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Puget Energy Merger Approved and Review

December 31st, 2008 by Jae Jun

The Puget Energy merger has finally been approved on December 30, 2008. After more than 1 year since I first got wind of this deal, the entire deal is expected to close in 2 weeks for $30 cash. Surprisingly, PSD is still trading at a discount to its final closing price. It is currently at $27.50. This still leaves room for a 9% gain with all uncertainty eliminated..

In my last post on PSD, let’s take a step back and review what happened, how I went about doing things, what went right and what went wrong.

Due Diligence

Here is a list of what was involved in my due diligence of PSD. A reference for new readers and future mergers.

A. Before purchasing any shares the important thing is that the conditions and state of the merger satisfies the following checklist. Also see this post to get started if interested in mergers.

  1. Due diligence by all 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

B. Throughout the past 3 months of following the deal closely, I have been keeping up to date with all filings submitted by PSD to the SEC via RSS.

C. Read each annual report and quarterly report since the merger announcement to see whether there were any changes in the verbiage. Also read the proxy and other documents to understand the structure of the deal. This was a cash deal so it was straightforward.

D. I also spoke directly with investor relations of PSD and got the impression that she was not worried about the deal at all.

E. Documented my reasoning and thoughts so that I had something to refer back to and remind myself if the price went down and I started getting emotional.

F. Went to the Washington UTC website and quickly browsed and read the concluding statements of the filing documents of involved parties. This part was what helped me drown out noise, stay focused and to draw up conclusions and scenarios.

G. Assign odds to the merger. If you don’t know what the odds of winning are, don’t even consider playing.

What Went Right

I must say that I was lucky with this deal. Lucky because utility merger approvals are very unpredictable with lots of opposition, lucky because Washington State has a history or killing deals at the last minute, lucky because the markets ignored the facts and depressed the prices heavily in our favor.

It was also a good thing that this deal was in my backyard and I had knowledge of the geography and makeup of the state and its affairs. Had PSD been in another state, my level of uncertainty would have been much higher. So if a merger is announced in your home state, always be sure to keep your eye on it. This is where you have home court advantage and something Wall Street will never know.

Wall Street not knowing = fear and uncertainty in the markets = good chance to pick up deals.

Add to that the buyer being an Australian company I was familiar with and it made the perfect arbitrage for me in 2008.

What Went Wrong

I had originally assumed the merger would take a week or so to close but I was completely off on this part. It ended up being 2 1/2 months. Although the upside gain more than compensated for the time, the period in which cash was held up was far too long and led me to miss out on better buying opportunities of SCHN (up 100%) and HANS (up 40%) which I had on my watch list.

What I will do differently next time is to think about the min and max time frame for completion just as we think about the min and max value of a company.

Asset Allocation

Back in September I had bought shares and just after the crash I sold it all while still ahead because I wanted to buy something else that got hammered.

Eventually the price went lower to its pre merger levels and I bought again, more this time. A couple weeks later, it went down to 10% below my purchase price on no news and I could sense people and some readers getting nervous. I doubled down at this point by selling my worst ideas. I didn’t want to make the same mistake I made with the Aquila merger by not investing enough to leave a decent profit after fees and taxes.

Puget Energy Coverage Closed at Old School Value

I am glad to say that on the last trading day of 2008, the announcement has lifted my sagging portfolio to a reasonable finish. The arbitrage helped keep my portfolio steady during the wild volatility as well as adding a nice return to my performance without having to speculate.

With 2009 expected to be worse than what we are going through now, I expect mergers to slow down further and fail more often. My decision to be involved in one merger at a time and focus on details has turned out to be safe and I will stick to this in the future.

Disclosure

I own shares of PSD at time of writing

[tags]PSD, special situation, mergers, arbitrage[/tags]

Tags: arbitrage, merger, psd, Special Situation
Posted in Featured, Special_Situation | 24 Comments »

Puget Energy Merger Delayed

December 12th, 2008 by Jae Jun

It has been announced that the PSD merger will not close by the end of the year. The merger agreement requires closing the deal 15 business days after all requirements have been met, including approval by the Utilities and Transportation Commission. Today being the 12th and not expecting an announcement this week, we run out of days in December for it to work out.

A New Question Regarding The Merger

On hearing the news, a slight concern related to financing came to my mind. What happens to the capital if the financing condition is based on a closure date of 2008. Would the money still be available in 2009?

After reviewing the Proxy statement, it does not reveal anything related to deadlines or timeframes for financing. I’ll consider this as the capital still being available in 2009.

Scanning through the proxy also served as a reminder to check on the banks (Barclays and Dresdner) providing the debt financing. (No comments on this yet.)

Going deeper into search led me to think about the ownership and how the Macquarie people were involved.

Ownership Interest

The latest 13D statement from Oct 2, 2008 shows the ownership of the Macquarie shareholders. Additionally, the notes bring up some interesting information, but first, the ownership is as follows:

  • Macquarie Infrastructure Partners A, L.P. – 1.3%
  • Macquarie Infrastructure Partners International, L.P – 1.4%
  • Macquarie Infrastructure Partners Canada, L.P. – 0.3%
  • Macquarie FSS Infrastructure Trust – 0.4%
  • Macquarie Asset Finance Limited – 1.5%

In total, Macquarie holds 4.9%. This is not a huge amount but it does show that the buyer is serious.

Regarding the notes, there is a section which states;

“On October 2, 2008, Padua MG Holdings (PMGH) transferred all of the shares of Common Stock that it held to Macquarie Asset Finance Limited (MAFL). As a result of the transfer, PMGH no longer holds any shares of Common Stock……

Macquarie Capital Group Limited (MCGL) is the operating company for Macquarie Group Limited (MGL) non-banking operations. MCGL often invests alongside Macquarie Group managed funds in investments similar to the acquisition of Puget in an underwriting capacity. This is the case for the Merger, and MCGL expects to sell down either the shares of PMGH or PMGH’s minority position to other Macquarie Group-managed funds prior to financial close of the Merger or shortly thereafter.”

It seems like the price drop starting Oct 2 may have been part of Macquarie’s process of acquiring shares from other holders. It’s also exactly at this time the market started going nuts. So all of this, being part of the process, was probably overshadowed by mad Mr Market. Talk about timing.

Odds of the Merger

Time for a numbers update. Here are the figures I am now applying considering all the information I’ve laid out here and in previous posts.

Upside Potential: 23%: $24.41 -> $30

Downside Potential: 20%: $24.41 -> $20

Probability of Success: 80% (probability decreased due to my financing worries)

Probability of Failure: 20%

Time Frame: 1 week,  >1week but <1 month,  1 month

It’s also important to note that the upside and downside percentages are inversely correlated. If the price goes up, the upside decreases and downside increases and vice versa.

Other Points

From my previous posts, it’s very clear that the Public Counsel is trying to delay the merger. As I don’t understand the way business works at the UTC I have no way of answering why they can’t just ignore the Public Counsel and get on with the job. Maybe it’s part of the Public Counsel’s job description to oppose everything. Who knows..? So from today on, I’ll probably deduct the influence the Public Counsel may have in preventing the merger.

A reader asked me what other situations I have been looking into. My arbitrage strategy is to focus on one at a time so that I have a understanding of the whole picture rather than knowing bits and pieces and filling in the blanks with my own assumptions. There is so much uncertainty to a deal that missing vital clues could be disastrous. This is a risk of why arbitrage isn’t for those that don’t have the time to try and find everything.

Disclosure

Long PSD at time of writing.

[tags]arbitrage, merger, psd, puget sound, Special Situations[/tags]

Tags: arbitrage, merger, psd, puget sound, Special Situations
Posted in Featured, Special_Situation | 2 Comments »

Puget Energy: Price Drop On No News

November 29th, 2008 by Jae Jun

Lately the price of PSD has dropped as much as 10%. If this was a regular market, that could mean something, but we are not in a regular market – it’s still driven by fear and emotions.

The status of the merger has not changed one bit from my last post. There have been no new publicly announced press releases, but some interesting filings with the Washington Utility and Transportation Commission (WUTC) may be of interest.

Recall that I wrote about how the final reply briefs had to be submitted by October 23,2008. Well, there were plenty of submissions and responses. I’ll provide a brief look at what’s been going on.

To read all posts related to PSD, click here.

Filings On October 23, 2008

Conclusion of the reply briefs submitted by PSD

  • The members of Puget Holdings have demonstrated a long-term commitment to
    PSE and its customers.
  • Puget Holdings’ commitment to PSE goes beyond financial support.
  • Puget Holdings has worked closely with other stakeholders in this process and has earned the support of almost all parties to this proceeding.
  • Only Public Counsel fails to recognize the benefits of the Proposed Transaction.
  • The supporting parties have divergent interests and goals, yet they have acknowledged that the Proposed
    Transaction is in the public interest, and they have supported the Multiparty Settlement Stipulation.

Conclusion of the reply briefs submitted on behalf of Commission Staff from Donald T. Trotter

  • Proposed transaction meets the Commission’s “no harm” standard
  • Commission should grant the Application according to the terms and conditions int he Settlement Stipulation
  • Commission should reject Public Counsel’s opposition to the transaction

Filings On October 24, 2008

Conclusion of the reply briefs submitted by the Public Counsel

  • Requests the Commission find the proposed transaction as described in the Settlement Stipulation is not in the public interest

Filings On October 28, 2008

Conclusion of Commission Staff Motion to Strike Portions of Public Counsel Reply Brief from Donald T. Trotter

  • The Commission Staff requests that several paragraphs from the Public Counsel’s reply brief be striked out
  • Public Counsel reply brief seeks to include additional information which should not be considered as it does not comply with the proceedings

Conclusion of Puget Holdings Motion to Strike Portions of Public Counsel Reply Brief

  • Much the same as the Commission Staff’s motion to strike. The Public Counsel only seeks to delay the proceedings

Filings On October 31, 2008

Conclusion of response from Public Counsel Opposition to Motions to Strike Portions

  • Citing late-breaking news in a brief is not ordinary procedure, for good reason. This is not an ordinary situation, however, and the rules provide the Commission the discretion and flexibility to address it.
  • Joint Applicants and Staff unreasonably ask the Commission to disregard developments that have occurred since the filing of the initial briefs, as they initially sought to do with events between the hearing and the initial briefs. Their position has been that the record should remain as it was at the end of August. Public Counsel does not agree that the Commission should operate in such a vacuum.

Filings On November 5, 2008

Conclusion of Granting Motions to Strike by the Commission

  • The Commission already has reopened the record once at Public Counsel’s request to allow him to introduce materials similar for the most part to what he seeks to introduce here.
  • The material he introduced then was of marginal relevance and cumulative to evidence already in the record which illustrates that financial markets in the U.S. and worldwide currently are volatile.
  • There is nothing compelling about what Public Counsel seeks to introduce.
  • Contrary to Public Counsel’s suggestion, the Commission is not “operating in a vacuum” in this regard, but is fully aware of current events.
  • The Commission grants Staff’s and Joints Applicants’ respective motions to strike.

Filings On November 11, 2008

Denying Public Counsel’s Motion Challenging Confidentiality

This filing is in response to the Public Counsel’s challenge to the Commission that it did not abide by the confidentiality codes.

  • Considering this, and the fact that Public Counsel challenges the confidential designation of all of the information highlighted in Mr. Hill’s testimony, we find Public Counsel’s motion deficient on its face.
  • THE COMMISSION DENIES the “(Corrected) Public Counsel Motion Challenging the Confidentiality of Certain Materials Provided in Discovery by Joint Applicants.”

Conclusion

It’s evident that the Public Counsel’s purpose is to delay the merger. They have been unable to provide any real argument and all their challenges have been met with denials.

All parties affected by the merger have agreed that the merger is in the best interest of the public except the Public Counsel. Even the commission staff has expressed that the merger meets all standards and it should be approved.

The only conclusion I can come up with is that hedge funds are selling their positions as they try to deleverage. Don’t be fooled that the market is efficient in the short term.

My estimated holding period of 1 week was way off. I’ve held PSD shares for 1 month now, but considering a nice gain is still available and the stability it is providing for my portfolio, I don’t mind holding for 1 more month.

Disclosure

I hold shares of PSD at the time of this writing.

The current price looks pretty good to me but I won’t be adding as I’ve already doubled down and am pretty overweight with this one.

[tags]PSD, merger, UTC, arbitrage, Special Situations[/tags]

Tags: arbitrage, merger, psd, Special Situations, utc
Posted in Featured, Special_Situation | 1 Comment »

Profit from Special Situations – Risk Arbitrage

November 12th, 2008 by Jae Jun

In part five of the series on special situations, I’ll briefly present the idea of risk (or merger) arbitrage.

This series is based on the book You can be a stock market genius! so for additional information, be sure to read it yourself.

New here? Catch up on the series.

Part 1: Odd Lot Tenders
Part 2: Book review on You can be a stock market genius!
Part 3: Spinoffs
Part 4: A Look at Dr Pepper Snapple

Quick Brush Up

There is no point in buying a stock speculating that the company will be taken over. Risk arbitrage, which I will just refer to as arbitrage, involves the purchase of a stock after the merger announcement.

The book quickly gets to the point and tells the reader to avoid arbitrage because of the high levels of uncertainty involved in the process. However, I would like to add that by waiting and choosing wisely, you will be able to make very good gains off low risk.

The basics and overview can be found in an earlier post here. It covers topics such as why you should consider arbitrage in your investing strategy, the types of homework you should do, what to look for and the risk involved.

Previous Arbitrage

So far, I’ve gone through three arbitrage opportunities in this blog. Aquila, Jazz Technologies and currently Puget Energy. I eeked out a tiny profit with Aquila and documented a vital mistake with this transaction, successfully did not partake in the Jazz merger due to the illiquidity and stock for stock condition, and would like to see the Pugest Energy merger close out soon.

Keep Things Simple

There are also different forms of arbitrage.

  • Cash only transactions where stock is paid for in cash
  • Stock for stock where the shareholders are given stock of the other company
  • Partial stock where a percentage of the share is converted to stock and cash
  • Purchase merger securities (the Greenblatt recommends looking into warrants)

Focus On This Checklist (source: fwallstreet.com)

Before you invest any cash, you should be able answer all the items below.

  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

Risks to Think About

  • Calculate the potential upside and downside vs time. In the PSD merger, I’ve given the chance of success 90% with a gain of around 25% within 1 month. This is excellent odds.
  • Unpredictability: Anything can happen in mergers. Financing can break down at the last minute, the market can go crazy and take everyone with them, earthquakes could ruin the operation of the business  etc etc.
  • Allocate assets accordingly depending on your odds.
  • Taxes will have to be paid because this is a short term strategy. Consider this when you calculate gains.

But most of all, stick to investing in solid companies if you are unsure or feel uneasy with the whole notion.

Disclosure: Long PSD

[tags]arbitrage, special situation, PSD [/tags]

Tags: arbitrage, psd, Special Situation
Posted in Featured, Special_Situation | 15 Comments »

Community Against Puget Energy (PSD) Merger?

November 3rd, 2008 by Jae Jun

Before I begin, let me start by saying that if you are invested in this PSD arbitrage and feel uneasy about the press Puget Energy has been receiving, I encourage you to sell out. You’ll still end up with a profit now and more comfortable nights.

People’s Concerns Over a Local Movement

Over at Seeking Alpha where my post was published, people have been commenting on the local counties wanting to start up their own Public Utility District (PUD) which would provide service at a lower rate than to Puget Sound Energy. I replied to a comment regarding this on the previous post.

Press Related to the PUD

Here is an article from the Seattle Times endorsing the local Public Utility District (PUD) and another by Crosscut and one more from the Whidbey News Times.

These three articles all have one thing in common. They only talk about the possibility of the PUD and what it would bring. No mention of any protests against the merger. What these local people want is lower rates. I would assume most don’t even know the details of the buyout. Classic case of noise interference.

Digging Around

So instead of just sitting around, I did some more digging to see what I could come up with.

On May 6, a UTC press release stated the following

“The commission has received 1,513 public comments to date on the proposed merger – 20 in favor, 48 undecided and 1,445 opposed. The UTC also has received about 2,854 public comments on the rate-hike request – 27 in favor, 73 undecided and 2,754 opposed.”

On September 25, another press release announced the approval of the rate increase.

Then on October 8, it was annouced that electricity rates would decrease by 3% while natural gas bills would increase 5%. This press release also mentioned another opposition from the public.

“The commission received 6,686 public comments on the PSE proposed rate hike – 12 in favor, 6,552 opposed and 122 undecided.”

This brings me to an interesting and vital point. There were over 9000 people opposed to the rate increase compared to the 32 in favor. YET, the rate increase was approved. Why and how? Because it’s in line with market prices and PSD meets the required no-harm standard and PSD have assured the UTC that service will remain just as good. Even Northwest Natural’s gas increase of 19% was approved.

There is also a worry that the company is being bought by foreigners but it will remain locally governed, managed and run.

Concern at the Back of my Mind

The only concern I have is related to the board members of the UTC. The three members that make up the board are appointees of Gov. Christine Gregoire and because she is up for re-election, the board may make a decision to make her look good. If politics gets involved, who knows how this will turn out..

Up till now, this has been my interpretation, but I also want to hear it as it is so I’ve scheduled a call with PSD investor relations today. I’ll share it when I get the chance.

Disclosure: I own PSD at the time of this writing

[tags]PSD, UTC, PSE, merger, arbitrage, special situation, puget sound [/tags]

Tags: arbitrage, merger, psd, puget sound, Special Situation
Posted in Featured, Special_Situation | 1 Comment »

Update: Puget Energy (PSD) Arbitrage

October 17th, 2008 by Jae Jun

I wasn’t planning to write an update on the PSD arbitrage but a reader asked for my opinion on how I currently see the PSD merger so I’ll share it with everyone else and try to provide additional information.

Reminder Points

If the deal is approved, each share of PSD will be converted to $30 cash.

The deal is being financed by a “consortium of long-term infrastructure investors led by Macquarie Infrastructure Partners, the Canada Pension Plan Investment Board and British Columbia Investment Management Corporation and also includes Alberta Investment Management, Macquarie-FSS Infrastructure Trust and Macquarie Capital Group (collectively, the Consortium).”

All approvals have been received and the only process remaining is for reply briefs to be submitted by Oct 23 so that the UTC can review it and make a decision.

Price as of this writing is around $22.40 with a spread of just under 33% with about 1 week remaining which is an annualized profit of 1488%! (since I was wrong about the timeline of 1 week, I cannot give the accurate %)

Along with every other company out there, Puget Energy was thrown out during the market meltdown.

Odds of the Merger

I’m going to do something very similar to what Sivaram from Can Turtles Fly has already done.

Upside Potential: 33%

Downside Potential: 10%

Probability of Success: > 90%

Probability of Failure: <10%

Time Frame: 1 week > 1week but < 1 month

From the odds that I’ve applied to the situation, this could be highly profitable.

Additional Details of the Merger

Back in July 23, PSD filed a multiparty stipulation involving Puget Holdings, Puget Sound Energy, Staff of the Washington Utilities and Transportation Commission, Industrial Customers of Northwest Utilities, Northwest Industrial Gas Users, The Energy Project, NW Energy Coalition, and The Kroger Company. A month later, on August 25, all but one of the issues have been agreed upon.

However, reading the appendix from the exhibits, it is clear to me that this one issue should not prevent or upset the merger. All parties, including the UTC staff, have basically given the Ok for the merger to be approved. Even though PSD has a lot to agree upon in the stipulation, I don’t see anything outrageous.

On Oct 9, a filing made by PSD reveals that capital has been committed and ALL approvals have been obtained. All that remains is a review of the reply briefs if they are submitted by Oct 23. This leaves 1 week for an announcement by the UTC.

Insiders have also been vesting their options without any of them selling of exercising. It’s always important to see how insiders view the merger and interviews and actions of insiders confirm that the merger is a high priority in 2008 and they all want to see it go through.

Risks

At this point, I only see that truly unpredictable occurrences, which the company has no control over, is the only thing that can upset the deal.

Completion Checklist

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

Conclusion

The market being what it is, irrationality has allowed the price to drop from the mid $27 to the mid $22 which is actually below pre-merger announcements. Even if by freak of nature the deal is canceled, the company offers a dividend yield of 4.5%. Not to mention that this is a reliable utility especially in times of a recession.

I don’t believe I’ve ever seen such an advantageous arbitrage opportunity as this one.

Disclosure

Entered into a 1/2 position at $22.50 and looking to add the remaining half between the range of $21.6 – $22.50.

[tags] arbitrage, psd, Special Situation,merger,utc[/tags]

Tags: arbitrage, merger, psd, Special Situation, utc
Posted in Special_Situation | 20 Comments »

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