Idea Brunch with Lionel Hutz of Valorem Research
Idea Brunch with Lionel Hutz of Valorem Research
Welcome to Sunday’s Idea Brunch, your interview series with great off-the-beaten-path investors. We are very excited to interview Lionel Hutz!
“Lionel Hutz” is the author of Valorem Research, a popular new publication on legal special situations and merger arbitrage. He is a former patent litigator and technology transactions/M&A attorney based out of New York, who left legal life in 2022. Now, he has built a smart dedicated following under his pseudonym @LionelHutz_Esq on Twitter.
This bonus Idea Brunch is being sent early because of the timely nature of topics discussed. In case you missed it, our last two posts were Idea Brunch #2 with Ryan Rahinsky and a list of the best stock research tools.
Lionel, thanks for doing Sunday’s Idea Brunch! Can you please tell readers a little more about your background and why you decided to launch Valorem Research?
Thanks for having me! I’m an ex-engineer turned lawyer turned legal special situations investor. I started my career at one of the big, global firms doing mostly patent and trade secret litigation, which had me traveling all over the U.S. to litigate cases, mostly in federal court, and coordinating parallel litigation matters all over the world. I loved the work, but I always knew I wanted to parlay my litigation career into an investment career. During law school I saw Kyle Bass using the patent system as an investment tool, and I thought that was awesome. I’m not sure he ever made money on that strategy, but it was the first time I had seen someone use the law, not just as a way to inform an investment decision, but actually as the main driver of the investment thesis.
After the litigation job, I moved over to the technology transactions side at another large firm to get reps on M&A and licensing matters. Once I felt like I had a handle on that—or at the very least felt like I knew what I didn’t know and knew the right types of questions to ask—I left to pursue legal special situations investing.
I started writing on Substack about a year and a half ago during the Elon Musk Twitter takeover saga. At first, it was just a way to crystallize my own investment process. I didn’t think anyone would read it, to be frank. But I knew that making the thesis public would force me to be intellectually honest about the arguments and potential pitfalls. The morning after I published the first article, I woke up to thousands of views on the article and dozens of emails in my inbox asking me to jump on calls with hedge fund partners, portfolio managers, and analysts. It was the first time I realized the scale of the demand for legal special situations expertise.
Since then I’ve re-invented the Substack as Valorem Research, and it’s now a more regular publication covering legal special situations, with a focus on merger arb, patent litigation, and international enforcement.
The common perception of merger arbitrage investing is that there is high downside, low upside, and it requires a tremendous amount of research. Is that right, and if so, why is merger arbitrage a good place to invest?
It certainly can be correct; you have to choose your battles. But even in these limited upside scenarios, it’s one of the rare instances in investing where you have a set upper and lower bound, or maybe a set upper bound and very educated guess of a lower bound. The Twitter saga and the Spirit saga were interesting because the downside on both changed drastically during the course of the respective litigation matters; however more often than not you’re looking at a target company that is maintaining the status quo during the pendency of the litigation in a less volatile environment. That means you can back into position sizing which can protect the downside over the long run if you have a good sense of your batting average.
I think it’s also important to recognize that we’re in what some might call the golden age of merger arb investing, where upside can be outsized relative to historical norms. Rangeley Capital’s Andrew Walker, who is super sharp on this stuff, has called it an “inflection point.” I largely agree. Beyond the “n of 1” scenarios like Musk’s takeover of Twitter, we’ve seen a steady stream of lawsuits from both the FTC and DOJ challenging mergers that neither agency would have dreamed of challenging in the past, and they’re frequently bringing cases under new theories of antitrust law that don’t yet have the foundational support to constitute legitimate challenges. That has meant we’ve also seen deal spreads blow out on news of a regulatory challenge, even if the challenge lacks merit. In short, it’s more opportunities, and the opportunities are skewed in favor of investors.
I can’t say with certainty the good times will continue to roll in the world of merger arb. Certainly, Republican administrations have been much more free market, and much less likely to challenge mergers, in the past. But even Republicans are now feeling the heat to crack down on big tech, and I think they’ve got the political support to do so given what many see is a “woke” censoring culture in Silicon Valley. I would suspect a Republican administration would be less favorable to merger arb investors looking for massive spreads, but I don’t think the opportunities will completely evaporate.
What are some common mistakes you see novice merger arbitrage/special situations investors make? And how have you seen yourself improve as an investor in these situations over time?
Like anything in the world of law, you get better with more reps. Our common law system is a system built on precedent, meaning the body of precedential or informative decisions only continues to grow. In that vein, I think the largest pitfall is not “shepherding case treatment.” I see folks often point to a decision that seems analogous to a current matter, but they don’t track down all the cases that came after that decision to see how later cases have either corroborated the earlier decision or been distinguished from it. Knowing the rule, but not the exception, or the exception to the exception, can be very dangerous.