The sheer audacity. Today, the AFR reported that “explosives maker Orica has come under fire from one of the world’s most aggressive and activist shareholders, New York-based hedge fund, Elliott Associates, over its handling of the $10 billion buy-out proposal it rejected in April.”

Orica has been one of the best performing companies on the ASX in recent years, under the previous stewardship of former North boss, Malcolm Broomhead and now Graeme Liebelt, its share price has risen from $4 in 2001 to more than $31 – an almost 800% rise. Despite its phenomenal performance, Elliott, along with San Francisco-based Canvas Capital, is believed to have “expressed discontent” with Orica’s decision to snub a private equity consortium earlier this year.

Elliott is unhappy at Orica because it has been unable to make a quick windfall profit with its attempted “merger arbitrage” – a common tactic of hedge funds. Merger arbitrage involves purchasing equity in a company subject to a takeover bid. In many instances, an auction will occur and the merger arbitrageurs are able to make a windfall profit on their (usually highly levered) investment.

Merger arbitrage is bread and butter for hedge funds and certainly isn’t rocket science, although hedge funds will often go to great lengths to maximise their investment (including staking out airport lounges or due diligence rooms for information about potential bidders).

Merger arbitrage however can come badly unstuck. Either by an obstinate target board who refuses to accept an offer (or put the company up for sale) or due to regulatory problems (as occurred when EU competition regulators blocked GE’s bid for Honeywell, or when Peter Costello blocked bid Shell’s bid for Woodside).

When this happens, the hedge funds get very annoyed because they have to sell out of their positions at a loss (this is often compounded by a stampede of short-term traders heading for the door at the same time). Long term holders will often be far better off – in Woodside’s case, it has increased from Shell’s offer of around $17 per share to more than $46 per share in seven years.

Despite Elliott’s criticisms – the role of a board is not to maximise the short-term share price to benefit short-term traders.

While the Coles board is rightfully receiving a barrage of criticism for its decision to reject KKR’s $15.25 offer late last year, that criticism is due to Coles’ performance subsequently being awful. By contrast, the Orica board is far more justified in rejecting the private equity foray earlier this year.

Unlike Coles, Orica’s performance remains exceptional and it has a clear record of improving shareholder value (EBIT for the six months ending 31 December 2006 was up 25%, while earnings per share have increased from 22.1 cents per share in 2001 to a forecast 88.0 cents per share for 2007). While Elliott Associates is operating under the guise of being a “shareholder-activist”, they should be more accurately described as a “self-interest activist”.

Orica has shown that it is capable of delivering long-term results – it should not be held captive to hedge funds angry that they were denied the opportunity of a quick windfall profit.