Sunday, May 16, 2010
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.
Monday, May 10, 2010
One of the aspects of merger arbitrage investing that we find appealing is how you have to be a generalist. Deals happen in all industries, and arbs are not precluded from following a company because of the nature of its business. Indeed, the ingress and egress of names under our purview requires proficiency in a broad range of subjects. In the last few weeks we’ve seen deals involving Qwest Communications, Interactive Data, Continental Airlines, Dollar Thrifty Automotive, inVentive Health, CyberSource, WuXi Pharmatech, Stanley Inc, and Palm, among others. As far as closings, investors can no longer follow BJ Services, Switch & Data Facilities, Terra Industries, 3Com, and Facet Biotech.
You can find an event analyst immersed in hydraulic fracturing one day, studying the likelihood of any possible legislation that could come about (and potentially derail the XTO Energy – Exxon Mobil merger). The next day the same analyst could evaluate the competitive impact of combining an internet payment gateway provider with a payment network (for antitrust issues in the CyberSource – Visa deal).
A recent trend we’ve noticed is that financial sponsors (private equity) have been more active lately. Thomas H. Lee Partners announced the buyout of inventive Health on May 6 for $1.1 billion. Warburg Pincus and Silver Lake reached a $3.4 billion deal for Interactive Data on May 4. It is being said that Blackstone, THL, and TPG are in talks to acquire Fidelity National Information Services for around $13 billion. That would be the largest LBO in nearly three years. A merger revival appears to be in the making. Even the inimitable Jimmy Lee of JP Morgan sees a deal boom on the horizon.
We are also watching a few companies who are “reviewing strategic alternatives” which very often leads to a transaction. We are welcoming the increased activity on our desk. Hopefully spreads will widen to attractive levels in the near future, since the risk-reward for many situations does not warrant a portfolio position. Given how merger arbitrage spreads have collapsed over the past 5-10 years, we hope that a more healthy supply of deals will soak up capital more effectively and possibly give us some "fat pitches" to generate sizeable risk adjusted returns.
Monday, May 3, 2010
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.