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For those that have noticed my Twitter updates, a merger that I have been looking into is Emageon (EMAG).  The spread at the closing date of Jan 16,2009 was 47% with a closing deadline of Feb 11, 2009. This leaves us 3 weeks to work with if the deal is sealed in time.

Basics Of The Merger

• Deal first announced on Oct 13, 2008 and worth $62m
• If the deal goes through, each share of EMAG will be converted to $2.85 cash
• Shareholder approval obtained and no other approvals required
• Financing is being handled by Stanford International Bank Limited(SIBL)
• Financing was cancelled at first on Dec 23 followed by a decision to continue.
• All debt buyout by Health Systems Solutions (HSS)
• SIBL holds over 20% ownership of HSS

Termination Details

The merger is at a stage where it is too late for the buyer to try and terminate the deal, however, the deal is not bound by any harsh conditions. The merger can be cancelled quite easily with neither party having to pay a termination fee on a mutual written consent. There are some conditions where EMAG will have to pay $3m if HSS cancels due to EMAG breaching the following rules:

• our Board withdraws, modifies or qualifies, or publicly proposes to withdraw, modify or qualify, in a manner adverse to HSS and Merger Sub, our Board’s recommendation to our stockholders that they adopt the merger agreement;
• our Board approves, recommends or endorses, or proposes publicly to recommend or endorse, any takeover proposal other than the merger;
• our Board enters into any letter of intent or similar document or any contract accepting any takeover proposal;
• we fail to include in this proxy statement the recommendation of our Board of Directors that our stockholders vote “FOR” adoption of the merger agreement; or
• we intentionally and knowingly materially breach any of our non-solicitation and related obligations with respect to acquisition proposals;

These are basic merger agreements so we don’t have to worry about EMAG having to pay $3m for breaking these conditions.

After the merger announcement on Oct 21, 2008, HSS deposited $5m into Escrow and recently deposited another $4m after SIBL came back right after refusing to finance the deal. If the deal is now not completed by the new extended date of Feb 21, 2009, EMGA is entitled to receive the $9m in the Escrow account.

Approvals

Under the merger agreement, we agreed with HSS to make, if applicable, all appropriate filings with the United States Federal Trade Commission and the Antitrust Division of the United States Department of Justice, under the HSR Act, and all appropriate filings under foreign competition or merger control laws. However, other than the filing of a certificate of merger with the Secretary of State of the State of Delaware in order to effect the merger, we do not believe that any regulatory filings or applications, including under the HSR Act, are required to be made in respect of the consummation of the merger

Nothing to worry about on the approval side. Shareholders have approved the deal so there are no further regulations holding the deal back.

Risks

The important thing to note is that a 50% spread does not refer to the chance of a deal being abandoned. Let me digress for a moment.

The spread points more towards the number of scared and uncertain people. E.g. on Thursday Jan 15, 2009, PSD, which I’ve covered numerous times, fell to $26.50 the day before the closing date announcement. PSD jumped to $29.60 the following day. Mergers are driven more by fear and uncertainty than evidence. Did you know that too many Wall Street and big players do not read the SEC filings? So how does the market know everything? It doesn’t. Now back to the topic.

The biggest risk to this deal is whether financing will hold but there are signs that it will. After the shocking news that SIBL decided to refuse financing, the press release from both parties expressed that they are still determined to go through with the deal and seeking other options if necessary. Shortly after HSS deposited another $4m into the Escrow account. Seeing as how HSS is funding 100% of the deal through debt to SIBL, HSS must have sold more convertible debentures to SIBL. In other words, SIBL financed a further $4m right after a refusal to finance.

This brings me to some questioning points;

1. SIBL is completely crazy to finance another $4m (total $9m) if they don’t plan on going ahead with the merger
2. It was an act of faith by SIBL and HSS to ensure the markets that they are committed
3. The only reason SIBL made that annoucement in Dec was to try and extend the merger date to make certain they could meet the deadline or
4. SIBL had tax, year end or quarterly numbers they had to meet and made up a bogus annoucement

However, the December report from SIBL (pdf link), reaffirms its investors that “although our earnings will not meet expectations in 2008, Stanford International Bank Ltd. is strong, safe and fiscally sound.”

I’ll leave it up to you to come up with your own conclusion, but I am leaning towards 3 and 4.

Also, we have to consider whether EMAG is the type of company that is worth holding if the deal fails. PSD was an easy one because it had a long history, electricity is a necessity and they also offer a nice dividend. EMAG has none of these qualities. Considering their short history, high cash burn rate and regular dilution of shares, EMAG is not a company I would like to hold in any normal situation other than a buyout.

Completion Checklist

1. Due diligence by both parties – Yes. Both have clearly stated so.
   
2. Financing and regulator approval – Yes. SIBL has recommitted and further financed an additional $4m
   
3. Get preliminary shareholder sentiment (or controlling shareholder approval) – N/A
4. Obtain regulator (SEC, FCC, any and all) approval – N/A
5. Get final shareholder approval at a meeting called for that purpose – Yes
6. Insiders continually vesting or buying shares – No. Accipiter Capital Management is the only big buyer in Dec. Insiders have not been buying but they have not been selling or exercising their options.

Odds of the Merger

Current Price: $1.94

Upside Potential: 47% / $2.85

Downside Potential: 47% / $1.02

Probability of Success: conservative: >60% | realistic: > 75%

Probability of Failure: conservative: < 40% | realistic: > 25%

Time Frame: min: 3 weeks | max: 11 weeks (3 months) until March 31,2009.

Additional Remarks

The interesting thing with this deal is that EMAG has $19.5m in cash, will receive $9m if the merger fails for a total of $28.5m which equates to $1.33 of cash per share. If the deal fails and EMAG falls to $1 again, we are entering another type of special situation where the company will be trading for less than its cash value.

With a potential $1.33 of cash per share, is EMAG worth $0.61 if we are to buy at the current price of $1.94? As I stated above in the risks, I am not sure how much the company is worth.

The odds are very enticing, but my failure probabilities and the quality of the company makes it difficult to make it a big position if I do decide to buy.

Disclosure

No positions at time of writing.

[tags] arbitrage,Special Situation,merger,emag,hss[/tags]

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Be Highly Selective With Merger Arbitrage

My assumption is that successful merger arbitrages will be hard to come by in 2009. Quite simply because banks are unwilling to finance deals, companies are less willing to use their own cash and takeover prices will be reassessed and most obviously, there is too much uncertainty..

Take a look at PSD and the 10% spread remaining. The risk of the deal failing is minuscule. Odds of 9-1 in my favor, yet the market is scared of something.

So this IS the good news. These conditions have widened the spreads of arbitrages starting September of 2008. Since I visit a list of pending mergers in the US regularly, I’ve definitely noticed the list getting shorter.

The following is a list of pending mergers as of Jan 8, 2009 courtesy of Merger Investing.

The spreads have closed on many of them since 2008 but there are some where the spread seems to be due to an overreaction.

One merger I started looking into today was EMAG. There is a 45% spread and most would immediately believe the deal to fail, but some other details and the contrarian in me tells me that this is an interesting play.

ROH is another potential deal and we know that Dow Chemical wants the merger. With a 30% spread, the recent pull out by Kuwait could actually have been a good thing IF the price is not lowered.

Disclosure

I hold PSD at time of writing.