Wednesday, July 28, 2010

Risk Arbitrage - AmeriCredit (ACF)

The demise of General Motors has been a well-chronicled affair. GM completed a Chapter 11 reorganization in July of 2009, and after $49.5 billion of TARP investment, emerged with debt decreased from $95 to $17 billion. An IPO is planned for the near future. On July 22, GM announced the definitive agreement to acquire AmeriCredit Corp (ACF) for $24.50/share, or $3.5 billion in cash. Let's dig into this risk arbitrage opportunity.

ACF is a consumer finance company specializing in purchasing, securitizing and servicing automobile loans. The acquisition establishes the core of a new GM captive financing arm that will enable GM to provide customers with a more complete range of financing options. The transaction is expected to enhance dealer receptivity and improve sales penetration rates through coordinated GM branding and targeted customer marketing initiatives. ACF already has relationships with approximately 4,000 of the more than 11,000 GM dealers.

At $24.50/share, ACF is valued at 9.3x LTM EBITDA, and a 24% premium to its previous close. While ACF was trading over $26/share in April, the takeout valuation is still a 25% premium to its closest peer. On the conference call to discuss the acquisition, GM CFO, Chris Liddell (former CFO of Microsoft), said that he expects no regulatory issues with the transaction. One would hope this is the case, since they had to have run this deal by the government before reaching the agreement, right? Well, when was asked on CNBC whether the government signed off on the deal, he said that while the government set up an independent board of directors, it was a company and board decision. He did say that the government was "notified" of the transaction before its announcement. Liddell said that the ACF deal will be funded with GM's cash balance, which exceeds $30 billion. As a 61% owner of GM, taxpayers might not think this is the best way for the cash to be used. One thing we have noticed is GM and ACF's use of the term "non-prime", in attempt to banish "sub-prime" from our lexicon. What else other than sub-prime could they mean by non-prime? Above-prime, perhaps?

The transaction is subject to approval by ACF shareholders. Both Leucadia National and Fairholme Capital (two investors we highly respect) have executed voting agreements for their combined 43.6% ownership of ACF. The shareholder vote appears to be a nonissue. Funding in place, no regulatory issues, a sufficient valuation and a locked up shareholder vote usually equate to a tight spread.

Congressional hearings on the wisest use of GM's cash are entirely possible. Indeed, Senator Chuck Grassley, ranking member of the Committee on Finance, sent a letter to the Special Inspector General of TARP, Neil Barofsky, the day the transaction was announced. Grassley said that "If GM has $3.5 billion in cash to buy a financial institution, it seems like it should have paid back taxpayers first. After GM’s experience with GMAC, which left GM seeking a taxpayer bailout, you have to think the company and, in turn, the taxpayers would be better off if GM focused on making cars that people want to buy and stayed clear of repeating its effort to make high-risk car loans.” What does this mean for this risk arbitrage situation? Simply put: This spread could be volatile over the next few months due to headline risk. We will keep our readers updated.

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Monday, July 26, 2010

New Value Investing Blog

Hey guys - I have started a new Value Investing Blog with heavy emphasis on Walter Schloss and other members of the Graham-Newman Corporation. Enjoy!

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Thursday, July 22, 2010

Merger Arbitrage Investing Lesson: Strategic Reviews

While risk arbitrage is concerned mainly with announced transactions with defined pricing considerations, a subset of the space deals with companies that are evaluating strategic alternatives. The result of this process could be a divestiture, a joint venture, a share buyback, or a sale of the company, among other things. Let's review a few outstanding situations of strategic reviews.

A recent example of a strategic review culminating in a merger is Argon ST Inc (STST). In early January, STST announced that it retained advisors to explore strategic alternatives. In late June, STST agreed to be acquired by Boeing Co (BA) for $34.50/share, a 61% premium to the unaffected January 8 price. That transaction should close by the end of August. Even if you bought the shares after the announcement of the review, that's a 36% gain in 7 months.

Novell Inc (NOVL) is a situation we have discussed previously. NOVL is different from the typical strategic review in that it has already received a takeover proposal. Elliott Associates proposed to acquire NOVL in early March for $5.75/share. On March 20, when the board formally rejected to unsolicited offer, a strategic alternative review was authorized.

Media maven Robert Sillerman's CKX Inc (CKXE) is a company that is likely familiar to the event-driven community. Sillerman (who owns 21% of CKXE) has seemingly had some transaction proposal or another ongoing since 2007. In 2008, there was the buyout offer of $13.50/share that was revised to $12/share. The board accepted the lower bid, and in November, five months after the agreement, Sillerman terminated the deal due to market conditions at the time (remember the fourth quarter of 2008?). One Equity Partners was said to be near a deal with CKXE in March of this year, and Sillerman resigned from his post as chairman in May due to his own interest in pursuing a buyout of CKXE. So, while a formal evaluation process has not been announced, it's safe to say the company is ready to review proposals.

California Pizza Kitchen Inc (CPKI) announced in mid-April that it is reviewing strategic alternatives. This company will surely be examined by financial sponsors, and it could also be sought by a strategic acquirer such as BJ's Restaurants Inc (BJRI) or Cheescake Factory Inc (CAKE). Recent restaurant transactions are the sale of Dave & Busters by Wellspring Capital to Oak Hill Capital at 6.8x EBITDA and Arcapita Inc's sale of Cajun Operating Co to Friedman Fleischer & Lowe at 7.0x. We recently covered the sale of CKE Restaurants Inc.

A situation that appears to be slowing down is Polycom Inc (PLCM). It was reported in March that Apax Partners was discussing a buyout of PLCM after several months of negotiations. In mid-April, PLCM was said to have retained advisors to evaluate strategic alternatives. In late June, PLCM's CEO (who was promoted from VP of Global Operations a month earlier) said that they are not involved in any takeover discussions. Furthermore, in mid-July, the CEO reiterated that the focus of PLCM is to remain a standalone company.

As the list of companies reviewing strategic alternatives changes, we will revisit this topic, especially how it relates to merger arbitrage investing, in the future.

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Sunday, July 18, 2010

Risk Arbitrage: Psychiatric Solutions’ Deal and a SonicWALL Update

On March 10, the Wall Street Journal reported that Psychiatric Solutions Inc (PSYS) was in talks to be acquired by Bain Capital. A perfect example of risk arbitrage. PSYS offers behavioral health programs to critically ill patients. The company owns and operates freestanding psychiatric inpatient hospitals and manages psychiatric units within general acute care hospitals owned by others. The article said that CCMP Capital, and KKR looked at the business but eventually passed. Blackstone considered merging PSYS into its hospital chain, Vanguard Health Systems, and decided not to pursue the transaction. Bain was said to be the most likely buyer, which reminded investors of the $21 billion buyout of HCA Inc in 2006 where Bain teamed up with KKR. Two and half hours after the WSJ's announcement, PSYS put out a statement saying that it "has been approached by third parties in connection with a potential acquisition". The stock closed at $29/share, up 21% for the day.

In mid-April, Universal Health Services Inc (UHS) was said to have retained advisors to explore an acquisition of PSYS. Joey Jacobs, the CEO of PSYS, was said to prefer a deal with Bain, since he would likely remain in his position with the private equity buyer. A strategic acquirer could deem his services redundant. On April 20, PSYS disclosed that the employment agreement for Joey Jacobs was amended to provide in a change in control (resulting in his voluntary or involuntary separation from PSYS) a lump sum of: Jacobs' earned but unpaid base salary through the termination date; three times his base salary plus an amount equal to his highest bonus in the last three years, and many other payments, including a full vesting of his stock options to comprise his golden parachute. Indeed, it appeared that the CEO was preparing for a takeover, and Jacobs was not taking any chances on his dismissal.

On May 17, UHS announced a definitive agreement to acquire PSYS for $33.75/share in cash, or $3.1 billion. The transaction has fully committed debt financing and is expected to be completed in the fourth quarter of 2010. Our first thought on this announcement is valuation. The takeout price assigns a 9.5x 2010 EBITDA multiple to PSYS, while its best comps were trading at about 6.5x when the merger was announced. Next, we want to know if PSYS was properly shopped to other potential buyers, which from all reports, it was. This mitigates the lack of a go-shop provision. However, we will know the details of the bidding process when the preliminary proxy is released. As for the premium for the takeout price, we must look at the unaffected share price, which is March 9, before the initial deal reports. This represents a healthy 41%.

Another area in need of evaluation is the antitrust risk of the acquisition. Strategic transactions generally require more regulatory scrutiny than those involving financial sponsors, simply because the former is more likely to have existing assets in the particular market segments. As we've discussed, two bodies review antitrust risk in the United States: the Department of Justice and the Federal Trade Commission. Each tends to specialize in certain areas, and historically, the FTC has reviewed hospital mergers. The review focuses on the combined effect of the companies and their ability to impact pricing. The companies have regional overlaps in facilities in areas such as southern California and certain east coast regions. Divestitures here will be required, and we can expect a review longer than the initial 30-day waiting period.

Speaking at the Wells Fargo Healthcare Conference, UHS said on June 23 that they have discussed the merger with the FTC staff and possible divestitures from the combination. UHS said it was confident that any required asset sales would not preclude the transaction from being accretive. This is what arbs like to hear, especially, from the acquirer. Of course the target is going to paint a rosy picture of things - they want to be bought. Especially if things become complicated, targets will maintain the stated benefits of the deal. It is the party writing the check from whom you want to hear positive statements.

On July 2, the release of the preliminary proxy confirmed our belief that an extended antitrust review will take place. The filing stated that "The initial HSR Act 30-day waiting period was set to expire on June 28, 2010. After discussions with the FTC, UHS withdrew its notification and report form effective as of June 25, 2010, and refiled on June 28, 2010. Refiling restarted the initial HSR Act 30-day waiting period. That HSR Act waiting period will expire at 11:59 p.m., Eastern Time, on July 28, 2010, unless earlier terminated or extended." As we've explained before, a voluntary refiling is preferred over a full Second Request. It would not be surprising to see UHS pull and refile again if it is not confident that the FTC will clear the transaction within the waiting period. That would reset the clock again. While an extended review is evident, this transaction should secure regulatory clearance. UHS appears committed to making the proper divestitures, which should allay the concerns of the FTC. Regarding the background section, the preliminary proxy revealed that a separate bidding party involving private equity firms offered as much as $33/share on May 16. So, not only did other parties review PSYS and not bid, but several parties were in the bidding process right until the end.

Now, let's update the SonicWALL Inc (SNWLL) deal we discussed previously. On July 6, SNWL announced that the unsolicited third party strategic bidder who offered $12/share informed SNWL that it no longer intends to pursue the acquisition. The SNWL board continues to recommend that shareholders approve the acquisition by Thoma Bravo and Ontario Teachers on July 23. The reasoning behind this move has not been disclosed, but we know that Thoma Bravo is pleased it is not forced into a position where it has to raise its offer. Stay tuned as we continue our in depth risk arbitrage analysis of these two transactions.

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Thursday, July 15, 2010

Merger Arb Spreads July 2010

Every few weeks, I am going to update this table of merger arb spreads below:



If you cannot read it (you probably can't), click on the image. Here is how to read the chart: Going from left to right, in terms of columns:
  1. Target
  2. Acquirer
  3. Consideration, in acquirer shares, to target shareholders
  4. Consideration, in cash, to target shareholders
  5. Current Acquirer stock price
  6. Current Target stock price
  7. Total Consideration = (3*5) + 4
  8. Dollar Premium = 7 - 6
  9. Percent Premium = 8/6
  10. Annualized Premium = 9 * (365 / (# of days until estimated completion)
Note, the dates are really the fuzzy math of this chart - Sometime a press release will say: "Estimated completion in the fourth quarter" ... and from there we use judgement. When no indication of timing is given, I have put TBD.

I have enabled comments for this post so would love to hear what I can add, change, got wrong on our first presentation of merger arb spreads.

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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