Showing posts with label merger analysis. Show all posts
Showing posts with label merger analysis. Show all posts

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.


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.


Wednesday, June 30, 2010

Merger Arbitrage: SonicWALL Inc (SNWL)

On June 2, SonicWALL Inc (SNWL) announced a definitive agreement to be acquired by an investor group led by Thoma Bravo, LLC and including Ontario Teachers' Pension Plan for $11.50/share, or about $720 million. SNWL is a leading provider of IT security and data backup and recovery solutions. The offer price represented a 28% premium to SNWL's previous closing price. SNWL expects the transaction to close in the fiscal quarter ending September 30 or early in the fiscal quarter ending December 31. The press release did not contain any more information, nor was there a conference call. Let's dig into this merger arbitrage situation.

Some people might be thinking, "great, a 28% premium from legitimate buyers", however there are warning signs that should be evident after reading the 8:30pm announcement. We have mentioned the first two issues several times on this blog. The first is that there is no go-shop period, which would allow SNWL to solicit bids from third parties for a specified time period, typically 30 days. These provisions are typical with private equity buyers. The second issue is that there is no voting agreement with shareholders. Or, shall we say, there was no announcement of any go-shop period or voting agreement. Since these are viewed favorably to shareholders of target companies, and management will go out of its way to display any shareholder friendly actions performed, we assume that lack of disclosure means that these items do not exist. We learn at 6am the following morning in a filing that there is a voting agreement, albeit for the 1% of shares that management and the board own. This is unconvincing, given that page one holders represent 64% of the shares outstanding.

These are nice ancillary points, one could say, but how about something more substantive? Okay, let's look at valuation. At $11.50/share, SNWL is valued at about 2.0x LTM revenues. SNWL's comps trade at a multiple of about 2.2x. All things being equal, which they admittedly never are, the takeout multiple should be higher than where the peers trade. The main reason is that shareholders must be enticed with a control premium.

For some background on Thoma Bravo, the private equity firm agreed to acquire Entrust Inc on April 13, 2009 for $1.85/share, or $114 million. The transaction contained a 30-day go-shop provision. Thoma Bravo was able to secure a voting agreement with 19% of Entrust shares. When the go-shop period expired on May 13, Entrust provided an update on what transpired in the process. After speaking with 35 separate parties, Entrust received written, non-binding indications of interest from three parties, each of which contemplated a price higher than the $1.85/share deal with Thoma Bravo. As a result, Entrust intended to provide additional due diligence and continue discussions and negotiations with these parties. Notwithstanding the foregoing, Entrust reiterated that its board determined that the merger with Thoma Bravo is fair and that they still recommend shareholder approval of the deal. On June 11, Entrust director Douglas Schloss (who runs the risk arb fund Rexford Management) publicly stated how the timing is poor to be selling the firm and that the offer price should be increased. Schloss was one of the two directors out of the nine-person board who voted against the $1.85/share deal. On July 10, Thoma Bravo amended its merger agreement with Entrust for an acquisition price of $2/share, or $124 million. The deal closed on July 28.

Now let’s return to the SNWL deal. On June 11, we learn from the preliminary proxy that three parties outside of the buying consortium entered confidentiality agreements with SNWL, though no offers were made. This does not support management's decision not to negotiate a go-shop provision, since clearly there were other interested parties. Surprisingly, this did not tighten the spread, as it remained at 2.4% after this news. The release of the definitive proxy on June 22 set the shareholder vote for July 23. It also disclosed that regulatory clearance from the FTC had been granted. The most important piece of information in the filing was added to the end of the background section, acting as the latest update. This is the section where one can learn about other conversations the company had about a transaction. Often there is nothing material (no big change in the background section from the preliminary to the definitive), though in this case, there is an important addendum:
On June 16, 2010, the board of directors of SonicWALL, Inc. received an unsolicited non-binding proposal from Strategic Party D, a privately held competitor, in which such party proposed, subject to completion of due diligence and finalization of definitive documentation, to acquire the outstanding shares of common stock of SonicWALL for $12.00 per share in cash. Strategic Party D’s offer identifies Financial Sponsor C and Financial Sponsor D as expected equity financing sources for its proposal and states that it is in discussions with debt financing sources.

On June 18, 2010, the board of directors of SonicWALL, after consultation with its financial and legal advisors, determined that the unsolicited non-binding proposal from Strategic Party D meets the criteria required by Section 5.6(b) of the Merger Agreement to permit the Company to provide information to, and negotiate with, Strategic Party D in accordance with its terms. Based on this determination and as permitted by the Merger Agreement, SonicWALL delivered a confidentiality agreement with a standstill provision to Strategic Party D and its proposed equity financing sources as provided for in the Merger Agreement and, upon its execution, will furnish information to Strategic Party D and enter into discussions with it regarding its proposal.

The board of directors of SonicWALL has not approved, adopted or recommended the acquisition proposal from Strategic Party D or declared it superior to the Merger Agreement and the merger. Moreover, SonicWALL’s board of directors has not withdrawn, qualified, or modified its recommendation that SonicWALL shareholders approve the principal terms of the Merger Agreement, the merger and the Agreement of Merger. Our board of directors continues to recommend that you vote “FOR” the proposal to approve the principal terms of the Merger Agreement, the merger and the Agreement of Merger. There is no assurance that negotiations with Strategic Party D will ultimately lead to a superior proposal, that SonicWALL and Strategic Party D will reach final agreement on terms regarding the acquisition of SonicWALL by Strategic Party D or that, if the parties do enter into such an agreement, regulatory approvals and other conditions to completing such a transaction will be obtained.
Knowing about Entrust, we are aware that Thoma Bravo has been in a similar situation. We also know that the result was an increase in the purchase price. The spread closed on June 22 at -3.0% after disclosure of this bidder. As of June 29, it is -1.5%, as investors are still very interested in the potential spoiler bid.


Monday, June 14, 2010

Merger Arbitrage: Javelin Pharmaceuticals

Similar to other areas of investing, following arbitrage deals helps you construct a historical framework from which to build your analysis. For instance, some deals are beneficial from an antitrust perspective. Some provide insight into M&A law. Other deals are good references for analyzing deals with multiple bidders. For Javelin Pharmaceuticals Inc (JAV), we have the latter two aspects. Using Bloomberg’s description, JAV is a specialty pharmaceutical company that develops drugs to treat intense moderate-to-sever pain.

On December 18, 2009, JAV agreed to be acquired by Myriad Pharmaceuticals Inc (MYRX) for a stock exchange of 0.282 MYRX shares per JAV share. The ratio valued JAV at $1.50/share, a 22% premium to its previous close. MYRX agreed to place 4% of shares in the combined company in escrow to be delivered to the pre-merger shareholders of JAV, depending on the timing of FDA approval of JAV’s Dyloject, a post-operative pain management drug. If approved by June 30, 2010 the ratio would be 0.3311, if by January 31, 2011 the ratio would be 0.3066, and 0.2943 if approved by June 30, 2011. MYRX also agreed to provide up to $6 million of interim financing to fund JAV’s operating activities prior to closing, which was expected to occur during the first quarter of 2010.

The preliminary proxy’s background section revealed on February 12 that there was outside interest in JAV. An unnamed European pharmaceutical company gave a preliminary indication of interest on August 6, 2009 of a stock exchange worth $2.20/share. A separate company offered a stock exchange work $2/share on August 7, which was revised to a $2.47/share value on August 30. Another company sent a letter of interest for $1.85 to $2/share in cash on December 10. JAV rejected this offer due to its lack of a working capital facility and because it was subject to further due diligence.

Millennium Management, a 7% JAV holder, disclosed in a 13D on March 3 that the proposed merger with MYRX does not maximize shareholder value, and cited the higher valuations from other parties in the sale process. The spread went from -4% to -7% on Millennium’s opposition.

On April 12, JAV announced that it had received a binding offer from Hospira Inc (HSP) to be acquired in a cash tender offer for $2.20/share. In addition, HSP would provide JAV a working capital facility under which JAV may borrow up to $4.5 million to fund operating activities prior to closing a merger, $8.3 million for JAV’s repayment of the principal and accrued interest incurred under a similar arrangement entered into with MYRX, and $4.4 million for payment of the termination fee to MYRX. JAV’s board said that if MYRX does not favorably adjust the terms of its offer within a five business day good faith negotiating period, then they expect to enter the merger and loan agreements with HSP. JAV closed at $2.15/share the day of this announcement, a 60% increase from the previous close. MYRX also rose 10%.

On April 19, JAV terminated the merger with MYRX, and later that day signed an agreement with HSP for $2.20/share, or $145 million. HSP said it pursued the deal to take advantage of synergies between JAV’s main product candidate, Dyloject.

As a side note, we see two similarities with the offers. One is that both provide short-term financing. This tells us that JAV is in a bit of a cash crunch. The second thing we notice is that both deals rely on Dyloject, so it is clearly important to JAV.

On May 19, HSP extended its tender offer to June 2, after 79% of shares were tendered. HSP extended the offer “based on its determination that all of the conditions to the offer had not been satisfied”. Normally one would think that the condition not satisfied is the minimum number of shares required, but four minutes later JAV released the following:

Javelin believes that, in asserting the failure to satisfy in full any such conditions, Hospira is purporting to rely on information regarding a supply chain issue in the United Kingdom described below.

Javelin was notified, on May 14, 2010 by a licensee of commercial rights to Dyloject in the European Union, that an issue has arisen in the UK Dyloject supply chain. Javelin notified Hospira of this matter promptly after being informed. Javelin is not aware of any issue in its supply chain for Dyloject in the United States.

Javelin disagrees with Hospira's position under the merger agreement that the conditions to the tender offer have not been fully satisfied and believes that all of the conditions of the tender offer have been satisfied. Javelin continues to honor its obligations under the terms of the merger agreement.

Wait a minute. That changes things. Remember how we mentioned Dyloject, and how both bidders found it to be an integral part of their strategy to acquire JAV? It’s certainly not a good thing when “an issue has arisen” with this product. JAV closed down 17% for the day.

On May 24, JAV finally clarified the European “issue”.

Therabel Pharma UK Limited ("Therabel"), a subsidiary of Therabel Pharma N.V. and Javelin's licensee of commercial rights to Dyloject™ (diclofenac sodium) in the European Union recently informed Javelin and publicly announced that it is withdrawing all batches of Dyloject (diclofenac 75mg/2ml) from the UK market with a Drug Alert Class 2 Medicines Recall.

Therabel reported that it became aware of the presence of a white particulate matter in some vials of Dyloject in its supply chain. These findings were promptly reported to The Defective Medicines Reporting Centre (DMRC) of The Medicines and Healthcare Products Regulatory Agency (MHRA) in accordance with standard procedures.

Therabel further reported that its review of pharmacovigilance information does not appear to indicate any detected patient safety concerns linked to the particulate matter found in some vials. Dyloject has been marketed in the UK since December of 2007.

Therabel has indicated that it is cooperating fully with the MHRA and is active in an investigation to resolve this matter and to restore the supply of Dyloject to the UK market as soon as possible. Javelin is providing assistance to Therabel with its investigation.

JAV closed down another 30% at $1.26/share on May 24, leaving the gross spread at 74%. The spread remained wide as investors were seeking to determine what HSP would do next. Would it continue with the transaction? Would it attempt to invoke a MAC?

The next move was made by JAV, when on June 3 it filed suit against HSP in the Delaware Court of Chancery. The suit seeks to compel HSP to complete the merger and also asks for expedited proceedings to allow for an early trial. The complaint contends that HSP breached the merger agreement by failing to accept and pay for the 79% of shares that were tendered through May 18 and by failing to complete the merger. Additionally, the complaint asserts that HSP breached the terms of the loan agreement under which HSP was obligated to $2 million on June 1.

HSP extended the tender offer on June 3 to June 16. The acquirer was careful to add that it “intends to continue to work with Javelin to confirm the satisfaction of the conditions to the offer as promptly as practicable”. In a letter to JAV’s CEO, HSP’s general counsel said that HSP “believes that the occurrence of the particulate issue, which directly affects the Company’s sole viable drug product, would reasonably be expected to result in a Material Adverse Effect, as defined in the Merger Agreement”.

The Court granted the motion to expedite on June 4. Later that day, JAV received notice from the NYSE staff that it is not in compliance with the NYSE Company Guide. Specifically, the staff indicated that JAV has “sustained losses which are so substantial in relation to its overall operation or its existing financial resources, or its financial condition has become so impaired that it appears questionable, in the opinion of the Exchange, as to whether Javelin will be able to continue operations and/or meet its obligations as they mature”. JAV announced on June 11 that HSP funded at $2 million loan under the existing loan agreement.

This is a very risky transaction to play right now, though the monster spread might be attractive to some people. The most likely outcome is this deal is terminated. Invoking a MAC in Delaware has proven to be a difficult task. It’s obvious why JAV wants an expedited trial – it is running out of money. The timeframe provided by the courts might not be fast enough for the company.


Sunday, May 16, 2010

Risk Arbitrage: CKE Restaurants: Is a Higher Offer Coming?

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 3, 2010

Merger Arbitrage: Sauer-Danfoss (SHS)

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.


Saturday, April 10, 2010

Merger Arbitrage: SkillSoft (SKIL)

On February 12, SkillSoft PLC (SKIL) agreed to be acquired by a consortium of Berkshire Partners, Advent International Corp, and Bain Capital for $10.80/share, an 11% premium to SKIL’s prior close. The transaction requires approval from a majority of SKIL shareholders, assuming at least 75% of them vote. A go-shop provision allowed SKIL to solicit alternative proposals until March 6. SKIL hosted a conference call to discuss the $1.1 billion deal, which set the tone for a trade that caught investors by surprise. Let us take a look at this risk arbitrage example.

As with most deal calls, the interesting part began with the Q&A. Of course management is in favor of the deal, or else there would be no agreement. We obviously have our own opinions on deals, but it is imperative to know how others perceive a transaction, and the Q&A portion is the first chance to discern their thoughts. Right off the bat, the questions force management to take a defensive stance. How well was the company shopped to other bidders? How did you arrive at the low takeout valuation? Why are you selling now, instead of a year down the road, when the sales that you said would pick up will be higher? Did you discuss the deal with any of your largest shareholders before signing? (The answer was no.) Even the largest shareholder chimed in, which rarely happens on deal calls. “Just out of curiosity, why weren’t the larger shareholders consulted?” After an unsatisfactory answer, the 22% holder said to the CEO “would you mind coming to see me?”

You understand the general tone. Investors are displeased, and the largest shareholder is unimpressed and surprised. So now, all eyes are on the go-shop period. The day the deal was announced, SKIL closed at $11.03/share, a spread of -2%. The spread was negative for the entire go-shop period, and SKIL peaked at $11.29/share (-4.3%) on March 9, as the market knew the go-shop expired, and announcement of a superior proposal was anticipated. The following day, SKIL provided an update on the process and said that Credit Suisse contacted 45 parties on SKIL’s behalf, entered 10 confidentiality agreements, and received one conditional preliminary proposal for an offer above $10.80/share, but no formal offer was made. So there it is. The company was shopped to third parties and no one took the bait, and SKIL immediately fell to $10.71/share.

On March 12, SKIL held its earnings call, and during the Q&A, the issue of shareholder approval arose again. Management said they had spoken with shareholders “both large and small”, and they are “feeling very good” about the April 6 shareholder vote. So with a 22% holder who sounded unimpressed by the deal initially, one would think that said holder’s blessing was secured in order for management to have such optimism. The spread should be tight, right? Wrong. As late March 29 SKIL was trading at $10.18/share, a 6% spread, for a deal that should close in two months. That is too wide, so we must be missing something. Reviewing the conference call transcript, we can determine one of two things. By saying that they are comfortable with the shareholder vote, management is either lying, or they are not disclosing all of the information they have. With a 6% spread, arbs were pricing in a low probability that the deal closes. It would be much tighter if there were any confidence in the vote. It’s tough to be a buyer (will the vote be successful?) or a seller at this point (SKIL’s downside valuation is attractive).

On April 1, with arbs’ hands behind their backs, and the vote a few days away, SKIL announced that the offer price was revised from $10.80 to $11.25/share. The vote was rescheduled from April 6 to April 29. Columbia Wanger Asset Management, the largest holder, entered a voting agreement in favor of the new terms. The offer was increased because SKIL thought the likelihood of success with the original deal was insufficient. SKIL closed that day at $11.10/share, for a spread of 1.3%. Not only did the market not expect a higher offer, which the 6% spread indicated, but you have to give credit to Columbia Wanger and the other parties involved for not showing their hand. The event-driven space is so used to having leaks that it is a shock when people don’t have an idea of what is going on behind the scenes.

The lesson here is that shareholders matter. If deal parties do not consult with, and receive voting agreements from, shareholders before a transaction is announced, then they better be sure that the valuation is attractive enough for the holders to agree with ex post.


Monday, March 29, 2010

Merger Arbitrage Update: Novell (NOVL)

To successfully follow risk arbitrage, one must have a solid understanding of the legal process. We do not have a JDs (it is in no way required, though it makes the learning curve less daunting), but both of us spend many hours a week analyzing legal documents. I also attend any court hearings or trials relevant to the deals I’m following. Long ago I stopped trusting live webcasts of proceedings, as my luck would have the feed cut out right before an important announcement. We will discuss at length the legal aspects of investing in the event-driven space over the life of this blog.

A trial I am currently following involves Novell Inc (NOVL), a target we reviewed earlier. The case involves the ownership of the copyrights to Unix, and is set to conclude a three week jury trial this week in Utah District Court. NOVL bought Unix in 1993 for $300 million, and then sold Unix to the Santa Cruz Operation of California in 1995. Since Santa Cruz could not pay cash for Unix, NOVL retained royalties from the pre-1995 versions, and also shares of Santa Cruz stock. To hedge against a substantial decline in Santa Cruz stock, NOVL also kept the copyrights to Unix. In 1996, the sale agreement was amended to include the transfer of the copyrights. Caldera International (later named The SCO Group) bought Unix from Santa Cruz a few years later. SCO filed suit against IBM Corp in 2003, accusing IBM of using Unix to make significant changes to the Linux operating systems, which made Linux a SCO competitor and forced SCO’s revenues to decline. After SCO sued IBM, NOVL claimed that it owned the copyrights to Unix, and that SCO’s suit against IBM was invalid.

The trial appears to be favoring SCO. Testimony from the Robert Frankenberg, the CEO of NOVL during the sale of Unix, reveals that it was his intention to sell the copyrights in 1995. Even the two top NOVL negotiators of the Unix sale said that the transaction included the copyrights, while one added that it “would not make any sense” to exclude them.

What does the agreement say? The amendment is obviously the relevant document, and it does not support SCO as heavily as the executives do. The wording is amazingly convoluted, but the amendment is essentially a promise to assign the copyrights to Santa Cruz, and therefore it is not evidence of a valid transfer of ownership. To throw more of a twist, the Utah Appeals Court has ruled that intentions matter in contracts, so the jury could rule in favor of SCO.

If SCO wins this case, then it will pursue its lawsuit against IBM. SCO is on the ropes, and it would be unwise for NOVL to look beyond this case. SCO was sent into bankruptcy court in 2007, and it remains under control of a trustee. SCO is in dire need of a financial settlement. NOVL could be on the hook for about $25mn, which would help SCO more than it would hurt NOVL (NOVL has $607 million in cash).

As for an update on the unsolicited offer from Elliott Associates, the board rejected the $5.75/share proposal on March 20, arguing that it undervalues the company’s franchise and growth prospects. Additionally, the board authorized a review of strategic alternatives, including, a share repurchase program, a cash dividend, joint ventures, a recapitalization, and a sale of the company. The last one is crucial, as it shows the company is a willing seller, at the right price. Some management teams are unwilling to let go of their company for any monetary figure. With management on board for a potential sale, a financial sponsor’s lurking, and assets ripe for revitalization by a strategic acquirer, NOVL is likely to be sold.


Sunday, March 21, 2010

Merger Arbitrage: Lions Gate (LGF)

Carl Icahn is a respected, and often feared, investor with an enviable long-term track record. His successes and failures have attracted attention throughout his high-profile career. I believe his current strategy with LGF is bound to end with a resounding thud. A bidder’s credibility and intentions are important aspects in the deal process, and while no one will doubt Icahn’s credibility, I’m not sure even he knows his intentions for LGF.

First, a little background will bring us nicely up to speed. Over the course of 2008, Icahn more than doubled his holdings in LGF to a stake of 14%. People were thinking that he would dust off his poison pen, rattle the cages, and encourage a sale of the company. Icahn said in February of 2009 that he is evaluating increasing the size of the board and adding his own directors. In March, he terminated his talks with LGF, citing the failure to reach a sufficient standstill agreement. Icahn’s next move was to make a tender offer for $325 million of LGF’s senior subordinated notes at 73% of par.

At this point, we know Icahn has a problem. LGF has a very concentrated shareholder base, and the top three holders (nearly 50% combined stake) are supportive of management. Interestingly, the top holder (20%) is Mark Rachesky, who was a senior investment officer for Icahn Holdings from 1990 to 1996. Rachesky left to launch MHR Fund Management and has created his own impressive legacy. He, too, is an influential investor, and it is inauspicious for Icahn that his protégé is not siding with him on LGF.

LGF struck a deal with convertible debt holders to keep $316mn of the securities out of Icahn’s hands, by restructuring the strike price from $14.28 to $8.25, and also extending the put date from 2012 to 2015. Investors showed their lack of support for Icahn’s offer when 5% tendered their notes.

In September, Rachesky was nominated to the board. Meanwhile, Icahn quietly grew his holdings to 19%. In mid-February, with LGF trading at $5.23/share, Icahn announced a $6/share partial tender offer to increase his holdings to 29.9%. Here is why I don’t think Icahn knows his intentions for LGF: After he announced the partial tender, he went on CNBC and said that he is not seeking control of LGF, and that he wants to increase his holdings so he can have more say in potential acquisitions the company makes. (In the past, he had criticized LGF’s acquisition of the TV Guide Channel.)

On March 12, LGF recommended that shareholders not tender to Icahn’s partial offer. Management argued that the offer is inadequate, and noted that $6/share is a 30% discount to the average analyst price target. They said that, with 29.9% of the shares, Icahn could effectively veto certain transactions and would have power over fundamental decisions. LGF pointed out that the Icahn Group lacks industry experience. The company noted that a successful partial tender would constitute an event of default under its credit facilities, which would permit the lenders to accelerate the maturities of outstanding borrowings ($516 million of such notes). The board also authorized a shareholder rights plan (poison pill) to “limit the potential adverse impact…of an accumulation of a significant interest in the shares”. The plan has a threshold of 20% (note that Icahn is holding 18.9%).

On March 19, Icahn amended his offer to buy 29.9% of LGF, and is now seeking to purchase all of the common shares outstanding for $6/share. He did not change the offer price, which was previously rejected. Icahn said that he intends to pursue legal proceedings to set aside the poison pill, and that it restricts the rights of LGF shareholders to accept the offer. If more than 50.1% tender to the offer, Icahn intends to replace the board with his own nominees. Icahn went on to address the change of control provisions in the debt, and said that his group is prepared to provide a bridge facility if the provisions are triggered.

His offer is not competitive. He said one month ago that he is not seeking control of the company – now he is. The $6/share offer was rejected in the partial tender, now he wants to make it for the whole company? Curious at best. We will be sure to follow this possible merger arbitrage investing opportunity in the future.


Thursday, March 4, 2010

Risk Arbitrage Situation - Cedar Fair

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.


Wednesday, February 24, 2010

Merger Arbitrage Fundamentals: HPQ and COMS

One of the most important aspects of a merger arbitrage transaction is the regulatory process. How a deal is deemed from an antitrust standpoint is critical, as failure to receive regulatory approval can derail an agreement. On 3Com, the company agreed to be acquired by Hewlett-Packard on November 11, 2009 for $2.7 billion ($7.90/share). 3Com is a familiar name to the arb community, as it was involved in a deal that was terminated because of regulatory issues.

For background, Bain Capital agreed to acquire 3Com on September 28, 2007 for $2.2 billion ($5.30/share). As a part of the transaction, Huawei Technologies (a Chinese firm) would acquire about 17% of 3Com and become a commercial and strategic partner. Shortly after the merger announcement, all the talk was about the scrutiny that US regulators would use to evaluate the deal. 3Com sells telecommunications systems to US government agencies, and the Chinese government had recently made publicized attacks on US government networks. The thought was that a party who is critical of US networks would have say in the strategic direction taken. (As a side note, Huawei’s president is Ren Zhengfei, a former officer in the People’s Liberation Army.) In early October of 2007, Bain and Huawei filed for a review by the Committee on Foreign Investment in the United States (CFIUS). Then came the influx of letters and resolutions from Congressman who sought to block the deal on national security concerns. In late February of 2008, the acquirers withdrew their CFIUS filing, and the stock, already at $3.73/share immediately dropped to $2.87/share. The shareholder vote was subsequently postponed twice, to further address CFIUS concerns, and two days before the vote was to be held, Bain terminated the agreement out of CFIUS fears. This left 3Com at $1.98/share, a far cry from the $5.30/share deal price.

With that bit of history, the first thought in arbs’ minds when the Hewlett-Packard deal was announced was “China”. Obviously, this transaction does not have the same risk as one with Bain and Huawei, since there is no national security concern. It does still, however, hinge on approval from China’s Ministry of Commerce. China initiated its review on December 29, 2009, and initiated a Phase II review period on January 27, 2010. The initial Phase II review lasts up to 90 days, with a possible extension of up to an additional 60 days. Your annualized return is diminished if you think a deal will close on a certain date, but regulatory issues prolong (or worse, prevent) its completion. Arb names only move on events like this if they were not priced in, and indeed, a Phase II review was largely factored into 3Com (closed at $7.55/share before the Phase II was announced).

So, with no national security concern, what is holding up China from approving the merger? We don’t know, exactly, since China is notoriously one of the least transparent regulatory bodies in the world. Some believe that China might block the deal to retaliate against the US for CFIUS’ past with Huawei’s attempt to take a 3Com stake. In January, the fear was that a block could follow Google’s threat to leave China. At the current $7.63/share, we are provided a 3.5% return (20% annualized to a late-April close) if the merger is successful. Excluding the China factor, this deal would have about half that return. However, arbs have priced in a discount due to this risk. From a pure antitrust perspective, approval should be granted, since the deal simply transfers ownership from one US owner to another. What will ultimately happen? This highlights the “risk” in “risk arbitrage”.


Sunday, February 21, 2010

Risk Arbitrage - An Investor's Guide: Chapters 1 and 2

Here at Merger Arbitrage Investing, we will cover a number of books related to risk and merger arbitrage. Our first book, "Risk Arbitrage: An Investor's Guide" will be discussed over the next few months, in tandem with other topical posts related to current deals in the market as well as case studies. The goal is to teach the reader, the in's and out's of merger arbitrage and to equip an investor with another tool in his arsenal.

Chapter 1 of the Risk Arbitrage discusses the merger of Staples and Office Depot that ALMOST occurred in the late 90s. This merger did not go through because of anti-trust considerations and many arbitrageurs got burned. It is an interesting case study but the meat of this post will be related to Chapter 2.

Chapter 2 discusses on overview of risk arbitrage. As the author points out, risk arbitrageurs are not speculators that try to predict if XYZ company is going to be taken over. Rather, they profit from the initial merger/take-over announcement and the resulting actions post this announcement.

For this blog - we are solely going to focus on merger arbitrage with a smattering of special situations that we deem appropriate for the readership. Generally speaking, any situation we currently profile would be something that any investor, no matter their size of capital, would be able to participate in. We hope some of these operations turn out to be profitable.

As discussed in a previous post in our first merger arbitrage example, once ABC company makes an announcement acquiring XYZ company, we go about and try to find as much information about the deal as possible. Reg FD has limited some of the disclosure that market participants have been able to gleam from management / IR professionals. That being said, the reason for all this information is to determine the potential risks and rewards of the deal and the outcomes that came spawn from it.

Just as important, we try to estimate the probability that a new suitor may come along, or if the chance the deal gets shut down by the FTC, or the chance the deal simply falls apart. All these probabilities and expected rewards and risks (defined as the dollar value of loss) are rolled together to allow an investor to allocate capital in the best risk/reward fashion - and also to figure out how to hedge these capital allocations.

In doing this, many market participants have legal consultants that they interact with - these people are well versed in anti-trust / corporate law and can be a wise guide to deciphering the archaic structure that is the FTC. Further, given the volatility we saw in merger arbitrage land in 2007/2008/2009, being able to pinpoint what the definition of a MAC is or what reps/warranties need to be fulfilled for a deal to be completed is as important as ever.

Why does the "spread" exist in a merger arbitrage transaction. First, the time value of money. Second, there needs to be an implicit spread to factor in the chance that the deal does indeed fall through.

For example, when rumors circulated that the EU was having issues with Oracle's acquisition of Sun Microsystems (JAVA), the stock fells precipitously for a number of days to the point where an investor could lock in a $0.75-$1.00 dollar spread on a $9.50 takeover price. And the deal was supposed to close in a few months. The reason? The market was pricing in that the deal probably would not go through - that being said, if you had other thoughts, you could of made a pretty penny on this transaction.

Next week, we will start digging into some calculations so investors can calculate their investment returns on merger arbitrage and risk arbitrage situations.


Monday, February 8, 2010

How to Read a Merger Agreement Part 1

How to Read a Merger Agreement

The merger agreement (sometimes called the “DMA”, for definitive merger agreement) is an important step in understanding a deal. The merger agreement is the legal tool through which the parties distribute risks between the target’s and bidder’s shareholders in relation to the road that, hopefully, leads to the closing of the merger. The DMA is usually filed with the SEC within three days of a deal’s announcement. Much of the DMA’s language is usually standard, however, one should never take this granted.

Fully understanding the merger agreement will come handy if the merger process becomes tumultuous somewhere down the road: there may be a counter bidder emerging, the transaction may face unexpected regulatory hurdles, or the economy may deteriorate, rendering the strategic rationale for the merger obsolete.

We will explain how to review a typical merger agreement, and the key sections of the document.


This section is, in general, less important for cash deals. It can be important for stock deals, since this is where the collar, if any, is detailed, and it also describes any pricing period.

Closing and Effective Time

For both cash and stock deals you can find information related to closing and the effective time of the transaction. These are, for the most part, not essential, as they tell within how many days a merger closes once all conditions to the merger are satisfied. However, for private equity deals, this section could be important: in private equity deals there usually is a marketing period for the syndication of loans that finance the takeover. The marketing period could be important: it could delay closing of the merger and could have a negative effect on the deal spread (e.g. have a look at Article 1 of the IMS Health/TPG DMA)

Closing Conditions

DMA’s are not binding on the parties unless the closing conditions are satisfied or waived (if allowed). In effect, they define the contingencies under which the parties are free to walk away from the deal. This is very important.

The closing conditions fall largely into four categories: (i) representations and warranties, (ii) material adverse change or material adverse effect (MAC/MAE) conditions, (iii) covenants, (iv) exogenous conditions (such as regulatory approvals). Most of these conditions are cross-references with other clauses and articles of the DMA. So every condition has to be analyzed and checked whether it is cross-referenced with some other clauses in the text.

Reps and warranties

These clauses are usually of less importance. To address the substantial gap between the seller’s and buyer’s information concerning the target company, the seller typically makes a set of contractual representations and warranties. It represents that these facts are true both at the time of the agreement and at closing. However, note that MAC is more than likely to show up in the reps and warranties section. In addition, in pharma/biotech transaction material, drugs could be references in this section, so be careful not to miss this section.


Most large acquisitions include a condition that allows the buyer to avoid closing upon the occurrence of a MAC. Definitions vary among agreements. They are usually subject to carve-outs for excluded categories of events (except to the extent that they have a “disproportionate” effect on the target). The carve-outs are very important. The broader the carve-outs, the more risk the acquirer bears. Carve-outs can range from general economic and political conditions, to market prices and revenue projections of the target.

Sometimes MAC clauses very explicitly define what constitutes a material adverse effect: for pharma companies, this could an upcoming FDA approval for a certain drug, or for an oil exploration company, a possible legislative action related to a specific extraction process such as fracturing.

For Delaware incorporated companies, the courts interpret MAC clauses narrowly, to encompass only unanticipated events or changes that materially and adversely affect the longer term value of the target. So, historically, it has been difficult for acquirers to successfully invoke a MAC/MAE clause.


The satisfaction or waiver of the seller’s covenants is a closing condition. A covenant violation triggers the buyer’s option to terminate the DMA. The covenant clause usually contains the so called “reasonable best efforts” language.

Sections that define reasonable best efforts give important clues to the original intentions of the parties, as to what they expect to do in certain circumstances. In relation to regulatory approvals, one can find the timeframe for regulatory approvals, whether the parties are willing to go to court if the deal is challenged. Reasonable best efforts language might also reveal how far the bidder may went to obtain financing for the deal.

Exogenous conditions

The two most common conditions are related to the financing and regulatory approvals of the deal.

The financing section is cross-referenced with a specific section on financing (apart from the reasonable best efforts language). The financing section is where any committed financing is detailed. Some transactions are funded with cash on hand, some by newly issued equity, and others through a combination of sources, which include bonds and loans. Of course, an investor can obtain a more thorough examination of the funding from a study of any credit agreements or indentures. Careful consideration must be given to the reliability of the lenders.

Exogenous conditions also provide a more detailed a list of regulatory approvals required for the deal to close. This condition is usually cross-referenced. The covenant section could limit the parties’ ability to offer remedies to regulatory authorities. Some merger agreements limit the types and value of the assets that could be offered for divestiture to satisfy antitrust authorities. A lot of times, the regulatory approval process is the main reason for a fairly wide deal spread.


The key pieces in this section are the termination date (sometimes called the “outside date”) and the termination fee. The termination date is when the agreement becomes void. It can have an extended date, which upon the election of the target and/or the acquirer, prolongs the agreement, usually for the sake of receiving regulatory approvals. Termination fees generally range between 3% and 4% of the initial deal value. Transactions can also have reverse termination fees, which are payable by the acquirer, and are historically as high or higher than the basic termination fee. The idea behind a higher reverse termination fee is to prohibit the buyer from walking from the deal.

Specific Performance

An order of specific performance requires a party to perform a specific act (in this case, complete the merger). Here is an example of a specific performance clause, from Silicon Storage Technology’s merger agreement with Microchip Technology, dated February 2.

“Each of the parties hereto acknowledges and agrees that, in the event of any breach of this Agreement, each nonbreaching party would be irreparably and immediately harmed and could not be made whole by monetary damages. It is accordingly agreed that the parties hereto (a) will waive, in any action for specific performance, the defense of adequacy of a remedy at law and (b) shall be entitled, in addition to any other remedy to which they may be entitled at law or in equity, to compel specific performance of this Agreement in any action…”

Governing law

This is usually a standard clause, but could become interesting if the merger process hits a rocky road. One recent example for an interesting case is Apollo’s acquisition of Cedar Fair. New York law is the governing law and venue for litigation. Choosing the laws of New York as governing law is a rare event for Delaware incorporated companies. A new research paper by Cain and Davidoff (”Delaware’s Competitive Reach: An Empirical Analysis of Public Company Merger Agreements“) evaluated the selection of governing law and forum clauses in merger agreements between public firms during the period 2004-2008. They found that, among Delaware-incorporated targets, 91% select Delaware law. So the question arises, which party gains by choosing New York as the governing law and venue of litigation? We will come back to this question in a later posting.


Sunday, January 31, 2010

Merger Analysis: Pepsi's Acquisition of its bottlers

We are going to analyze the antitrust situation brewing in PepsiCo’s (PEP) acquisition of its two bottlers, Pepsi Bottling Group (PBG) and PepsiAmericas (PAS). In merger arbitrage transactions, regulatory approvals are critical. For the Pepsi deal, the HSR notification is under scrutiny with the FTC (recall that the Hart Scott Rodino Act governs the US antitrust filing process). For a little background, PEP made an unsolicited cash & stock offer for both companies on April 20, 2009, with bids worth $29.50/share and $23.27/share for PBG and PAS, respectively. The offers are cross-conditional based on the successful completion of both transactions. At the time of the announcement, PEP said it saw no issues in obtaining regulatory approvals. The offers were rejected by PBG and PAS’ boards, as all initial unsolicited proposals are. The spreads were negative, indicating that a higher offer was expected, and on August 4, definitive agreements were reached. The new offers were a cash or stock election worth $36.50/share for PBG and $28.50/share for PAS.

The antitrust review of a deal is paramount in risk arbitrage. It plays an important role in the timing of deal close and the ultimate successful completion of a deal. Deals with the most attractive spreads are likely to have complex antitrust issues, therefore it is essential to get a handle on this facet of deal analysis.

The first step in analyzing antitrust issues is to check right away whether there are any horizontal overlaps between the two companies. Horizontal overlaps are of great importance as these are the most likely to be challenged by the Antitrust Division of the Department of Justice (DoJ) or the Federal Trade Commission (FTC), if the merger results in a Small but Significant and Non-Transitory Increase in Price (SSNIP). We will discuss the meaning of SSNIP later. In the PEP/PBG/PAS merger, we can right away conclude that the merging companies do not have any significant overlaps.

In fact, the merger is a vertical merger. This is very good news, as historically, US antitrust authorities have had a fairly hard time challenging vertical mergers in a court setting. This gives us sufficient comfort to say that there is a very low probability that the merger would be challenged (blocked) by the antitrust authorities.

The next logical step is to look at the expected timing of the antitrust approval. The first thing we want to check is when the merging parties expect to file under HSR. We can usually find information related to the filing date in the Merger Agreement. Usually the parties commit to file either with the DoJ or the FTC in a fixed time period (usually 10 to 15 business days). So we check the PBG and PAS Merger Agreements (click here for the PBG and here for the PAS Merger Agreement). We are not that lucky here though: Section 8.01 of the Merger Agreement states that the parties will file under HSR “as promptly as practicable.” To remain on the conservative side we would pencil in one month for filing (early September 2009).

Next, we seek to estimate the length of the antitrust review period (here, we will not discuss the deals’ required European Union filings). We know that the initial waiting period under HSR is 30 calendar days for mergers. However, if there are substantial competition concerns the DoJ or the FTC could further extend the review period. This could substantially postpone the closing of the merger. In a Second Request, the parties would have to substantially comply with the DoJ’s or the FTC;s request for further information, for which there is no time limit. Once the parties have substantially complied, another 30 calendar day review period will start.

Does it follow from the fact that the PEP/PBG/PAS merger lacks any horizontal issues that the merger will result a quick antitrust resolution? No. There are two things to consider here. First, the FTC’s or DoJ’s track record in a given industry. Second, how complex the transaction is.

Complexity of the transaction is important because the FTC and the DoJ have scarce resources to look at a particular merger. Don’t forget that there are lots of mergers ongoing at the same time, and as a result, the DoJ and the FTC have to allocate resources (time and staff) efficiently. The antitrust authority has 30 days to decide whether a given merger deserves an in-depth investigation. What can be done in 30 days? Not much; the antitrust authority requests data on the companies’ products, the companies’ financial reports, name of the customers, suppliers and market share data. In the event of some overlaps or potential competition concerns, the antitrust authorities will contact major customers and suppliers, and if these do not complain, will allow the merger to proceed after the expiration of the 30 day HSR waiting period.

In the PEP/PBG/PAS merger, we are skeptical that the antitrust authorities will reach a quick resolutions on the deal. Why? The FTC has a track record of looking at bottling integrations very carefully. The FTC published an interesting booklet focusing on antitrust issues related to the US carbonated soft drink industry in November 1999 (prepared by staff members of the Bureau of Economics of the FTC). The FTC report analyzed bottlers in the U.S. carbonated soft drink industry and the effect of consolidation on carbonated soft drinks. Although the FTC’s study concluded that vertical issues were not of serious concern, we should conclude that the FTC will likely be concerned about the PEP/PBG/PAS merger. In this specific case, our best guess is that the FTC will be concerned because both PBG and PAS distribute products of PEP’s competitors (such as Dr Pepper). The FTC has historically been concerned that, as a result of consolidation, third parties’ products may be excluded, resulting in a price increase for consumers. Considering this, we pencil in a longer review period for the deal.

After a September 11th HSR filing, PEP announced on October 9th that it had withdrawn its HSR report forms from the FTC, and that it intends to re-file. A withdrawal of an HSR form can have various effects on a spread. If clearance is expected, then a withdrawal is negative, since it shows that there are still concerns to address. If a lengthy review is anticipated, then a withdrawal is largely a non-issue. It is positive is when the companies re-file the form, because it shows that they are confident that the material presented will be sufficient to gain clearance. When the form is re-filed, the clock is restarted, giving the FTC an additional 30 days to review the transactions. The withdrawal and re-filing process is done to prevent a formal extended review or Second Request (we will review Second Requests in more detail in a later post). On November 10, PEP announced that it once again withdrew its HSR forms. As of today, PEP has still not re-filed its application with the FTC. In PEP’s case, the market clearly expected a lengthy review and as a result the spread did not move too much.

On January 11, 2010, PEP disclosed that that it believes it can complete the deals by the end of the first quarter of 2010 and do so without a remedy that would constitute a material adverse effect.


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