Wall Street's Highest Rollers

Multimillion gains--and losses--in arbitrage

Arbitrage until a few weeks ago was only a somewhat mysterious word to the average investor. Then it became known that a handful of Wall Street arbitragers who like to speculate on corporate takeovers were the big winners in a bidding war for Babcock & Wilcox Co. (TIME, Sept. 5). As soon as United Technologies Corp. made an opening tender offer, the arbitragers began sinking $100 million--much of it borrowed--into purchases of B & W stock, starting at $42 a share; they quickly bought up more than a quarter of the outstanding shares. Then they sat back happily while United and J. Ray McDermott Inc. made escalating rival offers for a controlling interest in Babcock, and eventually wound up selling out to McDermott for $65 a share. Estimated profit for the lucky gamblers: about $30 million in six months.

Since then, individual investors have been asking their brokers to cut them in on the game of arbitrage. Fat chance. Merger arbitrage is a gamble only for high rollers--people with the wealth and insouciance to risk millions on a single transaction. There are other types of arbitrage, but they are scarcely as exciting. The word arbitrage is old French, and in that language means "arbitration." In financial English, it has traditionally described trading on price variations on the same commodity in different markets --buying cotton in New York, say, and selling it in Hong Kong, where the price might be a trifle higher. That is still done, but the profits are tiny.

Merger arbitrage is a different and enormously expensive game: it consists of buying up big chunks of stock in a company that might be subject to takeover, in the hope of selling at a profit to the firm that eventually acquires the target company. The principal practitioners, all based in New York City, number no more than 20. They include such well-known investment houses as Salomon Brothers; Bache Halsey Stuart; Goldman, Sachs; and Lehman Brothers, which make arbitrage purchases for their own accounts, on behalf of wealthy clients, or both. There are also a few individual operators, ike Ivan Boesky, a lawyer, accountant, and security analyst. He set up his own firm two years ago to deal exclusively in arbitrage, and boasts that he works 18 hours a day at the game. Boesky, an immaculate dresser and a devotee of squash who once taught English literature in Iran, made an estimated $7 million on the Babcock & Wilcox auction.

The dean of the business, which requires steel nerves and a finely honed mind, is Leonard Sheriff, 62. He is president of Sheriff Securities, which is generally considered to be the biggest of all arbitrage traders. Sheriff has the air of a boulevardier, is a wine authority and one of the important U.S. philatelists. Trained as a lawyer (one of his former partners is Diplomat-Investment Banker George Ball), Sheriff did a stint with the Securities and Exchange Commission, and founded his arbitrage firm back in 1960. He is one of the few arbitragers whose clients give .him full discretionary authority.

Sheriff now has positions in some 300 companies--chosen in an unorthodox way. He pays little attention to the traditional means of measuring the desirability of a company's stock (book balances, quality of management, and earnings). Instead, along with his staff of eleven, he clips the main financial publications for snippets of news that might hint of forthcoming mergers or acquisitions, then acts on instinct.

Sheriff will not disclose his return on invested capital, which is reputed to be enormous. Most other arbitragers will not speak for quotation about anything; theirs is a highly competitive business, conducted in a secrecy about as deep as that surrounding Russian wheat purchases. A risky one, too: there is always a chance that a merger will collapse, and prices of the stock that arbitragers have been buying will go down with it. In April, for example, Anderson, Clayton & Co. bid $40 a share for stock in Gerber, the baby-food company, that was then selling at $33; arbitragers galloped in and pushed the market price above $39. But Gerber fought hard against the takeover, Anderson, Clayton pulled out, and the price of Gerber stock has fallen back to less than $28.

The big arbitrage action--and risk --is currently in Miles Laboratories, best known as the maker of Alka-Seltzer. After Bayer AG of West Germany bid $40 a share for Miles, arbitragers bought so much that they sent the market price up more than $12 in a single September day, to $42. If, as the arbitragers hope, Bayer gets into a bidding war for Miles with other companies, the plungers may profit handsomely. If no other bidders appear and Bayer pulls out or is blocked by antitrust authorities, the arbitragers will need something to calm upset stomachs.

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