Monday, May 3, 2010

Merger Arbitrage: Sauer-Danfoss (SHS)

Danfoss A/S, a 75.7% holder of Sauer-Danfoss Inc (SHS), announced on December 22nd, 2009 its offer to acquire the outstanding shares of SHS it does not already own for $10.10/share, a 19% premium to the price before the announcement. Danfoss stated that it would commence a tender offer in the first week of January. As this proposal was unsolicited, SHS closed at $11.61/share the day of the offer (-13% spread). SHS responded that its board established a special committee to review the offer and make a recommendation to shareholders. Let's dig further into the merger arbitrage example.

On January 8th, Danfoss delayed the commencement of its tender offer “because it is discussing certain matters with respect to the offer (not related to the terms of the offer) with the special committee”. You might be asking what we were at the time, which is, what could they possibly be discussing if not the terms of the offer? The topic of the discussions aside, Danfoss said it intended to commence the offer the week of January 15th. At this point, SHS was trading at $12.12/share (-17% spread) because people like that the two sides are talking (even if not about terms). On January 15th, Danfoss announced an additional delay in the tender and said that discussions with the companies will continue. Danfoss’ changed its language to indicate that the offer will commence “as soon as practicable once these matters are resolved”.

The spread remained negative as the companies were silent for the next two months. On March 9th, Danfoss increased its offer from $10.10 to $13.25/share. The special committee recommended that shareholders accept the offer. The 31% increase is extremely large for one offer to the next. Bids have been increased by this amount from the first offer to the last, but never with sequential offers. The offer was commenced with a scheduled expiration of April 7th. The market agreed with this price, and SHS traded around $13.20/share for the next month.

On April 1, Mason Capital Management announced that $13.25/share materially undervalues SHS and that it does not intend to tender its 4% to the offer. Mason reiterated its opposition on April 7th and pointed out that the special committee produced a four-part valuation in response to the initial $10.10/share offer which valued SHS at $13.38/share based on estimated 2010 EBITDA of $122 million. With a revised estimate of $159 million, Mason said that the special committee has no basis to recommend $13.25/share. Mason argued that SHS should take advantage of the current state of the capital markets and refinance its onerous debt load.

Danfoss extended the tender on April 8th by one day after an insufficient number of shares accepted the offer. On April 12th, Danfoss furthered increased its offer from $13.25 to $14/share, and the tender was extended to April 22nd. Danfoss called $14/share its “best and final offer”.
On April 16th, SHS announced that the board has asked management to prepare a set of updated projections for 2010 to 2012 to reflect the better than expected preliminary first quarter results SHS disclosed the previous day. The request was made to permit Lazard, its financial advisor, with information to make a recommendation on the increased $14/share offer. SHS cautioned that shareholders are not to rely on the previous recommendation in favor of the $13.25/share offer.

Danfoss extended the $14/share tender again on April 22 by seven days, citing a discussion it had with the SEC and statements from the special committee that they are reviewing the offer. On April 23, the special committee recommended that shareholders reject the $14/share offer, after consideration of SHS’ updated 2011 and 2012 financial projections, and shareholders would not be able to participate in the company’s future growth. The committee also mentioned the improved capital markets, and how the first quarter results improved the likelihood that they are able to refinance their credit agreement on commercially reasonable terms.

SHS provided in filings detailed information on various discussions that took place concerning the tender offer. On April 25, the committee told Danfoss’ CEO in a telephone call that $21.50/share is the price that it would recommend shareholders to accept, and that Lazard could approve this price for fairness purposes and Mason Capital would also support the offer. Danfoss confirmed on April 26 that $14/share is its best and final offer. During this process, SHS closed as high as $17.91/share, a -22% spread.

Danfoss announced the expiration of its tender offer on April 30, and since the minimum tender condition was not satisfied they will return the shares that were tendered (which totaled 20% of those not held by Danfoss). We give Danfoss credit for one thing – it said $14/share was its final offer and it stood by that comment. With the tender off the table, SHS closed on April 30 at $16.20/share. It is in Danfoss’ best interest to acquire the whole company, and the transaction could very likely be completed in the future. We would not be surprised to see Danfoss revisit the offer, and the floor on SHS appears to be $14/share.

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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