Wednesday, March 17, 2010
We detailed the Cedar Fair (FUN) risk arbitrage situation earlier, and it is worth the time to provide a follow-up. Shareholders were scheduled to vote on the $11.50/share buyout by Apollo on March 16. Recall that a significant number (at least 18%) of shareholders opposed the transaction, and the two-thirds vote requirement was looking uncertain. Let’s look at what has happened, and then at the role of proxy advisors.
On March 15th, the day before the vote was to occur, a certain M&A focused publication said that Apollo was considering raising its offer from $11.50 to $13.50/share. As is not infrequently common, Mr. Market took the report more seriously than perhaps it should have. The spread reacted violently, moving from 3.2% to -6.0%. It’s a bit worrisome to me that people so quickly believe this source, considering how wrong it consistently is. Nevertheless, the stock remained expensive. Later that evening (with the vote scheduled the next day), FUN announced that it will postpone the shareholder vote until April 8. The purpose of the postponement was to solicit additional votes and give shareholders more time to review the proposed acquisition.
FUN’s largest shareholder, Q Investments (18% stake opposing the deal), said today that it is concerned over reports that FUN is continuing price discussions with Apollo. Q Investments believes that it is not a matter of price, and therefore they are not supportive of any such effort. Instead, they are believers in the long-term potential of FUN, and will not support any transaction that forces them to surrender their shares. Furthermore, Q Investments recommended that the board request that Apollo allow FUN to commence discussions about various alternatives with its bank group to avoid covenant violations and a potential default.
My belief is that Apollo will not raise its offer. FUN can postpone the vote, but it will not secure a successful tally at the original terms. It was made public on March 9th that RiskMetrics Group, Proxy Governance, and Glass Lewis & Co all recommend that shareholders vote against the acquisition, while Egan-Jones was the lone dissenter. Of the four advisors, I consider RiskMetrics to be the most respected and analytical. The common basis for the recommended rejection was the low takeout valuation. This is a good time to discuss the role of proxy advisory firms.
Proxy advisors make recommendations to shareholders on issues that require a vote. Situations like mergers and board nominees commonly have one or all of these firms weigh in to advise shareholders. Take a merger, for instance. Institutional investors will do their own research and reach a conclusion whether or not to approve a transaction. However, individual investors like to hear from a source other than management (which will inevitably recommend shareholders approve a deal, or vote its nominees to the board). Another key audience for the proxy advisors is the index crowd. Many index funds are mandated to vote their holdings to the recommendation of the proxy advisors, and these shares can be pivotal in a close vote.
A recent deal in which proxy advisors had an important role was Alpha Natural Resources’ (ANR) acquisition of Foundation Coal Holdings, announced in May of 2009. On June 24, Stanley Druckenmiller’s Duquesne Capital filed as a passive holder of 7.7% of ANR. Since the merger was structured as a stock exchange, ANR shareholders had to approve the issuance of ANR shares for currency. (Technically, per NYSE Rule 312, a company requires a shareholder vote if it is seeking to issue a number of shares in excess of 20% of the number of common shares outstanding before the issuance. In this case, ANR was above 20%.) On July 16, Duquesne switched its filing from a 13-G to a 13-D, becoming active, and increased its holdings to 8.3%. At this point the fund indicated concern over the acquisition and said it will evaluate the benefits of the deal. A few days later, Duquesne said it will vote against the merger on July 31, arguing that the dilution to ANR shareholders will be irreversible. By this time, all four proxy advisors had recommended approval of the merger. The spread was widening on rumors that RiskMetrics was planning to reverse its recommendation. To my knowledge, they have never done such a thing, so the vote (and ultimately, the merger) would have been in serious jeopardy had this happened. Days before the vote, RiskMetrics and Glass Lewis reaffirmed their support for the deal, and Proxy Governance changed its recommendation to being against the deal. The spread was enormously wide for a merger with a few days to close, and after a narrow vote on the ANR side, the transaction was complete.
The lesson here is that proxy advisors can affect the trading of a deal, and also its outcome. A good lesson in real time for merger arbitrage.
Thursday, March 4, 2010
This post will highlight a current transaction with a large shareholder who opposes a deal. Since mergers either have to be approved by a target company’s shareholders by vote or by tender, consent by the owners is required. While a rare occurrence, shareholders can block a deal from consummating. A current situation in merger arbitrage that is at risk of being voted down is Cedar Fair LP (FUN). We will detail a lot of minor events in this deal, but it is worth the read to understand how an event trades.
On December 16, 2009, Apollo Global Management announced a definitive agreement to acquire FUN. The $11.50/share purchase price represented a 27% premium to the previous closing price. The agreement requires approval from two-thirds of FUN’s shareholders, and carried a 40-day go-shop period (a go-shop period allows FUN to solicit alternative proposals, with the intention of receiving a superior offer).
The spread first went negative (traded above $11.50/share) on January 6, closing at $11.63/share. On January 19, Q Investments disclosed ownership of 9.8% of FUN (which, oddly, was done in a 13G filing, indicating a passive holder). This brought FUN’s share price to $12.19, a spread of -5.6%. On January 22, Q Investments announced (while still a passive holder) that it will vote its shares against Apollo’s buyout, and argued that FUN has numerous options to deliver more value than the $11.50/share bid. FUN responded to this by saying that the acquisition is in the best interest of shareholders. Q Investments increased its ownership to 12% on January 25, driving the spread to -10%. On February 1, Neuberger Berman (correctly, in a 13D) said that it opposes the buyout with its 9.6% ownership. Q Investments (still in a 13G) bumped its stake to 17% on February 4, and then to 18% on February 12 (finally, in a 13D). Maintaining the quirkiness of this deal, the spread was then at 0.5% (yes, now positive). I found this unusual, because at this point, you have at least 27% of shareholders who publicly oppose a merger that requires two-thirds approval. On February 16, Neuberger Berman hinted at a change of heart when it switched to a passive holder and decreased its holdings to 7.7%, with no mention of opposition to the merger.
What about another bidder, you might be asking? Well, the go shop period expired, and in late January, FUN disclosed that it contacted 32 interested parties, though no party expressed any interest in making a proposal.
In early March, FUN released presentations which detail the rationale for the merger. FUN believes that $11.50/share is the highest and best value for shareholders, and reiterated that all available strategic alternatives were considered before they entered the agreement. Additionally, FUN explains nicely how challenging the environment would be in the absence of a transaction. High unemployment, low discretionary spending, and suffering sales are all cited as risks to FUN’s business if the deal is not executed. FUN says that its debt load (5.14x Total Debt/EBITDA) is unsustainable, and highlights that the covenants on its debt step down to more restrictive levels at the end of 2010.
Where does this deal stand now? The shareholder vote is scheduled for March 16. The spread is 4%, starting to price in the risk of an unsuccessful vote. You have at least 18% of shares being voted against the current offer (excluding Neuberger, since they switched to passive, but their current intentions are unknown). Again, a two-thirds vote is required for approval, and a failure to vote (think retail investors) has the same effect as voting against the merger. FUN clearly states that the company will face a tough time as a standalone, so if it is voted down, then the share price will really be hammered. Interesting risk arbitrage situation.