Monday, September 27, 2010

Risk Arbitrage Updates: Pactiv and Dollar Thrifty

When we last discussed the risk arbitrage situation in Reynolds Group Holdings’ pending acquisition of Pactiv Corp (PTV), we said that HSR (US antitrust) review was the main concern. That hurdle was cleared on September 23, when PTV announced that the HSR waiting period expired. A few weeks ago, this was not the mainstream expectation. Once investors began to have a firm grasp on the competitive impacts of the combined company, the spread gradually tightened into the waiting period’s expiration date. The shareholder remains unscheduled, but the companies reaffirmed a deal closing by the end of 2010. The spread closed on September 24 at 1.0%. This is priced as a low-risk deal at this point.

Dollar Thrifty Automotive Group Inc (DTG) has been an active name since our initial review. Recall that both Hertz Global Holdings Inc (HTZ) and Avis Budget Group Inc (CAR) argue that they are in a more favorable position to successfully acquire DTG, from an antitrust perspective. On August 26, CAR received a second request from Canadian regulators, a requirement that HTZ fulfilled in early August.

On September 2, CAR increased the cash portion of its offer from $39.25 to $40.75/share, with an unchanged exchange ration of 0.6543. Provided in CAR’s press release is a little snapshot of the mudslinging that can take place between rival bidders.

Contrary to certain Dollar Thrifty and Hertz statements, a reverse termination fee has nothing to do with certainty of closing. Economic compensation for failing to close does not impact whether a deal is reasonably likely to close. The Hertz deal is no more likely to be approved by the FTC simply because Hertz agreed in the context of a negotiated deal to pay a fee to Dollar Thrifty if it is not approved.

Both deals raise complex and similar antitrust issues and face comparable divestiture analyses. Hertz resorts to antitrust as a scare tactic and a smoke screen -- a last-ditch effort to deflect attention from its clearly inferior offer -- but Hertz is wrong on the process and wrong on the facts. Although outcomes of governmental reviews cannot be predicted with certainty, both companies are cooperating with an ongoing FTC review. Both companies have similar airport revenue shares and derive more than half of their revenues from leisure travelers -- although, significantly, Hertz has higher leisure renter revenues than Avis and Budget combined.

Both companies compete with Dollar Thrifty. In fact, Hertz uses its exclusive relationship with AAA to generate more than $500 million of annual revenues at low price points -- typically lower than Dollar and Thrifty rates -- targeted to compete directly with Dollar, Thrifty and other value brands. Through the value-oriented AAA relationship "brand," Hertz competes aggressively and successfully with other value brands and generates revenues that are comparable to Thrifty's U.S. corporate location revenues.

Furthermore, nothing blocks any of the market participants from renting cars to value and leisure oriented customers as there are no barriers to entry (with the exception of the Hertz exclusive agreement with AAA, which covers 50 million members). Pricing can be adjusted in seconds on each company's respective corporate websites and the related travel oriented websites.

CAR is correct – the inclusion of a reverse termination fee does not impact a regulator’s opinion of a transaction. It does, however, affect a board’s decision on deciding between competing offers with “complex and similar antitrust issues”. DTG wants assurance that they will receive some remuneration should a deal not be consummated.

Since CAR’s revised offer was 22% higher than the HTZ deal price, you know HTZ will have to increase its offer. That happened on September 12, when the merger agreement was amended to increase the cash portion by $10.80 to $43.60/share and maintaining an exchange ratio of 0.6366. The $44.6 million reverse termination fee was also unchanged. HTZ announced that it has begun the process of divesting Advantage Rent-a-Car. The shareholder vote was postponed from September 16 to 30, to allow shareholders sufficient time to consider the revised terms.

CAR increased its offer again on September 23, revising the cash portion from $40.75 to $45.79/share. CAR said “We believe that the increased value is warranted based on improving fundamentals in the industry and at Dollar Thrifty in particular. We would be willing to offer an even higher price in the absence of the break-up fee that Dollar Thrifty's Board has provided for in its agreement with Hertz. We believe it would be beneficial for Dollar Thrifty shareholders if the Dollar Thrifty Board of Directors engaged in a process to maximize value, rather than letting Hertz dictate timing and process.” CAR added that there is no justification for DTG to hold a shareholder vote before the FTC completes its review of the CAR and HTZ submissions.

On September 24, HTZ affirmed that is latest offer is its “best and final”. The progress with the FTC makes HTZ “highly confident” that it can close the merger by the end of the year.

CAR is not bragging about any progress with the FTC. It still has not received approval from Canada, and it refuses to offer a reverse termination fee. Without a meaningful increase in its offer price, CAR faces an uphill battle. We will continue following these risk arbitrage situations closely.

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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