Sunday, March 21, 2010

Merger Arbitrage: Lions Gate (LGF)

Carl Icahn is a respected, and often feared, investor with an enviable long-term track record. His successes and failures have attracted attention throughout his high-profile career. I believe his current strategy with LGF is bound to end with a resounding thud. A bidder’s credibility and intentions are important aspects in the deal process, and while no one will doubt Icahn’s credibility, I’m not sure even he knows his intentions for LGF.

First, a little background will bring us nicely up to speed. Over the course of 2008, Icahn more than doubled his holdings in LGF to a stake of 14%. People were thinking that he would dust off his poison pen, rattle the cages, and encourage a sale of the company. Icahn said in February of 2009 that he is evaluating increasing the size of the board and adding his own directors. In March, he terminated his talks with LGF, citing the failure to reach a sufficient standstill agreement. Icahn’s next move was to make a tender offer for $325 million of LGF’s senior subordinated notes at 73% of par.

At this point, we know Icahn has a problem. LGF has a very concentrated shareholder base, and the top three holders (nearly 50% combined stake) are supportive of management. Interestingly, the top holder (20%) is Mark Rachesky, who was a senior investment officer for Icahn Holdings from 1990 to 1996. Rachesky left to launch MHR Fund Management and has created his own impressive legacy. He, too, is an influential investor, and it is inauspicious for Icahn that his protégé is not siding with him on LGF.

LGF struck a deal with convertible debt holders to keep $316mn of the securities out of Icahn’s hands, by restructuring the strike price from $14.28 to $8.25, and also extending the put date from 2012 to 2015. Investors showed their lack of support for Icahn’s offer when 5% tendered their notes.

In September, Rachesky was nominated to the board. Meanwhile, Icahn quietly grew his holdings to 19%. In mid-February, with LGF trading at $5.23/share, Icahn announced a $6/share partial tender offer to increase his holdings to 29.9%. Here is why I don’t think Icahn knows his intentions for LGF: After he announced the partial tender, he went on CNBC and said that he is not seeking control of LGF, and that he wants to increase his holdings so he can have more say in potential acquisitions the company makes. (In the past, he had criticized LGF’s acquisition of the TV Guide Channel.)

On March 12, LGF recommended that shareholders not tender to Icahn’s partial offer. Management argued that the offer is inadequate, and noted that $6/share is a 30% discount to the average analyst price target. They said that, with 29.9% of the shares, Icahn could effectively veto certain transactions and would have power over fundamental decisions. LGF pointed out that the Icahn Group lacks industry experience. The company noted that a successful partial tender would constitute an event of default under its credit facilities, which would permit the lenders to accelerate the maturities of outstanding borrowings ($516 million of such notes). The board also authorized a shareholder rights plan (poison pill) to “limit the potential adverse impact…of an accumulation of a significant interest in the shares”. The plan has a threshold of 20% (note that Icahn is holding 18.9%).

On March 19, Icahn amended his offer to buy 29.9% of LGF, and is now seeking to purchase all of the common shares outstanding for $6/share. He did not change the offer price, which was previously rejected. Icahn said that he intends to pursue legal proceedings to set aside the poison pill, and that it restricts the rights of LGF shareholders to accept the offer. If more than 50.1% tender to the offer, Icahn intends to replace the board with his own nominees. Icahn went on to address the change of control provisions in the debt, and said that his group is prepared to provide a bridge facility if the provisions are triggered.

His offer is not competitive. He said one month ago that he is not seeking control of the company – now he is. The $6/share offer was rejected in the partial tender, now he wants to make it for the whole company? Curious at best. We will be sure to follow this possible merger arbitrage investing opportunity in the future.

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About the Authors

Hunter is the founder of the Distressed Debt Investing Blog and the Distressed Debt Investors Club. He has worked on the buy side for the past 7 years in high yield and distressed debt investing.

Edward has been a professional investor for four years, focusing mainly on the event-driven space. His investment philosophy is value-based, and he spends the majority of his time identifying near-term catalyst based opportunities.

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hunter [at] distressed-debt-investing [dot] com