Most risk-arbitrage hedge funds this year are down huge, as the greatest credit crunch in financial market history has scrapped a few prominent deals, causing some serious pain for those who bet on a merger’s final price.

In the marketplace, risk arbitrage is the practice of taking advantage of a price differential between two or more assets. Generally speaking, a “risk-arb” trader might buy the stock of a company that is the target of a takeover while shorting the stock of the acquiring company. Here, the market price of the target company is less than the price offered by the acquiring company, as the probability and timing of the takeover is never official.

Here are a few ideas investors in today’s market that you might want to check out for possible risk arbitrage plays.

Steward Enterprises (STEI): Currently trading for $7.90, Steward received an $11-a-share bid by Service Corp. International (SCI) last month. Steward hired Goldman Sachs as its advisor and is expected to make a formal reply within the next three to four weeks; look for management to accept the offer. Steward owns about 221 funeral homes and 139 cemeteries in the U.S. and Puerto Rico. Additionally, third-quarter earnings rose 12% as profit margins widened in both the cemetery and funeral operating business.

Anheuser-Busch (BUD): Anheuser-Busch, which is trading at 10% below its takeover price of $52 billion, or $70 per share, is the best risk arbitrage out there today in the market. InBev proposed to purchase the shares of Anheuser for $70 per share. Until the acquisition is completed, the stock of the target typically trades below the purchase price. An arbitrageur will buy the stock of the target and makes a gain if the acquirer ultimately buys the stock. Recently, Brazilian antitrust regulators approved without restrictions the sale of Anheuser-Busch to InBev.

Top Ships (TOPS): Top Ships is exploring a possible sale to an affiliate of George Economou, the single largest shareholder and the CEO of DryShips (DRYS), for $6 per share. A spokesperson for Tops said: “There might be other companies interested in buying Top Ships, once they look that it is up for sale. As of now, Economou has the first exclusive agreement. If he turns it down and someone else decides it's worth more, that could be a possibility.” Economou owns about 15% of Top Ships; DryShips management would be a perfect fit to replace current management in Top Ships.

Ikon Office Solutions (IKN): Currently trading for $17 flat, Ikon received an $17.25 bid from Ricoh, a digital office-products company. Both companies' boards have already approved the all-cash transaction, which is expected to close in the fourth quarter.

Nothing is easy in life, but finding the right risk-arbitrage idea, could offer your portfolio additional alpha.

Posted on Sept. 30, 2008