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

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…


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Sunday, August 22, 2010

2010 Merger Arbitrage Market - A Mid-Year Update

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

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

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

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

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

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Monday, August 16, 2010

Merger Arbitrage: ATC Technology Corp (ATAC)

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

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

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

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


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

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Thursday, July 22, 2010

Merger Arbitrage Investing Lesson: Strategic Reviews

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

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

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

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

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

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

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

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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.

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Tuesday, June 22, 2010

Risk Arbitrage: Charles River’s Acquisition of WuXi PharmaTech

This post will review a merger arbitrage situation with an extremely wide spread. For the same reasons stock prices fall, spreads widen on an increase in the perceived risk of a transaction, or investors simply don’t believe that management’s original plan for the deal will actually be realized. Charles River Laboratories’ (CRL) acquisition of WuXi PharmaTech Inc (WX) is currently facing opposition from CRL shareholders, which has forced the spread to 31.3% as of June 17.

WX is a drug research and development outsourcing company with expertise in discovery chemistry and with operations in China and the US. CRL is a global provider of research models and associated services and of preclinical drug development services.

On April 26, WX announced a definitive agreement to be acquired by CRL for $1.6 billion, consisting of $11.25/share in cash and $10/share in CRL common stock (to be determined by an exchange ratio with a collar). The ratio will be determined by dividing $10.00 by the weighted average of CRL’s closing price for the 20-day period ending the second business day prior to the closing. (For those new to arb, these “pricing periods” are standard for undetermined exchange ratios.) If CRL’s average price is greater than or equal to $43.17/share, then the exchange ratio will be fixed at 0.2316, and if CRL’s average price is less than or equal to $37.15/share, then the exchange ratio will be fixed at 0.2692. The companies anticipate closing the merger by the fourth quarter. CRL intends to finance the cash portion of the transaction through balance sheet cash on hand and its $1.25 billion financing commitment from JP Morgan and Bank of America Merrill Lynch.

During the conference call that CRL hosted later that morning, management stated that they were the only party which conducted discussions with WX about a merger. This can have both positive and negative implications, though mostly the latter. Shareholders of the target like to hear this because it could mean that the absence of a competitive bidding process equates to a lower purchase price. The flip side of that could be that they offered so high a price that the board of the target did not deem a market check for outside interest necessary. Conversely, when shareholders of the target hear that the acquirer was the only party with whom the board negotiated then they are want to cry foul. Indeed, it is the board’s fiduciary responsibility to extract the greatest value for shareholders in a sale process. The gross spread was 9.5% the day of announcement.

The merger agreement was released the evening of the deal announcement and it provided a glimpse into the confidence that CRL had in securing approval from its shareholders. The termination fee is $50 million, the reverse termination fee is $50 million (payable if CRL decides to terminate), and there is a $25 million fee if CRL shareholders fail to approve the acquisition. It’s the last fee that grabs our attention. This tells us that not only was CRL concerned with whether its shareholders would approve the acquisition, but it went so far as to include an out (at half the price) in the agreement if they do not. Logically, this is because they either ran the purchase by their top shareholders before the announcement and were unsure of their support, or they did not survey the top holders (perhaps because they knew it would be unwelcome) and were just hedging themselves.

Sure enough, on June 7, Barry Rosenstein’s JANA Partners (an investor we respect, and CRL’s largest shareholder at 7.0%) sent a letter to CRL’s chairman and CEO, James Foster. JANA said that they “have serious doubts about the wisdom of pursuing this transaction at this time. Even if the contemplated benefits can ultimately be realized, we believe that the high cost, significant integration risks and inopportune timing simply make the proposed acquisition the wrong path for Charles River shareholders. For these reasons, we intend to vote against the issuance of Company stock required to complete the proposed acquisition, and we believe based on shareholder sentiment it is likely that a majority of the Company's shareholders will do the same.” JANA cited that the 16x consensus 2010 EBITDA estimate valuation assigned to WX compared to 8x for CRL at the time of the announcement cannot be justified with WX’s declining margins and falling growth rates. JANA’s letter widened the spread to 28.1%.

On June 14, Foster responded to JANA’s letter and said he is “convinced that this combination will create meaningful additional value” for CRL shareholders. Foster believes that applying pre-tax EBITDA multiples is misleading given WX’s significantly lower effective tax rate than CRL. He further recommends that investors consider (when factoring in WX’s significantly higher expected EPS growth rate) the purchase price representing a 1.4x PEG, in-line with CRL’s own valuation. Foster said on June 15 that he has met with all of his largest shareholders and that the majority of them are agreeable to the acquisition of WX.

JANA fired off another letter to CRL on June 16 and cited one analyst who said that 35% of CRL shareholders already oppose the acquisition of WX. On June 17, Neuberger Berman, a 6.3% holder of CRL, joined in on the fun and said that acquisition is not in the best interests of shareholders. Neuberger correctly pointed out that CRL “needs to demonstrate that the current assets can generate returns well in excess of its cost of capital before being allowed to spend $1.6 billion of capital”.

The increasing shareholder opposition on CRL’s side is a severe hurdle to deal completion. Much of the criticism of the merger is well-founded. CRL has two choices: Press ahead with the deal or terminate before shareholders vote down the agreement. Terminating before the vote would save face, and show that the board is receptive to the concerns of a sophisticated shareholder base. However, they would save $25 million if they let the vote take place even while knowing it will be unsuccessful. This is the more likely route they will take.

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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.

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Monday, May 10, 2010

Recent Merger Arbitrage Opportunities

One of the aspects of merger arbitrage investing that we find appealing is how you have to be a generalist. Deals happen in all industries, and arbs are not precluded from following a company because of the nature of its business. Indeed, the ingress and egress of names under our purview requires proficiency in a broad range of subjects. In the last few weeks we’ve seen deals involving Qwest Communications, Interactive Data, Continental Airlines, Dollar Thrifty Automotive, inVentive Health, CyberSource, WuXi Pharmatech, Stanley Inc, and Palm, among others. As far as closings, investors can no longer follow BJ Services, Switch & Data Facilities, Terra Industries, 3Com, and Facet Biotech.

You can find an event analyst immersed in hydraulic fracturing one day, studying the likelihood of any possible legislation that could come about (and potentially derail the XTO Energy – Exxon Mobil merger). The next day the same analyst could evaluate the competitive impact of combining an internet payment gateway provider with a payment network (for antitrust issues in the CyberSource – Visa deal).

A recent trend we’ve noticed is that financial sponsors (private equity) have been more active lately. Thomas H. Lee Partners announced the buyout of inventive Health on May 6 for $1.1 billion. Warburg Pincus and Silver Lake reached a $3.4 billion deal for Interactive Data on May 4. It is being said that Blackstone, THL, and TPG are in talks to acquire Fidelity National Information Services for around $13 billion. That would be the largest LBO in nearly three years. A merger revival appears to be in the making. Even the inimitable Jimmy Lee of JP Morgan sees a deal boom on the horizon.

We are also watching a few companies who are “reviewing strategic alternatives” which very often leads to a transaction. We are welcoming the increased activity on our desk. Hopefully spreads will widen to attractive levels in the near future, since the risk-reward for many situations does not warrant a portfolio position. Given how merger arbitrage spreads have collapsed over the past 5-10 years, we hope that a more healthy supply of deals will soak up capital more effectively and possibly give us some "fat pitches" to generate sizeable risk adjusted returns.

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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.

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Sunday, April 11, 2010

Merger Arbitrage: Update on Recent Deals

We recently reviewed the Cedar Fair (FUN) and 3Com Corp (COMS) deals, and updates on both are necessary. As transactions have been closing or terminating recently, merger arb money is going to the sidelines to wait for the next opportunities. Fortunately, there are some situations that could provide attractive entry points in the near future, and we will be covering some on this blog.

For FUN, recall that its largest shareholder, Q Investments, opposed the $11.50/share buyout from Apollo, and vowed to vote it 18% position against the deal, which required two-thirds approval. We said that Apollo is unlikely to raise its offer, and that the vote would be unsuccessful on the original terms. We also said that the downside valuation for FUN would be severe. Two for three is not the end of the world.

On April 6, two days before the rescheduled shareholder vote was supposed to be held, FUN and Apollo announced that they have mutually terminated their merger agreement. The termination occurred after FUN determined that it lacked the required level of investor support. FUN agreed to pay Apollo $6.5 million for expense reimbursement, and both parties agreed to release each other from all obligations with respect to the merger, as well as from any claims arising from the merger. Additionally, FUN adopted a poison pill with a 20% threshold.

On our scorecard, we correctly determined that Apollo would not raise its bid and that the shareholder vote would be unsuccessful, but we badly misjudged how FUN’s share price would react to deal termination. FUN closed on Friday at $14.11/share, well above the $11.50/share deal price. The exact reasons for this are still unknown to us (if any of you, dear readers, care to elaborate, we’d love to know your thoughts), but we have a few ideas. While technically a “deal stock” FUN was never sufficiently owned by arbs. Viewing the HDS function on the Bloomberg terminal reveals very little event ownership. That would explain why FUN has moved on a fundamental basis (as opposed to being event-driven) when the merger broke. Clearly, people side more with Q’s view of the company’s future than they do with FUN’s own assessment. But what that doesn’t explain is why, when the shareholder vote was largely up in the air, the spread widened. Perhaps we’ll never know, but at least we were not short. To “Chinese” a deal (put on the trade in the opposite manner, i.e. shorting a cash deal instead of going long the target) is often very risky, and we stress capital preservation.

To tie-off thoughts on FUN, the timing of the shareholder rights plan is interesting. It’s very likely that, regardless of the higher current share price, FUN does not want to have a shareholder with more of a say than what Q currently has. Those with egg on their faces include management and FUN’s financial advisors, who recommended a deal which was summarily rejected by shareholders.

For COMS, we stressed the uncertainty and lack of transparency involved with China’s Ministry of Commerce. We said that that the acquisition by Hewlett-Packard should gain approval on pure antirust grounds, but noted that the China discount was a threat. On April 7, COMS announced that China, the remaining regulatory approval needed, cleared the transaction. The merger is scheduled to close on April 12. For those playing in risk arb, it will be bittersweet to watch this name disappear. We wish we could provide more color on the reasoning for approval, but again, given the black hole of information that is the People’s Republic, any explication would be a conjecture on our part.

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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.

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Sunday, April 4, 2010

Merger Arbitrage: Takeover Defenses

Not all acquisitions are negotiated in a friendly manner. Companies often become targets when they are weak, be it a depressed share price, or a troubling business environment. Management is always reluctant to relinquish control during these times. We all want to leave while on top, right? When a company receives an unsolicited takeover offer, it has several possible defense mechanisms. Defensive by-law provisions are designed to create structural impediments for acquirers, thereby allowing the incumbents to maintain control. We will highlight various takeover defenses companies use to thwart interested parties.

If a hostile offer is rejected by a target company’s board, the bidder will often seek to replace said board with its own nominees. To do this, the bidder will have to gain majority representation and vote to accept the proposal. To prevent this, the target can adopt a classified board, also called a staggered board. Assume a board is composed of nine directors, each serving three year terms. Further imagine that a takeover proposal is initially rejected in unanimous fashion (maybe the valuation is unacceptable, or perhaps the board is replete with friends of the CEO who don’t want to see their buddy out of a job when the new sheriff arrives). In a standard board, the bidder can elect its nominees, and if the sufficient number of shareholder votes is secured, then board control is realized. In a staggered board, a nine-member board will likely have three directors up for election each year. So, to gain control, it will take a minimum of two shareholder votes (often annual meetings) to hold the required number of board votes. This can be a lengthy and expensive process. What can also happen is that the target’s share price can drift to the offer price on a fundamental basis, which diminishes the bidder’s argument that it is offering a substantial premium.

Another tool commonly used is the shareholder rights plan, which is also called a poison pill. Recall that Carl Icahn is seeking legal proceedings to remove Lions Gate’s poison pill. The idea of a rights plan is that the board adopts a threshold above which the people who do not cross are allowed to purchase shares at a discount to dilute the triggering party. The longer-term trend shows that poison pills have been on the decline. In 2001, 60% of S&P 500 companies had pills in place, sharply higher than the 21% in 2009.

Let’s look at an example of how a pill has a dilutive effect. A company with a $10 stable stock price has a shareholder rights plan with a 20% threshold and a $40 exercise price. An investor hits the 20% mark, thereby triggering the “flip-in” feature of the plan. Each shareholder, except the triggering party, has the right to buy eight shares for $5 each (the right is to buy, for the exercise price, the number of shares equal to the exercise price divided by 50% of the 30-day average price). Let’s say there are 100 shares total, so the non-triggering parties own 80 shares, and have the right to buy 640 shares for $3,200. The triggering party would see his or her position go from 20% of a $1,000 company, a $200 interest, to owning 2.7% of a company worth $4,200, a $113 interest. The math goes from 20/100 to 20/740. This is assuming maximum dilution, and that each non-triggering shareholder exercises all the available rights.

The vast majority of companies are incorporated in Delaware. Since a board of directors must approve a merger, Delaware has the “just say no” defense, meaning that the board can reject an offer indefinitely. The remedy to this is to replace the board, and the aforementioned staggered board can prolong this process. Of course, if a compelling enough offer is continually ignored, then the directors will ensure their own ouster.

These are strategies that merger arbitrage investors keep in mind in unfriendly transactions. They will undoubtedly come up in future situations we will analyze

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Monday, March 15, 2010

Merger Arbitrage: Novell (NOVL)

As an arbitrageur, I’m often asked what companies I expect to be taken over soon. Most people do not realize that this is not what arbs do. It’s the job of bankers and the corporate development folk to determine which companies to buy. Arbs evaluate and take positions in situations that have already been announced, whether friendly or hostile. Friendly transactions are simpler to handle, since the terms, conditions, and timeline are all known. Unsolicited offers are a bit more complex. Let’s walk through a current example merger arbitrage example of the latter.

On March 2, Elliott Associates (a hedge fund concern with a smattering of private equity totaling over $16 billion in AUM) proposed to acquire Novell Inc (NOVL) for $5.75/share, 21% above its last closing price. Elliott currently holds 8.5% of NOVL. The proposal is subject to confirmatory due diligence, and obtaining financing is not a condition to deal completion. Elliott noted that they “intend to work with financing sources”, so it would be no surprise that, in its response, NOVL says that the lack of committed financing makes the proposal highly conditional. Elliott noted that NOVL’s cash balance represents almost 60% of its market cap, though a significant portion of that cash is overseas, and may not be realized in a tax-efficient manner.

The offer price values NOVL at 1.24x its 2010 consensus revenue. We need to determine if this is a fair price, so let’s first look to NOVL’s closest comps. They appear to be trading at a multiple of 1.55x. Admittedly, there is no perfect comp, but, all things equal, an agreement is unlikely to be reached at a 25% valuation discount to its peers. For a transaction multiple, Elliott tried to acquire Epicor Software Corp (EPIC) back in October 2008 for 1.5x forward revenues estimate. The EPIC valuation is on the low end, as other deals in the space have been executed as high as 6x.

An important aspect of any transaction, specifically in an unsolicited situation, is the bidder. How credible are they? How is their access to financing? Have they done deals in the past? Now, Elliott is a firm I respect. Paul Singer has been in the business for over three decades, first as an attorney for Donaldson Lufkin & Jenrette, and then founding Elliott as a convertible arbitrage shop. The firm eventually branched into the multi-strategy fund that it is today. Looking at the NOVL press release, Elliott’s history immediately came to mind.

Elliott made an offer to acquire EPIC in late 2008 for $9.50/share, a 20% premium to the prior closing price, and said that it would potentially offer a higher price if allowed access to due diligence. At the time of the proposal, Elliott owned 10% of EPIC, and increased its holdings to 12% two weeks later. After no negotiations with EPIC management, Elliott commenced a tender offer, which EPIC recommended that shareholders reject. A month after the proposal, the offer was lowered to $7.50/share, as Elliott stated that it was not granted due diligence. Elliott terminated the tender offer in late November, citing the recommendation from EPIC’s management that shareholders reject the offer.

Two things are key in the EPIC offer, and deciding which one to weigh more heavily could justify how one views the offer for NOVL. First, this is late 2008. Lehman had already failed, and all markets were in a tailspin. It’s very easy to believe that Elliott saw the environment as an inopportune time to pursue EPIC, and therefore it did not put up any fight to management’s rejection. The second route is to take Elliott literally, and believe that the any exogenous influence (the market) was not outcome determinative. This implies that Elliott merely did not want to continue without management support, and without such, it discontinued the offer. However, I’m more of a believer in the former theory. Elliott initially stated that its $9.50/share offer could be increased if due diligence merits a higher price. So, Elliott saw at least $9.50/share of value just from public information. To this, I ask, why did they lower the offer to $7.50/share after they were not granted the access? What information changed to warrant a material decrease in the offer price? Did they really expect any shareholders to tender to the lower offer? I would argue no, and that the overall markets were really a factor. Therefore, this makes me skeptical of Elliott’s stated intentions. Why didn’t they just cite the deteriorating condition of the financial markets, as companies have done in the past?

It is from this thinking that I question the commitment Elliott has to taking NOVL private. Remember, Elliott has an 8.5% position, so it could be drumming up interest from another bidder. Putting the firm in play could be its true intention. Indeed, NOVL’s under-utilized assets and bloated compensation structure could be remedied by a strategic acquirer.

I’m still on the sidelines with this risk arb transaction, but it is something to watch closely.

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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.

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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”.

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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.

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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.

Terms

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.

MAC/MAE

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.

Covenants

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.

Termination

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.

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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.

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Monday, January 18, 2010

Merger Arbitrage Example #1

For our first merger arbitrage example, we look at BRK's acquition of BNI. Berkshire Hathaway Inc (BRK/A) announced on November 3, 2009 a definitive agreement to acquire the 77.4% of Burlington Northern Santa Fe Corp (BNI) not already owned by BRK for $100/share in cash and stock. The deal price represented a 32% premium to BNI’s November 2nd closing price. The expected closing of the merger is in the first quarter of 2010. We will analyze various aspects of this transaction, including the offer structure, valuation, and the regulatory process.

The Burlington deal certainly answered the questions of what Berkshire Chairman and CEO, Warren Buffett, plans to do with the company’s $23.8 billion cash balance (as of September 30, 2009). The $44 billion transaction value makes BNI Buffett’s largest acquisition. It also provided a glimpse of how Buffett is seeing things, as he is an investor who is widely followed, and indeed, worthy of respect and emulation. Buffett called this deal “an all-in wager on the economic future of the United States”. Moreover, the merger, which Buffett deemed “a huge bet…on the railroad industry” caused Burlington peers Union Pacific Corp (UNP), CSX Corp (CSX), and Norfolk Southern Corp (NSC) to gain an average of 6.8% on November 3rd.

Let’s assume that it is November 2nd and we get into the office hearing the merger announcement. What is the first thing we do? First, we have to spend time to dissect the merger announcement. Risk arb is about being meticulous, or as Schoenberg, the composer, once said “the only way that does not lead to Rome is the middle way.”

The first read of the announcement reveals that we will have to deal with prorationing and a collar structure (we will deal with them in-depth in a later post). The agreement provides that each BNI share will elect either $100/share in cash or a variable amount of Berkshire Class A or Class B common stock, subject to proration if the elections do not equal 60% cash and 40% stock. Proration is required because investors generally prefer cash, and this limits the amount of cash that Berkshire has to pay out. The stock element is accompanied by a collar, whereby the price of Berkshire stock determines the number of shares payable to Burlington stockholders. There are different types of collars but for this transaction, the value of each Berkshire share received is fixed at $100 if the price of BRK/A at closing is between $80,000 and $125,000/share (BRK/A was $98,750/share at announcement). The ratio will be fixed at 0.001253489 shares of BRK/A per BNI share for values below the collar range, and 0.000802233 shares of BRK/A per BNI share for values above the collar range. While the majority of the shares issued will be Class A, for the holders of smaller amounts of BNI who elect the stock payout, Class B shares will be needed. To facilitate this, Berkshire’s board approved a 50-for-1 split for its Class B stock. This split is subject to shareholder approval (we already know that the stockholder vote will take place on January 20th).

So once we know the transaction structure, we can take a closer look at the risks related to the transaction. From the date of announcement our brain focuses on one single question: what could derail the deal from closing? We have to look for every single risk element, even if some of them may seem irrelevant now. Never forget that something irrelevant now could become decisive at a later stage (especially if the deal takes several months to close).

The first step will be valuation. The Burlington deal was announced pre-open, so we need to have an idea of where the price will open. If the deal undervalues the target, the stock price could trade above the deal price (there could be counter bidders, or stockholder opposition to the deal). If the deal overvalues the target, then the bidders’ stockholders could oppose the deal, or the spread could simply be too tight to enter. For the Burlington deal, $100/share values BNI at about 8.4x consensus 2010 EBITDA. This multiple is above the average 6.9x where the aforementioned comps (UNP, CSX, and NSC) are trading. Another metric to consider is the multiple at which previous deals in the space were reached, and in this case, the prior Railroad deals analyzed were done at an average of 10.0x (not an alarmingly large discrepancy considering current market conditions). Additionally, the 32% premium to the November 2nd close for BNI’s share price is in-line with the premiums for previous Railroad deals. In short, the valuation is fair, and BNI should not trade through (with a negative spread), nor should it have an inordinately large spread. The transaction requires approval from two-thirds of BNI’s shareholders (other than the share held by Berkshire). So given our valuation analysis, we conclude that the stockholder vote is unlikely to be an issue (who would vote against Buffett?).

The second step in risk localization is regulatory approvals. A merger typically has to be approved by regulatory authorities. The most obvious regulatory authority is US antitrust (Federal Trade Commission and Antitrust Division of the Department of Justice). The Hart Scott Rodino Act is very important, and deals often trade based on the perception of how well/poorly the HSR review is going (we will look at them in more detail in a later posting). Having read the announcement, we know that the transaction requires antitrust clearance under HSR, and approval by the Federal Communications Commission (FCC). This deal poses little antirust risk, since BRK is not a prominent railroad operator. No wonder that BRK received HSR clearance quickly, on December 4th. The FCC is usually an important regulatory authority for telecom-related deals, however, we assign a low probability to FCC related issues here, given that the only reason the deal requires FCC approval is that trains use radios to communicate with the communications center. The deal has since received FCC approval. So, provided the low antitrust risk, we determine that the estimated first quarter closing is manageable.

Our analysis for the merger announcement day is more or less complete. We have done the job that was necessary to decide whether we want to enter the trade. The Burlington – Berkshire deal is a fairly safe transaction for merger arbitrageurs. The buyer is legitimate, the strategic rationale makes sense, there is no regulatory concern, and financing is not an issue. The market opens and although the spread is tight, we like the deal. In the meantime we wait for the next step in our risk localization process: the publication of the Merger Agreement. The current spread is 0.9%, which represents a 7.6% annualized return, assuming an early March deal closing. Now, 7.6% a year is hardly the most attractive opportunity for capital allocation, but due to its safety, it is position in many arbitrage portfolios (and let’s not forget about the current low interest rate environment). We will some cover higher risk, higher return situations in the future.

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About the Authors

Hunter is the founder of the Distressed Debt Investing Blog and the Distressed Debt Investors Club. He has worked on the buy side for the past 7 years in high yield and distressed debt investing.

Edward has been a professional investor for four years, focusing mainly on the event-driven space. His investment philosophy is value-based, and he spends the majority of his time identifying near-term catalyst based opportunities.

Email

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