From Selling Gummies to $15 Billion? John Paulson's story & how to replicate it.
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Former Hedge-Fund Manager John Paulson is often mentioned alongside other investing greats like Warren Buffett. But he's actually famous for making billions betting AGAINST the 2000s housing boom. However, Paulson also made a small fortune for himself and his investors with something called merger or risk arbitrage and what some called “The Greatest Trade Ever.”
Enter the book about him…
There's a lesson in the framework he used to acquire his first billion.
A mentor of mine once said, 'if you can understand risk arbitrage trades you can understand just about anything in the world of making money.' I want to pass that gift on to each of you. Let’s break down how this trade and investment type works, how we can apply it ourselves, and why it’s so interesting.
What’s A Merger/Risk Arbitrage?
Investopedia defines risk arbitrage as “simultaneously purchasing and selling the respective stock of two merging companies to create ‘riskless’ profits.” Discounting his ‘Big Short’ and recent fame, much of Mr. Paulson’s life work focused on this strategy of risk arbitrage.
Here’s where it started. In 1960, Mr. Paulson’s grandfather bought him a pack of Charms candies. Young John quickly realized the candies were worth more if he pulled the pieces out of the pack and sold them individually. This is the arbitrage part, buying (in this case being given by your grandpa) something for one price and then selling it (in whole or part) for more than you bought it for. This is a strategy we’ve talked about before with cars. It’s a short mental step from looking at how Mr. Paulson broke up the whole pack of candy into pieces, selling at an even bigger profit for each individual piece, to running a hedge fund focused on merger arbitrage. So, let’s do a slightly more complex example this time.
In 2014, Mr. Paulson’s fund Paulson and Company bought Salix (a pharmaceutical company) at $102 a share.
Why? He anticipated a merger tender offer (someone wanting to buy) Salix. That happened when Valeant Pharmaceuticals a few months later offered to buy Salix at $173 a share. Paulson bought in at $102, then sold out at $173.
That’s a 69% increase.
TLDR, Paulson took whole packs of CHARMS candies and sold the individual pieces as a kid. As an adult, he anticipated individual companies' mergers, bought a piece at a low price, and once the companies merged (or even on the rumor of a merge), he profited on the raise in the soon-to-be-acquired businesses stock. But, we don’t have millions of other people’s $$$s to anticipate stock pricing changes, Codie?
So how might you apply this story to your life, you ask?
You may not be a hedge fund manager looking to invest in ‘boring’ businesses but I promise there are echoes for everyone.
The overarching trend I see today is that arbitrage is all around. While the “risk arbitrage” trade may have died down on Wall Street, here are other areas where I see a huge gap between what the market thinks something is worth, and what it will be in the future.
Your opportunity? How do you jump in to fill the gap between the numbers and the narrative?
Trucking & Logistics - Canada aside, shipping and logistics is up in flames. Can you buy industrial infill real estate to help with last mile delivery? What about buying a trucking company right now? How about investing in AI trucking co’s? Wherever there is pain there is profit.
Grocery delivery - Shelves bare, limited supply, scares about lack of produce or meat with a next run. Might be a good time to invest in a delivery business? Farmland? To buy into a local co-op and help them push out produce locally.
Cars - Get on the wait list for Porsche, then turn around and sell it on the secondary market for higher perhaps? Flip cars across the board right now given demand.
Events - These are coming back with a vengeance. How can you play? Go to your neighbors in Austin and see if anyone wants to rent out their house for SXSW and you’ll manage and uplist it? Or rent out your own? Or invest in event companies?
This list is FAR from exhaustive but it’ll get your juices flowing. If you think the lessons are just for investing, not at all. Here are life lessons… we’ll call it the M&A Superpower List.
M&A Superpower:
The sum of a whole is often greater than the individual parts.
Other People’s Money: Financing can be done with a group of trusted partners, or even strangers, lowering an individual’s up-front cost to purchase an asset. Shaan Puri is a great example of raising $$ with strangers on Twitter, then turning that money into a VC fund where he gets paid to oversee it.
Tax Arbitrage: Multiple strategies can be used together in a sort of metaphorical sum of the whole being greater than its parts….remember Peter Thiel combining a tax efficient output stream (ROTH IRA) on top of his money making business (Paypal)?
Skill Arbitrage:Skills can be stacked on top of one another. You pair your mediocre (or average) ability together with multiple other divergent skills and those together can replace the 10,000 hours necessary to become a singular expert.
Holding Company: Multiple streams of income combine into a single income stream when put under one umbrella. That umbrella company or Hold Co can then be sold for more than any of the individuals similar to Shaq’s:
Service Stacking: Features or services can be stacked… Hannah Ingram added car wash vending machines to her existing car wash for example, and leveraged the cheap business with high cashflow to acquire more assets.
The truth is there is always an arbitrage opportunity. The question is, are you willing to deviate from the crowd to take advantage of it? That lesson sure as hell just ain’t for finance.
Stack cash and combine businesses,
Codie
Not Boring
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Disclaimer – This is the “Be an adult” section. Everything mentioned above isn’t advice, just a recount of what I did. That said: This article is presented for informational purposes only. The opinions stated here are not intended to recommend any investment or provide tax advice. Neither are they an offer to sell or the solicitation of an offer to purchase an interest in any current or future investment vehicle managed or sponsored by Codie Ventures, LLC or its affiliates. All material presented in this newsletter is not to be regarded as investment advice, but for general informational purposes only. Day trading and investing do involve risk, so caution must always be utilized. We cannot guarantee profits or freedom from loss. You assume the entire cost and risk. You are solely responsible for making your own investment decisions. We recommend consulting with a registered investment advisor, broker-dealer, and/or financial advisor. If you choose to invest with or without seeking advice from such an advisor or entity, then any consequences resulting from your investments are your sole responsibility. By reading/sharing this newsletter or consuming our content on our other channels, you are indicating your consent and agreement to our disclaimer.
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