin off entities. Recently, several companies have concluded the spin-off process including the following:

  • DXC Technology, a provider of information technology services, spun off its government services business into Perspecta Inc. (PRSP), leaving the remaining company with a clean balance sheet and focused on commercial IT services.
  • Spirit Realty Corp (SRC), a real estate investment trust, spun off its distressed assets into Spirit MTA leaving the remaining company with a clean portfolio of triple net lease retail assets.
  • Wyndham Worldwide (WYN) spun off its hotel management business into Wyndham Hotels (WH), leaving the remaining company focused on the timeshare business (WYND).
  • La Quinta (LQ) sold its hotel management business to WYN and then spun-off its hotel real estate into a REIT called Corepoint Lodging (CPLG).

Such corporate transactions offer idiosyncratic ways to invest both long and short, with opportunities during both the pre-spin stage and the post-spin stage.

This week two rumored names, Envision Healthcare (EVHC) and USG Corp (USG), ended up being acquired. EVHC agreed to be acquired by KKR for $46 per share in cash, while USG entered into a definitive acquisition agreement for $44 per share.

Rent-A-Center (RCII), which announced last fall its plans to conduct a strategic review following a $13 per share cash approach by Vintage Capital during the summer, concluded its strategic review. Management decided not to sell the company, but Vintage submitted a best and final offer to acquire RCII at $14 per share immediately following RCII’s announcement.

Macro Update

Many moving pieces around the world are keeping investors cautious going into the summer.

This week, the Federal Open Market Committee (FOMC) met on Wednesday where the market is increasingly focused on whether the committee will drop language it has used since late 2015 that says rates would remain below historical levels “for some time” to come.

According to Reuters, that small change would mark a broad acknowledgement that, nine years into the second-longest US economic expansion on record, monetary policy and the economy in general are starting to look increasingly normal, both domestically and abroad.

Adding to the theme of interest rate policy normalization, the European Central Bank (ECB) meets on June 14 to debate ending its massive bond purchase scheme later this year, taking its biggest step in dismantling crisis-era stimulus. The end of the purchases is a foregone conclusion, and the key question is how the ECB will guide markets on the interest-rate outlook.

Recent volatility in Europe, created by Italian political dynamics, subsided this week after the new Italian Minister of Finance over the weekend rejected the idea of Italy leaving the European Union. His comments were well-received by markets and led to a rebound in European indices.

A spin-off is the creation of an independent company through the sale or distribution of new shares of an existing unit of a parent company. A triple net lease is a lease agreement on a property where the tenant or lessee agrees to pay all real estate taxes, building insurance, and maintenance on the property in addition to any normal fees that are expected under the agreement.

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