Chris DeMuth's State of the Markets June 2022 (podcast #114)

Episode Summary

Executive Summary: Andrew Walker and Chris Muth argue that late-June 2022 market dislocation is creating unusually attractive merger-arbitrage opportunities, while also exposing how deal-specific breaches, buyer leverage, and reputation constraints shape outcomes. They focus on Plan, Citrix, Twitter, and Continental Resources, concluding that wide spreads and stressed markets can produce high expected value for disciplined event-driven investors.

Main Topics: Market stress and broken price discovery (Priority: 5/5): Chris describes weak, volatile markets where merger-arb spreads are widening in ways that seem disconnected from fundamentals, financing, or regulatory progress. He sees this as a moment when prices are becoming irrational and capital can be deployed aggressively into late-stage deals. Plan/Toma Bravo recut as a deal-specific precedent (Priority: 5/5): The discussion centers on Plan’s merger agreement breach, the small price cut from $66 to $63.75, and whether this signals broader private-equity renegotiation behavior. Chris argues it was driven by explicit contract minutiae and target-side breaches, not a general pattern. Reputation versus rational self-interest in private equity (Priority: 4/5): The hosts debate whether private-equity sponsors will close bad deals to protect reputation or walk away when economics worsen. Chris argues behavior is context-dependent: firms may act mercenary in stress, but will also honor definitive contracts when reference points and incentives favor closure. Banks and financing commitments in stressed markets (Priority: 4/5): They discuss whether lenders can or will pull financing. The conclusion is that bank commitments are usually highly correlated with the buyer’s obligations and that bank reputation, fees, and repeat business make technical walkaways rare. Twitter/Elon Musk as an archetypal wide-spread arb (Priority: 5/5): Twitter is framed as a classic event-driven trade with asymmetric outcomes and a large gap between market chatter and legal commitments. The hosts expect regulatory approvals to proceed and see the transaction as likely to close or at least remain highly actionable for arb investors. Energy equities and the Continental Resources take-private (Priority: 4/5): Chris views energy as bullish on fundamentals because equities still underreact to commodity strength and underinvestment. He is conflicted on Continental Resources, seeing both cycle-timing skepticism and the appeal of a majority owner buying a minority stake at a modest premium. Behavioral lessons from crypto, meme stocks, and shorts (Priority: 3/5): The conversation closes with a reflection on how 2022 is forcing a reversion to fundamentals after a bubble era. Both speakers acknowledge they were too slow to call out speculative excess in crypto, meme stocks, and other momentum trades.

Key Arguments: Wide merger-arb spreads create multiple ways to win; investors do not need perfect certainty when downside is already priced in. Plan’s recut was not evidence that all sponsors will renegotiate; it was driven by concrete contractual breaches and a target that gave the buyer an explicit out. In stressed markets, buyers and banks may become more mercenary, but definitive contracts and reputational incentives still matter. Banks are unlikely to be the marginal source of deal failure because they are highly incentivized by fees, repeat business, and litigation risk. Twitter is especially attractive because the spread is large enough to absorb adverse scenarios, and the market’s commentary is overly circular and reactionary. Energy equities remain interesting because current prices embed underinvestment and supply constraints that could persist for years. Majority-owner take-privates are often appealing because the insider has the best information and incentives, though timing risk remains material. The market is moving from speculation back toward fundamentals, exposing former bubbles and making skepticism more valuable than momentum-chasing.

Data Points: Market decline since prior episode: Another 10% to 15% down - Andrew says markets fell further since the mid-May podcast. Merger arbitrage example: Citrix (CTXS) deal price: About $101 per share deal value; stock dropped from about $97 to $90 - Used to illustrate spread widening and forced selling. Citrix implied upside/IRR: Over 10% gross; IRR approaching 100% - Discussed as an example of a huge spread in a late-stage deal. Plan original deal price: $66 per share - Original private-equity acquisition agreement for Plan. Plan recut price: $63.75 per share - Small price cut after alleged merger agreement breaches. Plan share comp limit breach: 30 million allowed vs. 35 million issued - Contract term cited as part of the buyer’s claimed out. Plan hiring limit breach: 200 allowed vs. 220 hired - Another explicit contractual breach cited in the proxy. Standalone Plan value estimate: Low $30s per share - Chris’s rough estimate of downside if the deal broke. Market-implied probability for Plan: About two out of three - Chris argued the market was implying only a ~66% chance of closing, low for a signed definitive deal. Toma Bravo perceived court-win odds after recut: About 5% to 6% - Andrew estimated the recut implied very low buyer victory odds in court. LVMH/Tiffany price cut comparison: $135 to $131 - Used as a historical comparison for a small recut. Alere/Abbott price cut comparison: About $5 per share - Used as a comparison for a larger deal reset. Twitter deal price: $54.20 per share - Referenced repeatedly as the agreed acquisition price. Twitter stock price during discussion: About $38 per share - Used to show the market discount to deal value. Twitter spread-implied downside estimate: Low $20s standalone value - Chris said the market implied significant downside if the deal failed. Twitter market-implied probability: Just over 50% - Chris framed the market as uncertain about deal completion. Twitter regulatory progress: SEC clearance expected soon; HSR already cleared; vote and close before Labor Day - Discussion of the proxy and process toward closing. Continental Resources bid: $70 per share - Offer from the Hamm family to take the company private. Continental Resources trading price: Around $66 per share - Market price at the time of discussion. Hamm family ownership: About 80% - Explains why the family can influence a take-private. Elon Musk Twitter stake: 9% - Cited as an example of a buyer with existing interest in the target. Leverage/market stress reference: Late-stage arb spreads - No exact figure; used as a recurring market condition theme. Tax/legal cost vs. deal size example: $10 million legal bill on a $44 billion deal - Used to argue penalties should be larger to matter for wealthy buyers.

Pivotal Quotes: "Markets have been weak and volatile. ARB spreads have been weak and volatile." — Chris Muth: Opening framing of the late-June 2022 environment. "A merger agreement is like a pregnancy test. It's pretty damn binary." — Chris Muth: Explaining why signed deals should be treated as largely in-or-out, not vaguely optional. "I think it is kind of an archetypal widespread where there are lots of ways to win or at least survive." — Chris Muth: Describing Twitter as an especially attractive event-driven trade.

Implications: For event-driven investors, stressed markets are creating unusually rich spreads, but selectivity matters: favor definitive contracts, near-term closings, and deals with strong downside support. The episode also warns that speculation and narrative trading are giving way to fundamentals.