A Look at Aquila (ILA) Arbitrage


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In continuation from the arbitrage post, here I will give an example of a current pending merger with a price spread of 21% annualised to 178%. With the economy in a recession and things not looking to brighten up anytime soon, studying and practicing anti-recession techniques may be one of the few things that saves you.

Basics of the Merger

The deal was first announced in Feb 2, 2007 so the deal has been ongoing for more than 1 year now. The condition of the deal is that

At the effective time of the Merger, each share of Aquila common stock will convert into the right to receive 0.0856 of a share of Great Plains Energy common stock and a cash payment of $1.80. The exchange ratio is fixed and will not be adjusted to reflect stock price changes prior to the completion of the Merger.

This tells us that the closing price will vary depending on the price of Great Plains Energy at the completion of the deal. With GXP last trading at $24.70 on Mar 19, the closing price for ILA comes out to $3.92. With the current price of ILA being $3.24 here is a potential gain of 21% or 178% annualised. Not a bad return, but only if it plays out without any surprises.

Termination of the Merger

Based on the contractual agreements as outlined in the DEFM14 Proxy form, both parties of the merger can terminate the deal if it has not closed by Feb 6 2008. Obvioiusly, the deal was not completed and so the initial termination date was extended to May 1 but is subject to extension until August 6, 2008. Simply put, if the deal doesn’t close by May 1, the deadline can be extended again or any side of the party can choose to terminate the deal.

With both sides investing heavily into completing this deal, as well as Aquila spending $2.3 million and $16.6 million due to investment banking and legal costs in 2006 & 2007 respectively and $8.8 million in retaining non executive employees, I can’t seem to see a reason why the company would want to cancel the deal.

However, should Aquila or Great Plains Energy decide to terminate the deal, a $45 million termination fee would have to be paid to the other party. Compared to other mergers where the fee is around $15-25 million, this fee is quite a sum of money and one which neither company would want to pay.

Approvals

The deal so far has been slow but steady. All approvals have been obtained except from the Missouri Commission.

Check the proxy statement and you will notice the list of approvals that are required for the merger to complete. From that list, everything seems to be in place and only one approval remains. The Missouri Commission.

Additionally, shareholders from both ends have approved the deal.

Completion Conditions

All approval hurdles are close to being clear but it doesn’t just end there. For this deal to complete, Aquila has to complete an asset sale to Black Hills. Once the deal between Aquila and Great Plains have been finalised, the sale between Aquila and Black Hills must be completed in order for the deal to close. (edit: I really meant the sale to Black Hills must be completed before the deal between Aquila and Great Plains is completed. I meant “finalised” in the sense of receiving all approvals.)

This deal is dependent on all 3 parties which can complicate things because it requires due diligence from all 3 parties. If one side screws up, the other 2 are in danger of falling through as well.

But Now What?

From my previous post, there was a list of 7 points.

  1. Due diligence by both parties;
  2. Agree on a price, terms, and contingencies (financing, regulator approval);
  3. Get preliminary shareholder sentiment (or controlling shareholder approval);
  4. Secure financing arrangements (if needed);
  5. Obtain regulator (SEC, FCC, any and all) approval;
  6. Get final shareholder approval at a meeting called for that purpose;
  7. Complete the deal.

Now the important thing is to check, double check and triple check your data is correct and satisfies the above conditions in order to make as safe a bet as possible.

There is a Risk

There is no such thing as 100% risk free when involved in the market. However, the purpose of any intelligent investing is to find odds with low risk but high return. Just because they are so far into the merger, it seems like the deal will definitely close, but crazy and unexpected things can happen. Arbitrage is for people who either enjoy or are capable of ripping apart and analyzing documents, news and details so do your homework before jumping in. Otherwise that is just gambling.

The risks are also explained in the proxy statement.

What Would I Do + Disclaimer

First of all, I don’t hold any share of ILA and this is just a suggestion for further research. But I am keeping my eye on this for a reason. Because I believe the odds of winning are higher than losing. If the odds of winning are in your favour and if you continue to be disciplined and do the same thing over and over again, probability tells you that you will come out on top. Sure there wil be losers mixed in, but if I’m sure I can win overall, that is my goal.

With my previous workouts, I usually only purchase when all approvals have been obtained. With Missouri being what I deem to the last “big” hurdle, my cash is safe in my pocket for now.

But I would love to hear what you think and would do.

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