Sunday, May 16, 2010

Risk Arbitrage: CKE Restaurants: Is a Higher Offer Coming?

CKE Restaurants Inc (CKR) is an interesting risk arb situation that we are currently following. It first agreed to be acquired by Thomas H. Lee Partners for $11.05/share, then it terminated that deal to accept an offer from Apollo Management for $12.55/share. While the remaining spread is $0.11 (0.9%), there is some optionality on the name that investors might find attractive.

On February 26, 2010, CKR announced a definitive agreement to be acquired by THL for $11.05/share in cash, a $928 million price tag. The price was a 24% premium to CKR’s prior close, and valued the company at about 5.5x EBITDA. The agreement contained a go-shop provision which allowed CKR to solicit third party proposals until April 6. During the go-shop period, CKR closed as high as $11.56/share (-4.4%) as investors anticipated a higher offer. Reports were that Wendy’s/Arby’s Group (WEN) and other private equity firms were evaluating a bid and looking at CKR’s books. Let's delve a little deeper into this risk arb situation.

CKR disclosed on April 7 that it received an alternative takeover proposal which was reasonably expected to lead to a superior proposal. No terms were disclosed, but CKR said that it will engage the party in further negotiations until April 27. When this news came out, the stock went to $11.81/share (-6.4% spread). As things usually go in arb land, everyone knew it was Apollo who made the bid, though it had not been officially stated. On April 20, CKR announced that the party offered $12.55/share, which the board deemed a superior proposal. The new proposal, which valued CKR at 6.3x EBITDA, had an expiration date of April 24. On April 26, CKR announced that it terminated the THL agreement and entered a new merger agreement with Apollo for $12.55/share.

So this tells us that THL was not interested in matching Apollo’s offer, since a match from a party with whom you are already in a definitive agreement is preferable, so the company can avoid paying the termination fee. However, this turned out not to be the case. CKR disclosed in the deal background section of its preliminary proxy on May 4 that THL actually did match the $12.55/share offer. The revised THL offer, made on April 23, included a provision whereby CKR would be obligated to pay a termination fee of $29 million in the event that a new merger agreement was executed with Apollo, and a $15 million fee for all other buyers. THL also wanted a two business day match right. Later that day, CKR’s advisors, UBS, made three suggestions as to how THL could improve its latest offer: 1) increase the per share consideration 2) eliminate the two business day match right and 3) make the termination fee applicable to Apollo equal to the fee for other potential bidders. THL declined to negotiate these terms and stuck with their proposal.

Here’s where it could become interesting. Also included in the proxy was that CKR requested wire instructions from THL on April 22 in order to prepare the wire transfer of the $9 million termination fee payable to THL. Subsequent requests were made, but THL had not provided the instructions by the May 4 proxy. This seems odd to those versed in M&A. When a company announces that a transaction has been terminated, it usually includes in the same press release that the termination fee has been paid (or will be paid imminently). Why is THL delaying the receipt of the termination fee? Perhaps they are preparing to make another offer. Let’s imagine that THL is planning to make an offer that it believes will win CKR. In this scenario, the payment of the termination fee is irrelevant, since THL would own CKR. Why transfer the cash from a target to its eventual owner if the owner will appropriate the assets upon deal completion (which should happen in the second quarter)? We already know THL was willing to pay $12.55/share.
There is your option on CKR. The stock is at $12.44, with a 7% spread annualized to June 30. Not an eye-popping number, but it’s a relatively safe deal, and you could potentially see an increase in the deal price. Remember, the role of merger arbitrage investing is to provide non-correlated, attractive risk-adjusted returns. This transaction is a sufficient example.

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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.

Email

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