Sunday, August 29, 2010

Merger Arbitrage Analysis: Pactiv (PTV)

We have previously discussed how risk arbitrageurs are not interested in speculating on what companies will be acquired. The majority of portfolio positions are comprised with definitive agreements. Included in the "announced transactions" bucket are unsolicited offers where the (eventual) deal price is unknown, and even situations where initial terms have not even been disclosed (GENZ). The idea here is that we're not searching for takeover candidates. One of the downsides to companies with no agreed deal is that the timeline can be inauspicious. For example, Novell Inc (NOVL) received an offer in early March and has yet to announce a deal. This post will discuss Pactiv Corp (PTV), a company for which deal speculation began three months before a merger was announced. PTV produces consumer and food packaging products, including disposable plastics, foam, pressed paperboard, aluminum, and molded fiber. The company is well known for its Hefty brand.

The Wall Street Journal reported on May 17 that buyout firm Apollo was in talks to acquire PTV. The logic behind a deal with Apollo centered on Berry Plastics Corp, a packaging company that Apollo acquired in 2006 for $2.25 billion. Apollo then merged Berry with another portfolio company, Covalence Specialty Material Corp. In 2008, Berry acquired Captive Plastics Inc for about half a billion dollars. An announced transaction with PTV was said to be weeks away. PTV's share price increased 19% for the day on this news to close at $28.44/share.

A few days later, the WSJ said that New Zealand-based Rank Group and Georgia-Pacific entered the bidding process. In late July, the New York Post said that Koch Industries was considering a bid for PTV. The auction process was expected to be finalized by the middle of August. (You'll notice we include the publication when we mention a news report. This is because each media outlet has its own credibility factor. If the WSJ is told by sources that a company is shopping itself, while Joe's Newswire says the same company is not, are the contrasting stories weighed equally? Not on our desk. We have our preferred publications, and we even go so far as to consider the individual reporters).

On August 17, PTV announced the definitive agreement to be acquired by Rank Group subsidiary Reynolds Group Holdings for $33.25/share. The $6 billion deal represents a 39% premium to PTV's May 14 closing price, the last trading day prior to published reports regarding a transaction. The premium is 7% to PTV's August 16 close (lower, obviously, because of the expectations of a deal). The takeout price values PTV at 7.5x EBITDA. Reynolds obtained committed financing from Credit Suisse, HSBC, and Australia New Zealand Bank.

Now, what can we learn about Rank Group? It turns out, the conglomerate's driving force is its principal owner, Graeme Hart. The 55-year old New Zealand native ranks as #144 on the Forbes list with a net worth of $5.3 billion. The former tow truck driver and high school dropout later returned to school and earned an MBA from the University of Otago in 1987. Using Rank Group as the vehicle for essentially a one-man buyout shop, Hart began to acquire companies, turn them around, and sell them for a profit. Lest you think our money man is driven only by the buck, in early 2007, after spotting a burning yacht off Waiheke Island, Hart rescued three people and a dog from the conflagration. The yacht soon sank, and Hart was touted for his selflessness.

The spread is 3.3% as of the August 26 close. That's fairly wide for a definitive agreement with no glaring risks. Capturing that spread hinges on regulatory approval. We talk about the HSR (US antitrust) process often, and it is the driving force in the PTV deal. The combined company would have some concentration in the garbage bags and storage bags segments. Market share information for these areas is scarce, but it is safe to say that the HSR waiting period will not receive early termination. A second request is quite possible. Reynolds Group even mentioned a second request on a conference call, but they were adamant that any concerns regulators have could be resolved. Even when it's obvious a second request is expected, spreads widen when they are disclosed. In lieu of a second request, there could be one or more re-filings.

The way to approach this deal is to put on a portion of your desired position now, and see what happens on the HSR front. Say you want it to be 5% of your portfolio. Take it up to 4% now, and if it widens on a second request, put on the remaining 1%. If it tightens on news of a smooth review, still put on your remaining 1%. At least you had 80% of your position established at a wider level. Can't win 'em all. Stay tuned for more merger arbitrage analysis in the near future.


Sunday, August 22, 2010

2010 Merger Arbitrage Market - A Mid-Year Update

Of course, as soon as we mention that "the merger revival that so many strategists and analysts predicted has not occurred" yet, M&A sprints off to the races. Even with the recent spurt, M&A volume in the U.S. is up only 1% YTD versus 2009, according to Dealogic. Before we highlight some of the recent announcements, it's important to note that we are not claiming that the good times have returned. A solid print for one quarter of earnings does not a trend make, especially after two years of shoddy announcements, though it allows for further momentum to build. Colleagues point out to us all the time that corporations have historically high levels of cash on their balance sheets. True, but acquisitions are not the only method of deployment for said cash. (As for the "cash on the sidelines" argument people use to portend higher equity prices, we are thankful that John Hussman is cerebral enough to elucidate the fallacy of such a statement.) Also, we're not convinced the economy is positioned for an inevitable near-term rebound, and it's entirely possible that executives at these companies aren't either. While we have a more forceful opinion on this matter, this is merger arbitrage blog, not a forum for our macro pontifications. Let's look at some situations from the last week.

IBM Corp (IBM) agreed to acquire Unica Corp (UNCA) for $480 million on August 13 to help its clients streamline and integrate key processes including relationship marketing and marketing operations. Later that day, Blackstone Group (BX) announced an agreement to acquire Dynegy Inc (DYN) for $4.7 billion. This is a transaction that has caused a bit of an uproar with the media, due to the financing structure, and we will likely cover it in the future with more detail. On August 16, Dell Inc (DELL) agreed to purchase 3PAR Inc (PAR), a global provider of highly-virtualized storage solutions with advanced data management features, for $1.15 billion. Also on Monday, Canadian buyout firm Onex Corp (OCX CN) made a proposal to buy Res-Care Inc (RSCR) for $370 million. OCX owns 24.9% of RSCR, so we probably haven't heard the end of that situation.

The big one came on August 17, when BHP Billiton Ltd’s (BHP) $40 billion proposal to acquire Potash Corp (POT) was made public. POT quickly implemented a poison pill, in case BHP planned on taking the offer directly to POT shareholders, which is precisely what happened. BHP launched a $130/share tender offer, but nothing under $145 has a chance of succeeding. This is another transaction we will cover in a later post with more detail.

Pactiv Corp (PTV) put the final touches on its auction process on August 17 when it announced that Rank Group Ltd subsidiary, Reynolds Group Holdings, would purchase the consumer and food packaging leader for $6 billion. Rank Group is a New Zealand-based company owned by Graeme Hart, an investor whose savvy use of debt has propelled him to extreme wealth (think of him as a less-hated Ira Rennert).

McAfee Inc (MFE), the security technology company, announced its agreement to be acquired by Intel Corp (INTC) on August 19. The $7.68 billion deal is INTC's first multi-billion acquisition of a public company in over 10 years. Lastly, we note the NewAlliance Bancshares (NAL) merger with First Niagara Financial Group Inc (FNFG) for $1.5 billion, also on August 19. The merger consideration is 86% in stock and 14% in cash. Again, we will provide a deeper evaluation of several of these deals in the future.


Monday, August 16, 2010

Merger Arbitrage: ATC Technology Corp (ATAC)

Considering how the merger revival that so many strategists and analysts predicted has not occurred, the event-driven community is in all the same names. Since there is an inadequate number of situations to follow, spreads are tight. However, ATC Technology Corp (ATAC) is an merger arbitrage opportunity with an attractive 14% annualized return to a mid-November close.

On July 19, GENCO Distribution System Inc announced a definitive agreement to acquire ATAC for $25/share in an all-cash merger valued at $512 million. Privately held GENCO provides contract logistics, reverse logistics, product liquidation, and government solutions for manufacturers, retailers, and US government agencies. ATAC provides comprehensive engineered solutions for logistics and refurbishment services to the consumer electronics industry and vehicle service parts markets. The merger consideration represents a 43% premium to ATAC's July 16 closing price. The agreement contains a go-shop provision to allow ATAC to solicit superior proposals until August 17. GENCO has been afforded the right to match any competing offers. The companies expect to close the deal during the fourth quarter.

There appears to be no regulatory risk. As GENCO is privately held, they do not provide as much information as we would like, but the required antitrust approval should be a non-event. We've spoken to some investors who are concerned with financing. GENCO said that it intends to finance the acquisition through the application of proceeds of approximately $125 million from the sale of GENCO shares to Greenbriar Equity Group LLC and from borrowings under a $450 million new line of credit to be extended by PNC Bank and Wells Fargo, in addition to cash on hand. GENCO executed a definitive stock purchase agreement with Greenbriar for the equity financing. The commitment letter GENCO entered with the banks is not conditioned upon syndication of the credit facility. Taken together, the financing looks pretty stable, so perhaps those concerns are overblown. It is worth nothing that the merger agreement contains a $2 million fee payable to ATAC if GENCO is unable to complete financing. This is a fairly uncommon feature in merger agreements, and it shows that financing was a part of the negotiations.

Another aspect of this transaction that could cause some to be wary is investor support. ATAC was trading over $24/share in March, so the 43% premium can be misleading. Some shareholders are bound to think that GENCO is making an opportunistic purchase. This is a valid argument, though GENCO's response will be "you have until August 17 to find a better deal". Here is the case those shareholders would make, graphically represented:

The preliminary proxy has not yet been released, so we do not know if they were any other bidders for ATAC. Spreads often move on the release of this information. ATAC was asked on the July 19 conference call whether a competitive bidding process took place, and CEO Todd Peters simply answered "this is an unsolicited offer from GENCO". We don't know if Mr. Peters did not understand the question, or if he was intentionally being vague, but he did not answer the question (an unsolicited offer from GENCO does not preclude a competitive bidding process). After evaluating the risks, with the current opportunity set, one could do worse than a position in ATAC.


Monday, August 9, 2010

Risk Arbitrage - Dollar Thrifty (DTG)

With hindsight, a nice place to have looked in March of 2009, when nearly every manager was facing redemptions and thought the sky was falling, was the rental car industry. Specifically, Dollar Thrifty Automotive Group Inc (DTG) went from $0.70/share 17 months ago to over $48/share now. Let's look at what is happening to the name right now. It is a very interesting risk arbitrage situation.

Hertz Global Holdings Inc (HTZ) announced on April 26 that they signed a definitive agreement to acquire DTG for $41/share, an 11% premium to DTG's prior close. The terms consist of exchange ratio of 0.6366, $25.92/share in cash, and a $6.88/share special cash dividend to be paid by DTG immediately prior to the transaction's closing. DTG, with more than 1,550 corporate and franchise rental locations, was assigned a value of $1.6 billion. HTZ estimated that a closing would take place within six months. The market interpreted the combination favorably, as HTZ rose 14% the day of the announcement. On the conference to discuss the merger, an analyst from large hedge fund with holdings in both DTG and HTZ expressed how he thought the acquisition was a "steal".

Another party who was not pleased with the announcement was Avis Budget Group Inc (CAR). On May 3, CAR CEO, Ronald Nelson, sent a letter to DTG CEO, Scott Thompson, to explain CAR's thoughts on the news. We will include it in full, because it has several important elements.
"I was very surprised by your April 26 announcement that you had signed a definitive agreement to be acquired by Hertz for approximately $41 per share, of which only about $34 is being funded by Hertz itself. This is particularly true given that, on April 19, a mere week before the Hertz announcement, Scott and I agreed to meet for dinner on April 28 to discuss a transaction between our companies, which you cancelled after the Hertz announcement.

As you know, we at Avis Budget have on several occasions in the past expressed interest in entering into a transaction with Dollar Thrifty, yet at no stage over the last several months did you or your financial advisor engage us in any discussions about a transaction or offer to provide us with information so that we might submit a bid. I spoke with your financial advisor in early April to reiterate our interest in a potential transaction between our companies and to try to arrange a meeting, yet neither they nor you engaged us in any substantive discussions or communicated your interest in Dollar Thrifty being acquired in the near term. It is hard to understand how your failure to engage in discussions with an interested strategic buyer, who you know also would be able to achieve significant synergies as a result of a combination, can be consistent with the fiduciary duties that you and your board carry to seek the best possible deal for your shareholders.

This failure is all the more surprising given that, at the time you signed a definitive agreement to be acquired at virtually no premium, you clearly had knowledge that published earnings estimates for Dollar Thrifty were well below the updated guidance that you were going to provide as part of your first-quarter earnings announcement after the signing. Given that the Hertz offer is primarily cash, your shareholders in addition to being offered virtually no premium to a stock price that did not reflect favorable non-public information, would have little opportunity to participate in the substantial upside associated with your improving results, the combination-related synergies or the substantial upside we all see as the industry recovers from its recent lows.

Now that we and our advisors have had access to the terms of the merger agreement, we are astonished that you have compounded these shortcomings by agreeing to aggressive lock-up provisions, such as unlimited recurring matching rights plus an unusually high break-up fee (more than 5.25% of the true transaction value, as described by your own financial advisor), as a deterrent to competing bids that could only serve to increase the value being offered to your shareholders. Given the complete failure to conduct a pre-signing market-check of the virtually no-premium deal with Hertz, such preclusive defensive measures are clearly not supportable in this situation.

We would like to make a substantially higher offer to acquire Dollar Thrifty, especially in light of your recent performance and the potential synergies associated with an acquisition of Dollar Thrifty by Avis Budget. We are confident that the antitrust analysis and clearance timetable for an Avis/Dollar Thrifty transaction are comparable to those associated with a Hertz/Dollar Thrifty transaction. We request access to legal, financial and business due diligence information relating to Dollar Thrifty, including access to management, so that we can formulate and submit such an offer. In that regard, we would be prepared to sign an appropriate non-disclosure agreement. We also request that the egregious provisions of the merger agreement be eliminated so that a level playing field can be created.

We look forward to the opportunity to engage in productive discussions with the board of directors of Dollar Thrifty to allow its shareholders the opportunity they deserve to realize the full value of their investments in Dollar Thrifty."
DTG closed at $50.70/share on May 3, up 15% for the day.

On May 6, CAR signed a confidentiality agreement with DTG to review financial data to evaluate a possible offer for DTG. HTZ CEO, Mark Frissora, repeatedly remarked how the HTZ offer for DTG is superior "on both financial and regulatory" grounds. That may be true, but what is the offer? Here is a helpful (facetious) note to management teams out there: if you want investors to evaluate your offer, and potentially agree with your "superior" argument, then providing terms of the offer is essential.

In mid-June, both HTZ and CAR received Second Requests (requests for additional information to conduct the antitrust review) from the Federal Trade Commission. From an antitrust perspective, it all depends on how the FTC will define markets. Law professor Steven Davidoff contributes valuable thoughts on the topic. He said that if the rental care market is segmented into the two categories, premium and travel/leisure, then both HTZ and CAR classify themselves as premium car rental companies serving those on business and those who are less sensitive to price changes. DTG categorizes itself as travel/leisure. However, you can also classify the market by airport and off-airport. In this manner, both HTZ and CAR compete with DTG. HTZ stated on the merger call that they have 26% of the airport market share and DTG has 11%. HTZ also said that the FTC will probably carve down market share if it is over 40% or 50%.

On July 6, DTG scheduled a shareholder vote on the HTZ deal to be held on August 18. Doing so effectively set a time frame within which CAR must operate if it wanted to bid for DTG. Yes, it could present an offer after the vote, but this could delay the merger, a move that shareholders would not happily accept. To further nudge CAR to make a superior offer, DTG announced on July 7 updated guidance of 2010 EBITDA of $200 to $220 million, versus the previous range of $170 to $190 million. The company also provided an updated outlook for fleet cost per unit per month for 2011, which was lowered to a range of $300 to $310/month, compared to previous guidance of $325/month.

On July 19, DTG rescheduled the shareholder vote for the HTZ merger from August 18 to September 16. No reason for the postponement was immediately provided, but the following day it was disclosed that the SEC stated that additional time was required for DTG shareholders to be notified of their rights in the merger.

On July 28, nearly three months after it publicly disclosed interest in DTG, CAR announced the terms of its offer. The offer was valued at $46.50/share ($39.25/share in cash and 0.6543 of CAR stock). CAR has fully committed financing for the cash portion. CAR said it was prepared to enter into a merger agreement with substantially the same terms as the HTZ agreement, but which includes removing the matching rights, eliminating the break-up fees, and increasing the commitment to secure antitrust approvals.

DTG responded to CAR's proposal on August 3 and gave some observations on the offer. DTG said that CAR's offer is more favorable, from a financial point of view, to its stockholders than the HTZ merger, and that it has fully committed financing to support the bid. Where DTG said it does not have sufficient information is in determining if the CAR transaction is reasonably expected to be consummated on a timely basis. The letter to CAR indicated:
"As you are aware, our respective advisors have had numerous discussions with respect to the antitrust risks attendant to a merger of our companies. Your legal advisors have stated clearly their position, based on their econometric and other analyses, that the divestitures to which you have committed in your proposal are sufficient to remediate any competitive issues. But citing our inability to enter into a joint defense agreement with you as well as our contractual obligations to cooperate with Hertz, your advisors have been unwilling to disclose details of their data and analyses beyond their general approach to the issues.

More problematic is Avis Budget's unwillingness to provide a reverse termination fee. As we have stated on several occasions, our Board accords substantial weight to the extent to which Avis Budget is willing to share the risk of the ultimate regulatory outcome. This is especially true where Avis Budget is unable to provide compelling objective evidence in favor of its antitrust position. Indeed, Avis Budget's unwillingness to offer a meaningful reverse termination fee can only represent to us, to the market and to any objective observer a lack of confidence by Avis Budget in its position. As you know, transaction certainty has consistently been a key criterion for Dollar Thrifty in evaluating possible transactions. We feel strongly that in order to merit favorable consideration by our Board, the relative magnitude of the reverse termination fee should be at least consistent with that of the Hertz transaction. Obviously, a fee of greater magnitude would demonstrate even greater confidence in your ability to procure antitrust approvals, as well as your willingness to take steps beyond your stated divestiture commitment to do so.

Your advisors have suggested that there is a natural trade-off between the transaction consideration and deal certainty. Unfortunately, the "Superior Proposal" determination simply does not work in that way. Each of the three prongs must be met, and a higher price cannot compensate for a deficiency in deal certainty. But even if we could blend the factors as you suggest, Avis Budget's unwillingness to provide a reverse termination fee, coupled with your disinclination to provide analytical data supporting your antitrust position, leaves us incapable of making such an assessment."
DTG's agreement with HTZ includes a reverse termination fee of $44.6 million if antitrust approval is not secured. CAR is not offering this fee, and DTG has expressed its disapproval. In hopes of addressing DTG's concern, CAR is willing to dispose of up to $250 million of revenue in the US and up to $325 million worldwide.

When DTG and CAR iron out their differences (which we expect to happen), then DTG will be obligated to accept CAR's superior offer. That will leave the next move to HTZ. This is one of those deals where it’s great if you had already put on the risk arb spread before CAR came around, but doing so now is dangerous. HTZ’s offer is about 19% below where DTG is currently trading and CAR’s bid carries a negative spread of roughly 5%. We would caution investors that the risk-reward of entering a position at these levels is unfavorable.


Monday, August 2, 2010

Risk Arbitrage: Hostile Offer for Casey’s General Stores Inc

We like to follow situations with many moving parts. While they get the job done, there’s really not much to some (a distinct minority) of the deals out there. A large private equity firm is buying a small box manufacturer. Say it’s a $200 million transaction. There’s no financing risk, it’s safe from a regulatory standpoint, valuation is fair, and it was decently shopped. Sure, we’re not against putting that in the portfolio (assuming we cannot fill it with better risk-reward scenarios), but that 2% spread we captured in three months is not the most didactic experience. Fortunately, there’s a current situation from which we can learn and also apply our knowledge. It involves an unsolicited bid, questionable strategy on the offensive side, and takeover defense tactics. Let's take a look at this risk arbitrage situation.

On April 9, Alimentation Couche-Tard Inc (ATD/B CN) announced that it submitted a proposal to acquire Casey's General Stores Inc (CASY) for $36/share in cash. CASY operates convenience stores in the Midwest. ATD is the largest independent convenience store operator in North America. The $1.9 billion offer was a 14% premium to CASY's April 8 closing price, and valued the company at 7.4x LTM EBITDA, or about $1.3 million per store. In the letter that ATD sent to the CASY board it was disclosed that "repeated efforts" to engage in deal discussions began in October 2009, and ATD said that if CASY continues to refuse negotiations, then they are prepared to commence a proxy contest to replace the board. CASY's share price closed at $39.10/share for a -8% spread.

CASY, of course, again rejected the proposal, which it called "opportunistic". About a week after the unsolicited offer was made, CASY implemented a shareholder rights plan (poison pill) with a one-year expiration and a 15% threshold. Technically, this is a reinstatement of the pill, since it was adopted in 1989 and allowed to expire in 2009. ATD commenced a tender offer on June 2 and announced its intention to nominate a full slate (nine) of directors to the CASY.

In early June, the Wall Street Journal brought to light that ATD had sold its entire 4% position in CASY for an average price of $38.43/share on April 9, the same day it made its $36/share offer, for a $13.9 million profit. Now, this is just in poor taste. If ATD thought that $36/share was a full price (the highest it will pay) for CASY, then it was ill-advised to come out with this as its first offer. As we've said before, agreements are never reached at the initial price of an unsolicited proposal. Since ATD has done transactions before, one can assume that they know the rules of the road. In short, it's bad deal etiquette, and likely to upset CASY. Sure enough, CASY filed suit on June 11 in the Southern District of Iowa, alleging that ATD manipulated the market and violated securities laws with its activity in CASY shares. ATD said that the lawsuit is entirely without merit and is designed to distract CASY shareholders from the real issue - ATD's "premium bid". A weak response, admittedly, but we'll let the courts determine that area.

On June 28, ClearBridge Advisors (1.6% CASY stake) sent a letter to CASY urging them to engage in formal negotiations with ATD with respect to the $36/share offer. Anything less, ClearBridge argued, gives the impression that independence, not the maximization of shareholder value, is the board's highest priority. On July 12, ATD's tender offer was extended to August 6, after 19% of shares were tendered at $36/share. CASY responded "The low number of shares tendered reflects what Casey's has heard from many shareholders -- that this hostile, highly conditional offer is inadequate. The response of our shareholders to Couche-Tard's tender offer speaks for itself. We believe that our shareholders recognize Casey's industry-leading performance and superior value potential. The Casey's Board reiterates its recommendation that shareholders not tender their shares into the offer." CASY is a bit off with this comment, since a 19% acceptance rate for a low-ball bid is unusually high, but those who did tender likely did so as a referendum for an eventual deal, instead of approving the $36/share price.

On July 22, ATD increased its offer from $36 to $36.75/share in another (the first being the sale of CASY shares after the offer was made) move that makes one wonder what ATD's thinking is on this deal. The increase is insignificant, as nothing under $40/share would be the basis for an agreement. If ATD is seeking to negotiate with CASY, as it publicly stated, then it has made shoddy attempts at doing so.

On July 28, CASY announced that its board approved a $500 million recapitalization plan to be executed through a modified Dutch auction (self-tender offer) for a price of $38 to $40/share, to be funded by a combination of debt financing and available cash. CASY also rejected the $36.75/share offer from ATD, saying that the buyback of approximately 25% of its own shares is a better investment. CASY CEO, Robert Myers, said "the bottom line is that Casey’s shareholders will receive far more value from our accretive recapitalization plan and the substantial future upside of our growing company than through Couche-Tard’s inadequate, self-serving offer.”

Make no mistake, the recapitalization is purely a takeover defense mechanism, and not done just because CASY saw an attractive investment opportunity. If it were done solely for the latter, why didn't CASY launch the recap at $33 to $34/share before the ATD offer when its stock was trading around $31/share? That would have been a much better investment. While it is possible that CASY remains independent, the recap does place a price floor on a buyout. If CASY is willing to buy a quarter of its shares for $40/each, then an outside party will certainly have to beat that figure if it wants acceptance from CASY holders.


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.


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