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.


Monday, September 20, 2010

Merger Arbitrage: Opposition to the Cogent Inc (COGT) Takeover

In this post, we will look at a strategic deal that is facing shareholder opposition. On August 30, 3M Co (MMM) announced a definitive agreement to acquire Cogent Inc (COGT) for $10.50/share. The cash tender offer has an aggregate value of $943 million. MMM is a research and development firm whose core strength is in applying its more than 40 distinct technology platforms to a wide array of customer needs. COGT is a biometric identification solutions provider to governments, law enforcement agencies, and commercial enterprises. MMM was attracted to COGT because of its participation in the biometric market, which MMM projected to have an annual growth rate of 20%. Let's dig deeper into this merger arbitrage situation.

The deal price was 18% higher than COGT's August 27 close. All else equal, this is considered to be on the low side for a takeover. Especially with a strategic acquirer, who is expected to squeeze synergies out of a transaction (which should, in turn, translate into a higher offer price, thereby passing the added value to shareholders). The merger values COGT at about 12.5x consensus EBITDA, while the best peer is L-1 Identity Solutions Inc (ID), which trades at about 13.5x consensus EBITDA. Not only is ID's business similar to COGT's, but ID commenced a strategic review process in February, so the stock has takeover potential baked into the price. Another detail not in MMM's favor is that COGT was trading for over $11.25/share in January. Founder and CEO, Ming Hsieh, entered a voting agreement in favor of the merger with his 39% position in COGT, but noticeably absent are other shareholders, apart from this insider.

What these factors are telling us is that there's a good chance COGT was not adequately shopped. For, if it were, the competitive bidding process would have driven up the deal price to a higher valuation. We won't know about the deal background until the tender documents are released, but so far, investors are skeptical. COGT closed on August 30 at $11.09/share, for a spread of -5.3%. On September 1, Pointer Capital, Iridian Asset Management, and Corbyn Investment Management (who combined hold about 8% of COGT) came out against the merger, specifically its low valuation. Pointer Capital explained that the fundamental value of COGT exceeds $15/share.

MMM commenced the tender on September 10 (due to expire on October 7), and with that, we were provided the background section of the tender documents. Similar to how a child goes straight for the comics section of a weekend paper, an arbitrageur's first stop is the background section. COGT's was of particular interest, given the aforementioned reasons. The document explains that a third party gave a preliminary non-binding indication of interest of $11 to $12/share on August 18. MMM's initial offer (of $9.25 to $10.25/share) was made on May 24. Even if you are far along in the process with one party, the board has a fiduciary duty to exhaust discussions for a credible offer that is superior. Perhaps COGT did finalize negotiations with this bidder, but the topic was left dangling in the tender document. Either way, this is a mistake on COGT's part.

Pointer Capital again took offense to the newly-public information. In a thoughtful letter to the COGT board on September 14, the Atlanta-based investor noted:
The Company provided 3M with financial estimates through 2013. The most noteworthy item was the drastic cut in gross margins beginning in 2011. The Company projects 66 percent gross margins in 2010, in-line with management's historical projections of 60 to 65 percent. However, 2011 estimates show a reduction to 57 percent gross margins. During the second quarter earnings call, the Company continued to reiterate that 2011 looks promising and was excited about business prospects.

How does this compare to the fact that management is now projecting a 900 basis point decline in gross margins year over year? Should the gross margins remain at historical levels, we believe the Company would produce in excess of $60 million of EBITDA in 2011. Are these estimates that management provided to 3M too conservative or has there been a material adverse change to the outlook by Cogent's management?
In the announcing press release on August 30, the companies said that the expected close is in the fourth quarter. This is acceptable, especially since it is a tender offer (and antitrust approval was granted on September 10). However, Pointer Capital identifies a potential motivation for the timing of the transaction:
It appears to us that December 30, 2010 is an arbitrary date with one caveat: the proposed tax changes to long-term capital gains. At $10.50 per share, it is unlikely that many shareholders have long-term gains at this price so the proposed tax change may be a moot point. The only shareholder with a significant long-term capital gain to speak of is the Company’s CEO. While we understand his position, the lack of fiduciary responsibility to shareholders is very evident.
COGT has yet to respond to the shareholder opposition. With a Q2 cash balance of $3.0 billion, MMM can afford to increase the offer price. A higher offer is not out of the question, but we encourage investors to be mindful of chasing this too high. Sure, another 3PAR Inc (PAR) could happen, but that’s unlikely, and no one anticipated what happened there.


Friday, September 10, 2010

Risk Arbitrage: The Battle for 3Par

A bidding war for 3PAR Inc (PAR) ended last week, with Dell Inc (DELL) and Hewlett-Packard Co (HPQ) driving the price up to levels that surprised many investors. In just over two weeks, PAR's share price increased 240%. Let's review how this risk arbitrage situation unfolded.

On August 16, DELL announced a definitive agreement to acquire PAR for $18/share in a $1.15 billion cash tender offer. PAR provides a virtualized utility storage platform addressing limitations of monolithic and modular arrays, and can reduce storage administration costs by up to 90% and infrastructure costs by up to 75%. The offer price was an 87% premium to PAR's previous close and valued the company at about 5x LTM revenues. 33% of PAR shareholders executed voting agreements in favor of the DELL transaction. The spread closed that day at $0.0, indicating that investors are confident in a deal being completed. The spread widened to $0.07 on August 17 as comfort with the merger was widespread. After all, the valuation was attractive, the price premium was large, and a third of the shareholders have already signed off on the terms.

Enter HPQ. On August 23 HPQ announced that it had submitted a $24/share cash offer for PAR. The $1.6 billion price was 33% above DELL's definitive agreement. A rival bid this much higher than the initial deal price is extremely rare. We know right away that HPQ is serious. Latest figures show that DELL has $11.7 billion of cash on hand compared to HPQ's $14.7 billion. Both companies can clearly afford to pay more for PAR. The obvious question is who is willing to pay more. PAR's board has a fiduciary duty to obtain the best offer for its shareholders. At this point in the bidding, HPQ appears to be more determined to win PAR, evidenced by the boldness of its initial offer. PAR closed at $26.09/share on August 23 for a -8% spread.

PAR's board determined that HPQ's offer is "reasonably likely to lead to a 'Superior Proposal' (as that term is defined in the Merger Agreement)". This language always conjures a laugh. Of course it's superior. At any rate, the matching rights afforded to DELL dictate that it has three business days to negotiate an amendment to its merger agreement. Shortly after the market opened on August 26, PAR accepted an increased offer from DELL of $24.30/share. Immediately after the close, HPQ announced a revised proposal of $27/share, or an enterprise value of $1.8 billion. See the trend here? DELL is nickel and diming while HPQ is looking for the knockout. Of course, at a certain level HPQ's tactics will irritate its own shareholders, but they have no say in a cash transaction.

On August 27, PAR accepted the matching offer of $27/share from DELL. Two and a half hours later, HPQ increased its proposal to $30/share. PAR closed at $32.46/share on August 27 for a -7% spread. On September 2, HPQ increased its offer to $33/share. One hour later, DELL announced that it will not increase its offer, and that it ended discussions regarding a potential acquisition. PAR paid DELL a $72 million termination fee. Later that evening, HPQ announced its definitive agreement to acquire PAR for $33/share, or $2.35 billion. The tender offer expires on September 24.

Oh, to have been long PAR before the initial offer…


Thursday, September 2, 2010

Risk Arb: Lions Gate (LGF) – Icahn Persists

It's time to resume our review of Carl Icahn's pursuit of Lions Gate Entertainment Corp (LGF). We have discussed his unsolicited offer several times in the past, and new events (some would say Icahn's stubbornness) have brought about more details to cover. For a quick review, Icahn announced a tender offer on February 16 of $6/share to increase his holdings from 18.9% to 29.9%. Icahn increased his proposal to $7/share on April 15 for all the shares he did not already own. By the June 16 tender expiration, Icahn owned 31.8% of LGF. Icahn lowered his offer to $6.50/share on July 20, at which point he already owned 37.9%. Icahn also disclosed his intention to replace the entire LGF board. On the same day LGF announced the completion of a "deleveraging transaction" where $100 million of its senior subordinated notes were converted into common shares at an effective conversion price of $6.20/share. This transaction was done with Mark Rachesky, an LGF board member, which increased his holdings from 19.6% to 28.9%. It also diluted Icahn's stake from 37.9% to 32.8%.

On August 31, Icahn increased his offer to $7.50/share. The revised offer is conditioned on there having been validly tendered the number of shares to constitute 50.1% ownership by Icahn. It is also conditioned on (now here is the big one) that the 16 million shares issued to Rachesky are either (i) rescinded prior to the expiry time, so that such shares are no longer outstanding; or (ii) reformed to convert such shares into a new class of non voting common shares. This offer expires on October 22. In typical Icahn prose, the announcement added "Given its recent decision to issue shares to an insider at $6.20 per share without conducting a market check, we would normally expect that the board must recommend that shareholders accept our offer of $7.50 per share, but with this board anything is possible. The Icahn Group believes that this board will stop at almost nothing to entrench its position at the expense of shareholders. However, we believe that even these directors will realize that their fiduciary duties dictate that they not deprive shareholders of the opportunity to receive a significant premium for their shares and therefore not enter into further inappropriate transactions which would breach the conditions of the offer." On the $7.50/share news, LGF closed at $7.14/share on August 31, up 10% for the day.

Icahn has very likely demanded too much in his latest missive. Asking Rachesky to either undo his transaction or give up voting rights is a tough sell. We don't think it will happen. Icahn has changed conditions of his offer several times in the past. He could waive this condition and increase his offer again, thereby paving the way for a deal. Remember, Rachesky is supportive of current management and Icahn is not. It's a battle of the old guard versus the new, and this is the first time Icahn is not in the "old" camp.


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