Mergers and Acquisitions Arbitrage Activity


The merger arbitrage activity has been slow of late and it is no surprise. I mentioned in January that I expected mergers and acquisitions to slow down as financing became difficult to acquire.

In particular, merger arbitrage opportunities have been scarce ever since the failed EMAG deal with Stanford (my theory anyways) and the spread for other mergers have not been wide enough to offer any real decent returns.

I invest in mergers when it is close to finalized in order to reduce as much risk as possible. Step 5 is usually a good time to invest in a merger if the spread is still decent on an absolute basis after considering fees.

I do not invest after a merger announcement as there are too many variables to consider.

  1. Due diligence by both parties
  2. Financing and regulator approval
  3. Get preliminary shareholder sentiment (or controlling shareholder approval)
  4. Obtain regulator (SEC, FCC, any and all) approval
  5. Get final shareholder approval at a meeting called for that purpose
  6. Insiders continually vesting or buying shares

Pending Merger Acquisition Arbitrage List

Looking at this list, there isn’t much to take advantage of. Disk has far too much risk involved and the company fundamentals are terrible for it to be a standalone company.

Fat Pitch Financials recently tweeted about an initiation of ENPT which does seem to be the best merger at the moment.

As always you can find the latest pending details at MergerInvesting

Symbol Announced Date Closing Value Last Price Closing Date Profit Annualized Profit
DISK 11/20/2008 $2.75 $1.58 4/6/2009 74.05% 0.00%
ACBA 9/10/2008 $5.14 $6.04 4/30/2009 -14.97% -237.58%
FRBK 11/10/2008 $7.12 $7.60 4/30/2009 -6.26% -99.31%
NTMD 1/27/2009 $0.80 $0.75 4/30/2009 6.67% 105.80%
BFBC 11/10/2008 $9.21 $9.68 4/30/2009 -4.86% -77.07%
CVTX 3/12/2009 $20.00 $19.94 4/30/2009 0.30% 4.78%
EQ 10/27/2008 $37.94 $37.38 6/30/2009 1.49% 6.46%
CYCL 11/7/2008 $8.50 $8.32 6/30/2009 2.16% 9.40%
ZICA 2/26/2009 $0.81 $0.77 6/30/2009 4.68% 20.32%
ABNJ 12/15/2008 $7.83 $9.50 6/30/2009 -17.57% -76.35%
PBKS 12/19/2008 $8.07 $7.52 6/30/2009 7.29% 31.67%
AANB 1/2/2009 $2.38 $2.25 6/30/2009 5.87% 25.53%
SWIM 1/8/2009 $8.89 $8.75 6/30/2009 1.58% 6.86%
AVNX 1/27/2009 $28.97 $2.14 6/30/2009 1253.96% 5448.77%
NCX 2/23/2009 $6.00 $5.83 6/30/2009 2.92% 12.67%
GVHR 3/5/2009 $4.00 $4.01 6/30/2009 -0.25% -1.08%
ENPT 3/11/2009 $2.50 $2.05 6/30/2009 21.95% 95.38%
LIMC 4/3/2009 $2.48 $2.25 8/15/2009 10.44% 29.32%
MXGL 3/2/2009 $16.77 $16.48 9/30/2009 1.78% 3.69%
MV 4/1/2009 $25.72 $25.04 9/30/2009 2.71% 5.61%
WYE 1/26/2009 $46.35 $42.48 10/31/2009 9.10% 16.05%
TKTM 2/10/2009 $3.88 $3.81 11/15/2009 1.71% 2.81%
SGP 3/9/2009 $25.63 $23.20 12/31/2009 10.49% 14.28%
FCVA 4/3/2009 $9.25 $8.00 12/31/2009 15.62% 21.27%

Disclosure

No positions held at time of writing

  • Paul

    ENPT does sound interesting. I have been following for a little while. The acquirer – Din Global Corp appears to be the current CEO and members of his family.

    Perhaps the family just wishes to take the company private. I believe they own some 25% or so already. But there I cannot determine how the acquisition will be funded.

    I do own some DISK which although risky – the various bounces have been profitable.

  • Edward

    Besides the constant delays, what is so risky about DISK? It seems as though Nyx is continually putting money into the company in order to keep the merger alive, so I wouldn’t think that they are having second thoughts. Every other step has been met, except for the actual funding, which is probably why Nyx has to keep extending the date.

    At any rate, it is supposed to close in 5 days at double the current price. So I would really like to know why this is considered “risky”.

  • I want to first mention that I put in an order to buy some DISK after reading all that has been happening. For regular readers and others who came across EMAG, this looks and feels similar but what I also learnt was that I can not overweigh or allow past negative experiences to affect my judgment.

    Business wise, I certainly dont like how this company loses so much money in its operations and having to rely on debt to stay alive. The deal extensions doesn’t make it attractive either. The reason for the hold up is financing. However, Nyx has never backed off the deal or mentioned that it’s financier is backing off like they did in EMAG. DISK and Nyx has been very open and transparent to update shareholders which is a good indication that Nyx wants to go through with it. Problem is Nyx is seriously stupid or something. Constantly having troubles depositing even $500,000 and constantly amending the agreement every few days.

    I see the potential downside of around 40-50% on DISK.It will probably end up at $0.80 if it fails but the extra $2.5million (IF they can receive it) will certainly boost the cash value per share. Not saying the quality of the shares will be great, but it will be significantly better than what it is now.

    If Nyx wants to extend the merger again, the new deadline would be May 4 and they will deposit another $3 million. DISK could also potentially collect another $3m, increase its cash by $5m total from fees which will be around $0.25 in cash per share.

    Another reason as to why I am buying DISK now is that it had multiple bidders at the $3 mark. If Nyx fails to complete, there are good chances of other buyers coming in.

    I see this as a 60-40 bet of going through at best. Therefore I have made my bet accordingly. If the deal is successful, my portfolio moves up 3%. If it fails, it goes down 2%.

  • A total summary of what has happened. It really is a joke. http://dealbook.blogs.nytimes.com/2009/04/15/send-in-the-clowns/

  • Paul

    @ Edward – my rule around arbs is when the spread is more than 50% there is usually some element of risk. It implies that there is a lot of money that do not believe that deal is solid. The number of failed attempts to close is also very disconcerning.

    The blog posting is a good read of the events.

    Jae – thanks for your thoughful posting – it more clearly articulates my view on DISK. I did sell out my entire DISK position today as it was spiking. I may go back in again.

    Right now – ENPT seems more appealing to me. And although the spread on NCX is small – it meets my criteria and I’ll probably open a position in NCX.

  • @ Paul
    I just fixed some numbers. I wasn’t sure whether I made sense as I was rushing to write up the comment at work… shame on me…
    But I’ll have to see whether I made a mistake if Nyx fails to release or deposit money again.

    Disclosure: Long DISK.

  • PlanMaestro

    Jae Jun, thanks for your excellent commentary. Up to this point, I wish I had been just a spectator of this circus; instead I have been one of the company clowns. Well, here are my thoughts, including and amateur try to valuate Image Entertainment:

    1. Probability of Closing: This deal is almost a perfect example of Knight’s uncertainty so I won’t dare to throw a guesstimate. It could be anything. However, uncertainty is our friend because it scares momentum players and arbitrageurs. I would say that at this moment most of the big shots are long gone.

    And what weapon do we have small players have against this uncertainty? Klarman’s golden glove to catch falling knives: margin of safety

    2. Margin of Safety: Most people buying DISK do not even know what they are buying. They just see recent sell-offs and use that as a proxy for downside risk.

    Since when we value investors trust Mr. Market? Especially since film libraries are assets that time and again are being underestimated by our bipolar partner. P/E ratios lack accounting of the heavy non-cash depreciation and amortization expenses, And M/B ratios usually undervalue the library because it is not marked to market.

    At the same time the library has some particularly favorable economics:

    – Growth potential across formats and internationally with marginal investments
    – Low maintenance CAPEX
    – Steady royalty cash flows

    In other words, they are the perfect LBO or acquisition target. The only problem is the risky film production. But once you have the rights, no sweat! Buffet likes, or used to like, newspapers. I like film libraries.

    I prefer to use equity free cash flow and in this case, EBITDA is a good proxy for FCF because of the low maintenance CAPEX. And because of the steady cash flow, compared to real estate for example, a multiple of EBITDA is a good estimate of asset value.

    VALUATION Q3 2008

    I used Q3 numbers because the company has changed for good in a hostile financial environment.

    – Expand theatrical distribution rights to higher-profile feature films.
    – Conservative prints and advertising expenditures to cap risk in the event of theatrical failure and greater focus on the rental marketplace
    – Acquire “direct-to-video” content and distribution opportunities from the closing of the independent and specialty divisions of major studios
    – Reduced distribution expenses through agreement with Arvato for replicating, warehousing and fulfilling retail orders

    I did not include working capital in the valuation because it was very volatile quarter to quarter. If someone has insights into that, they are very welcomed

    Earnings from Operation: 2.0 million
    Amortization and Depreciation: 1.8 million
    Interest Expense 0.9 million
    Taxes 0.0 million
    – Other Expenses – 0.8 million (just in case, mainly $561,000 M&A)
    EBITDA 3.9 million per quarter
    15.6 million annually

    4x EBITDA 62.4 million (a low multiple even for industrials)
    – Debt 20.3 million

    Value Standalone 42.1 million
    Market Cap 31 million
    Margin of Safety 27%

    Another way of thinking about this is trying to estimate the rate of return for the un-levered firm. For that I am going to assume a conservative 30% tax rate given they NOL carryforwards.:

    EBITDA 15.6
    After tax free cash flow 10.9
    Enterprise value (Market Cap + Debt) 51.3
    FCF / EV yield 21.2%

    That is right, a wide moat business with an un-levered 21.2% annual rate of return after taxes. And consider that international and digital is less than 4% of current sales, 2.5 M USD in cash from the escrow release, no value added from potentially being acquired player with global distribution, and short term catalyst at twice its current price.

    In my opinion it looks very compelling even if the deal does not close … if it would survive maturities, covenants, capital requirements to finance working capital and a blundering management.

    I am falling asleep. To be continued….

  • Great analysis PlanMaestro. I’ll have to copy this to a new post in order to get more attention and discussions going. But as you said, DISK assets lies in its library. Just like RHIE and LGF. Still need to get a better understanding though.

  • Paul

    It looks like the DISK merger has been terminated.

    http://finance.yahoo.com/news/Image-Entertainment-bw-14964740.html?.v=1

    But based on history – it sounds like QBlack and Image wants to close the deal. Just can’t raise financing. Any opinions on whether there will be another suitor for Image? DISK doesn’t really fit my investing criteria for an arb but I find the merger history so fasinating that I can’t help but continue to follow it. (feels like a night-time soap-opera)

    Disclosure: I have no current position in DISK. But have held positions in past 30 days.

    Other topic – LIMC – The lack of merger activity makes me more curious about all stock mergers. I have only ever invested in all-cash deals. The LIMC merger looks promising. (1) TAT already owns a large percentage of LIMC (2) Stock-deal so no financing issues.

    In an all stock-deal – how much hassle is it to deliver the converted stock to cover the short of the acquirer. I have a regular online brokerage account (Fidelity) and I was planning to call and ask but was wondering about others experience. Or do people prefer to buy puts (if available) on the acquirer instead? Also – are there any issues with shorting-the-box rules if a broker cannot delivery the converted stock to the shorted stock.

    Thanks for any opinions.

  • I guess my impatience got the better of me again. Im holding a small portion of DISK at the moment.

    As for stock deals, I don’t like them period and I haven’t shorted anything before, so I hope someone else here can answer your question.

  • You know, it’s funny you guys were talking about DISK. I got burnt on DISK.

    And then I’m hoping for the ENPT deal to close like it’s supposed to.

    http://buyandholdplus.com/blogweb/index.php?/archives/50-New-Purchase-ENPT.html

  • I didn’t invest much into DISK knowing the risk. My other positions have balanced it out but I’m holding and will see whether another company believes their assets is valuable.

  • Tristan Luckett

    Jae,

    I just started looking at Arb deals again. Anything on your radar?

    Thanks,
    Tristan

  • Hi Tristan,

    I haven’t been looking at mergers lately. There just doesn’t seem to be any really good ones. I’m not interested in gaining 10% over 5-6 months. It just doesn’t make sense.

    The only one that may be worth the effort would probably be ENPT but that one still has over 1 1/2 months remaining.

    With the market moving up, although it’s unclear whether the upward movement can be sustained, arbitrage plays aren’t so profitable. In a flat or down economy, yes. But if the market crashes again, I’m hoping to pick up some great companies I have on my list.

  • Paul

    @Tristin – I like the ENPT and NCX deals.

    With NCX – the spread may not be large but the risk seems low.
    1) shareholder approval
    2) EU antitrust approval
    3) No financing conditions

    I don’t hold a position in ENPT.
    I do hold a position in NCX.

  • @ Paul,

    Thanks for the idea and update Paul.

  • John

    Just a quick note on NCX… I don’t hold a position because of something I heard awhile back that could cause a problem with the merger and could be why the spread is as wide as it is. I never followed up so I would be interested to hear any feedback, but the article that I read mentioned some worry of the formation of a monopoly and that the Canadian gov’t could get involved and strike the deal down because of a nationalistic stance.

    Paul mentions the other conditions that have been satisfied, but I am pretty sure that the deal required some kind of Canadian Government agency ok.

    I am playing ENPT, but small because of some shady dealings that I have read about the Din family. Again, not sure what to believe, as much of this was posted on message boards by less than reputable sources, but I think there is some cause for caution. I am beginning to question the lack of a set date for the shareholder meeting. I hope this is resolved soon. I might be more willing to take a bigger position then.

    Any other opinions would be much appreciated…

  • John

    Sorry for two posts but I got curious after my last one and checked into the NCX deal a bit more. Found this on MSN Money which may answer my question about Canadian approvals:

    The U.S. Federal Trade Commission granted early termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act and the Commissioner of Competition appointed under the Competition Act (Canada) issued a “no-action” letter advising the parties in writing that she does not have grounds on which to initiate proceedings before the Competition Tribunal under the merger provisions of the Competition Act (Canada).

    I may take a position in NCX this week.

  • Thanks for the updates John. I appreciated the research you’ve done and I’m sure others do as well.

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