Hedge fund also allegedly placed bets that made the financial crisis
Back in 2013 when a buyout took Dell private, hedge fund Magnetar
Capital was one of the biggest opponents of the deal. Now, the
Chicago-area investment manager, which became famous for making big
bucks off the housing bust, is set to become the biggest winner from a
case tied to the transaction, scoring an additional $25 million
payout, or about 28% more per share than most other shareholders
Here’s how it went down: A Delaware court
ruled on Tuesday that Dell founder
Michael Dell and private equity firm Silver Lake Partners paid too
little for Dell when they bought the computer company for $25 billion
three years ago, or $13.75 a share. The court ruled that the
fair price was
actually $17.62 a share for Dell. But the only shareholders
who can collect the rest of the money that the court deemed their
shares were worth are those who voted against the deal, and Magnetar
is the largest of just a few investors who did, according to
The Wall Street Journal.
This was likely Magnetar’s strategy all along, and indeed its reason
for investing in Dell in the first place—it bought Dell stock after
the buyout was already announced, intending to go to court to sue for
extra compensation. Of course, Magnetar could only protest the
acquisition price in court if the deal was approved despite its
objections. In other words, while the hedge fund voted to reject the
deal, it was banking on losing that vote—it must have expected other
shareholders to approve the deal anyway. Had a majority of
shareholders voted with Magnetar and blocked the deal, the hedge
fund’s whole strategy would have been moot.
If that game plan seems backwards and counterintuitive, consider that
Magnetar, which manages more than $13 billion, has made a killing
literally betting against itself in the past. The hedge fund famously
profited during the financial crisis by investing in risky mortgage
securities known as collateralized debt obligations (CDOs) while also
shorting them, a maneuver highlighted in Michael Lewis’s book “The Big
Short.” Magnetar was the focus of
Prize-winning investigation by journalism non-profit
ProPublica into the deals that caused the housing bust. Magnetar has
maintained that it was implementing a “market neutral” strategy that
would make money no matter what happened in the housing market; while
the Securities and Exchange Commission investigated the hedge fund’s
actions, it eventually
investigation without pressing charges. The SEC has levied
fines on Merrill Lynch and other firms for their roles in the Magnetar
Magnetar’s tactic of filing lawsuits challenging takeover valuations
in order to make money, also known as appraisal arbitrage, has become
increasing popular with hedge funds in recent years, especially in the
merger litigation hotbed of Delaware. In 2015, 54 such cases were
filed in Delaware, and so far this year, 29 have been filed through
the end of May alone, according to the Delaware Court of Chancery,
which handles appraisals in that state (including the Dell case).
That’s up from fewer than 10 cases filed in 2010, according to a
recent study published in the
Washington University Law Review.
In the M&A appraisal game, Magnetar is one of the most active players.
by Columbia Business School professor Wei Jiang found that the hedge
fund filed appraisal petitions on five M&A transactions between 2010
and 2014. Magnetar has long specialized in merger arbitrage, a
strategy that involves trading around deals and occasionally engaging
For example, besides the Dell case, Magnetar was one of several hedge
funds to share in a $127 million
payment from Safeway in June 2015 to settle the investors’ claims that
the grocery chain sold itself to Albertson’s for too low a price. The
sum amounted to a 26% premium over what the funds originally received
for their Safeway stock in the deal.
And in December 2015, Magnetar again split the proceeds,
at more than $300 million, of a settlement of its lawsuit claiming
that the 2013 buyout of Dole had undervalued the fruit company. More
recently, in late January of this year, Magnetar received another
settlement of about $11 million, according to
filings, from CEC Entertainment—the operator of Chuck E.
Cheese kid-friendly restaurants—which it had sued seeking additional
shareholder compensation in CEC’s 2014 buyout by private equity firm
Apollo Global Management.
As with Magnetar’s mortgage bet, investing in M&A deals with the
primary purpose of challenging them is also controversial. Some
argue the lawsuits are frivolous and an abuse of the legal system.
Others complain that the litigation may benefit a few institutional
investors like hedge funds with pockets deep enough to go to court,
but it does more harm than good for most shareholders by levying extra
expenses on companies and squeezing them for settlements. Delaware
itself has recently
amendments that could limit such lawsuits.
Magnetar defended the practice. “Decades ago, shareholders in Delaware
corporations were granted the right to seek appraisal in mergers where
they believe they are not receiving fair value for their shares,” a
spokesperson for the firm told Fortune. “The appraisal process—which
is exercised multiple times a year by shareholders—allows a court to
determine fair value through a judicial process.”
Of course, when takeover appraisal cases do make it all the way to
court, there’s no guarantee that the hedge fund will reap a return on
its efforts. Sometimes, the court decides that the acquiring company
paid the right price—or even too much compared to the target’s fair
value. In 2013, for example, Magnetar and several other hedge funds
sued over the acquisition by 3M of biometrics company Cogent, seeking about 55% more money for
their shares in the target, which they claimed were priced too low.
But the judge said the shares had only been undervalued by $0.37
apiece, and that Cogent was worth less than 4% more than what 3M paid.
The Dell deal may have had just the right combination of factors to
make it a winning candidate for appraisal litigation, but Magnetar and
other investors may not always be so lucky.
This story has been updated with new statistics on
appraisal cases from the Delaware Court of Chancery.