Hedge funds, longstanding players in M&A deals, are now trying to beat private-equity firms at their own game by bidding for companies themselves to boost returns that are sagging elsewhere. The invasion of private-equity territory is well underway in the United States, and investment banks in Europe are already geared up to advise hedge funds on similar moves here. "In the US last year there were more than 20 large transactions involving hedge funds," said Pascale Alvanitakis-Guely, who recently started focusing on European hedge-fund coverage at Lehman Brothers. "This trend is now arriving in Europe," she said.
Bankers say that five years ago private-equity buyers were almost ignored in an M&A situation, but now there is hardly an M&A deal where financial sponsors are not involved. They predict the same will happen with hedge funds.
Alvanitakis-Guely, an M&A banker at Lehman Brothers in London specialising in financial institutions, moved into her new role in hedge-fund advice at the end of last year.
She said Lehman's decision to provide M&A advice to hedge funds was partly because of market trends towards consolidation in the hedge-fund industry.
Investment banks, commercial banks, insurance companies and asset managers are buying hedge funds. J.P. Morgan Chase & Co, for example, has bought hedge fund Highbridge Capital Management and Lehman Brothers has just bought a stake in US hedge fund Ospraie.
But her group is also advising hedge funds on strategic investments they make for their own portfolios.
"There is convergence between the hedge-fund world and the private-equity world and hedge funds are participating a lot more in private-equity-type situations," Alvanitakis-Guely said.
The US has seen a spate of big deals where hedge funds have been in the driving seat.
In February, US hedge fund Highfields Capital Management made a $3.3 billion hostile bid for electricals retailer Circuit City.
In November last year, Kmart Holdings Corp bought rival Sears Roebuck and Co in a $12.3 billion deal, where Kmart Chairman Edward Lampert's hedge fund ESL Investments was the largest holder of both Kmart and Sears shares.
A hedge fund recently bought troubled German movie firm Senator Entertainment by buying up its debt at an 80 percent discount, using this as a route to a take-over via a debt-for-equity swap, sources close to the situation said.
Another hedge fund is currently using the same strategy at pharmaceuticals retail firm Ihr Platz, the sources said.
In Europe, bankers see hedge funds becoming more aggressive participants in M&A situations because their traditional business is getting tougher.
"Their core markets have become much more difficult," said Nick Gaynor, managing director in Deutsche Bank's financial sponsors group, which ranks number one in Europe as advisor on private-equity deals, according to Thomson Financial.
"For example, it is very challenging to make good returns in merger arbitrage because too many guys are trying to do it now," he said.
"They've peered over the fence at their private-equity competitors, they see economics that they fundamentally understand ... and they are jumping in."
But Gaynor said running a company is not what hedge funds have been used to doing.
"Actually buying a business, living with it for three years, changing the management, being involved strategically - these are skills that most hedge funds don't have."
Hedge funds also have shorter time horizons in terms of tying up funds than private equity, which usually takes on investors' money for three to five years.
"They are trying to address this by creating sub-pots of money in their funds that have one- to three-year lock ups, but that's historically not been the hedge fund way so they may find it tough," Gaynor said.
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