Steve Craige, CFA¹
Institutional Portfolio Manager
Mutual Series

The Mutual Series team complements its core value-investment discipline with two other strategies-distressed and merger arbitrage investing. We started the year not knowing if any merger arbitrage opportunities were going to appear as the market for corporate deals had collapsed alongside the equity markets in 2008 and early 2009, and uncertainty, risk aversion and frozen credit markets were paralyzing the business landscape.

To provide perspective on the dire corporate credit situation in early 2009, it is useful to remember that the spread between high-yield securities and government debt was historically high as investors tried to drastically reduce risk and transferred assets to safer government securities. The spread was far greater than the comparable high yield-to-Treasury spread during the last credit crisis in 1997-1998, as investors discounted a looming credit default cycle on a par with that of the Great Depression, marking the severity of this global credit crisis.

Nevertheless, a few large pharmaceutical industry deals emerged in early 2009, as acquirers took advantage of their relatively strong balance sheets and the attractive, inexpensive market prices of targeted acquisitions. These merger deals included Genentech-Roche, which closed earlier in the year, and Pfizer-Wyeth and Schering-Merck, both of which just recently closed. We were happy to participate in each of these opportunities, and each situation proved beneficial to our shareholders.

As the financial system has continued to mend, the availability of corporate credit has vastly improved. As credit resumes flowing, high-yield spreads have narrowed considerably, which also implies a significant reduction of risk. With corporate credit markets beginning to thaw, companies may be able to finance deals more easily. Exceptionally low interest rates, ample access to capital for some, and attractive prices for targeted acquisitions, corporate CEOs are on the hunt, and the Mutual Series team believes this may support more merger arbitrage activity in the near future.

As well, investment bankers are relating that their calendars are very full these days, so we believe the merger arbitrage space could continue to be quite fruitful for us over the next six to nine months.

A good example of this acquisition trend is Kraft Foods' recent bid for UK-based confectionary maker Cadbury, which has been an undervalued equity holding of Mutual Series for some time. In fact, Mutual Series has been one of Cadbury's biggest investors. The Mutual Series team identified the confectioner some time ago when it was trading at a deep discount to the team's estimate of its intrinsic value, long before Kraft Foods' unsolicited takeover approach. Kraft took its hostile bid to Cadbury's shareholders in early November, and we are presently awaiting a resolution.

Please click on the following to find out more:
FTIF - Franklin Mutual Beacon Fund
FTIF - Franklin Mutual Euroland Fund
FTIF - Franklin Mutual European Fund
FTIF - Franklin Mutual Global Discovery Fund

Footnote
¹CFA^® and Chartered Financial Analyst^® are registered trademarks owned by the CFA Institute.