Chris DeMuth's state of the markets May 2022

Episode Summary

Executive Summary: In this podcast, Andrew Walker and Chris Muth discuss current market conditions, event-driven investing, and specific situations like Activision Blizzard, Twitter, and Kohl's. They analyze the impact of regulatory environments, credit markets, and ESG mandates on deal-making and energy stocks, highlighting opportunities in special situations and the disconnect between commodity prices and equity valuations.

Main Topics: Market Conditions and Event-Driven Investing (Priority: 5/5): Discussion of the current market drawdown, the importance of liquidity and hard catalysts, and the resilience of the deal market despite regulatory and credit concerns. Regulatory Environment and M&A (Priority: 5/5): Analysis of the Biden administration's antitrust stance, the FTC/DOJ's approach, and the impact on deals like Activision-Microsoft and Twitter-Elon Musk. Specific Deal Situations: Activision Blizzard and Twitter (Priority: 4/5): Deep dive into the Activision-Microsoft deal (regulatory risks, spread) and Twitter-Elon Musk deal (financing, reputation, reprice risk). Energy Sector and ESG (Priority: 4/5): Discussion of the disconnect between high commodity prices and low energy stock valuations, the role of ESG mandates, and opportunities in domestic supply. Kohl's Takeover and Pre-ARB Opportunities (Priority: 3/5): Examination of Kohl's as a pre-arbitrage opportunity with multiple bidders, real estate complexities, and the signal from its stock price. Warren Buffett's Moves and Market Signals (Priority: 3/5): Analysis of Buffett's purchases in Activision and Occidental, and the implications for event-driven and energy investing.

Key Arguments: The deal market remains functional with strategic and financial buyers active, despite regulatory headwinds and market volatility. The current FTC/DOJ is more unpredictable and punitive, making definitive merger arbitrage less attractive, but broken deals offer future opportunities. Activision-Microsoft deal has a wide spread due to regulatory fears, but Microsoft likely has a strong case in court; the downside is cushioned by Berkshire's interest. Twitter-Elon Musk deal faces reprice risk due to Tesla's volatility, but Musk's reputation and the contract terms make walking away difficult. Energy stocks are undervalued relative to commodity prices due to ESG-driven selling and market correlation, creating a buying opportunity. ESG mandates are creating a supply-demand anomaly in energy investing, similar to tobacco, which could benefit rational investors.

Data Points: Russell 2000 drawdown: 27-28% - Over the past six months, indicating a significant market decline. Activision Blizzard stock price: Below $77 - Trading at a 25% spread to the $95 deal price with Microsoft. Twitter stock price: $48 - Trading at a 13-14% spread to the $54.20 deal price with Elon Musk. Kohl's stock price: $51 - Down from $60, with multiple bidders including a confirmed $64 bid from ACTG. Activision break fee: $2 billion - Relatively small for Microsoft, indicating confidence in the deal. Oil futures curve: $80-75 - 12-24 months out, but market prices energy stocks as if oil will be $60.

Pivotal Quotes: "I think that I'm certainly most comfortable around situations with fairly hard catalysts so we can know within a few weeks or within a few months if we're basically right." — Chris Muth: On the importance of event-driven investing with clear catalysts in volatile markets. "The head of the FTC kind of just graduated from law school and is a real... it's kind of like debating antitrust with them is more like talking about somebody else's religion than it's like comparing views on antitrust." — Chris Muth: Critiquing the current FTC's unpredictable and ideological approach to antitrust enforcement. "I feel like ESG is going to push energy... into the category of it's going to be Philip Morris-like investing, where it's going to be great for investors because of this weird anomaly of a supply and demand created on who's willing to invest in it." — Chris Muth: On the long-term opportunity in energy stocks due to ESG-driven selling.

Implications: Investors should focus on event-driven opportunities with hard catalysts, be cautious of regulatory risks in M&A, and consider energy stocks as a contrarian play due to ESG-driven undervaluation. The current market favors special situations over passive index investing.