It's spooky weird that you featured CVRs in this week's blog, I literally just posted some questions and analysis on a CVR deal that is expected to close imminently.

As a quick aside, your commentary on potential product issues reminds me of BAYRY's acquisition of CPTS and their Essure female sterilization device. I was covering healthcare at the time for a long/short hedge fund, and had talked to several docs about Essure. It was - or should have been - obvious to anyone with Internet access (there were reams of patient complaints and horror stories posted online) that Essure was highly problematic, Ess-entially a class action lawsuit in search of a California jury. I'm embarrassed that my recall isn't perfect (I've looked at literally tens of thousands of investment opportunities since then) but I think it's likely that "we" (aka "I") were short CPTS when the deal was announced. Clearly no one in BAYRY's legal department had Internet access; but then given BAYRY's corporate history, maybe they don't have a legal department?

I'm familiar with all the deals that you mentioned, and was lucky enough to own ALBO, CNCE, and HRZN when the acquisitions were announced, and bought ABMD for the CVRs. I've been pondering similar questions:

1. Is there any research on the returns from buying biotech/medtech CVRs?

It's tempting to speculate that - due to the structural issues that we have both identified - CVRs are the mythical Wall Street free lunch in the land were many professional investors would sell their grandmothers into slavery if they could get a fair price. But maybe CVRs are fools' gold, overvalued by risk-seeking lottery ticket punters and dewy-eyed biotech investors seduced by pie in the sky management projections? Natural selection would favor the latter, since legacy shareholders presumably owned the stock because they were hooked on the kool-aid. So maybe CVRs are a con perpetrated by cynical acquirers on gullible target shareholders ripe for manipulation?

It would be nice to have some data; and I'd be shocked if some academic hasn't crunched the numbers!

2. Who are the natural buyers of these CVRs?

I hadn't thought of the issues that you raised in terms of the personal incentives (or lack thereof) for arb analysts, but there are some other issues that do puzzle me. Presumably arb funds don't want to tie up capital that could otherwise immediately be leveraged and recycled into new deals? And presumably arbs' core competence is handicapping deal probabilities, not valuing and then warehousing esoteric CVRs (with all the associated administrative issues that you identified)? CVR investing also seems antithetical to the arb business model of highly-leveraged high-probability but very short-term outcomes?

3. As another of your readers observed, CVR investors who aren't playing the arb game can minimize deal risk by deferring purchase until deal closure is imminent. And as another reader asked, I'm also wondering if real time information is available on the expected closing date as closure is imminent? This is important, since as you note, you need to low a plot of capital into a deal to get a meaningful allocation of CVRs.

4. It's interesting to observe that the expected returns from CVR scalping are highly sensitive to tiny perturbations in the target's stock price., with the leverage proportional to the value ascribed to the CVR as part of the total consideration. So for example if you think the ABMD CVR is worth $2, your expected return is 100% at $381, but you can expect to lose more than half your money if ABMD's stock price pops 1% at closing.

CVR scalpers should therefore be very price sensitive and/or highly selective in finding deals where the CVR is egregiously underpriced and either the acquirer can't move the goal posts or there are material costs to doing so.

All of which suggests that the Wall Street free lunch remains as scarce as - but hopefully more tasty than - hen's teeth.

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i agree that waiting until the last possible second to put on the trade is the best way to go about things here

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