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

Tuesday, September 30, 2014

How to buy Kinder Morgan at a discount

Back in August, Kinder Morgan Inc (KMI) announced that it was going to simplify its structure by acquiring the limited partner interests in its pipelines. The company expects plenty of benefits, which would enable it to pay close to $2 in annual dividends per share in 2015. After that, the company expects that dividends will grow by about 10%/year for five years.

As a result of the deal, unitholders of Kinder Morgan Energy Partners (KMP) and El Paso Pipeline Partners (EPB) are going to receive shares in Kinder Morgan Inc, as well as some cash consideration. KMP unitholders will receive 2.1931 KMI shares and $10.77 in cash for each KMP unit. EPB unitholders will receive .9451 KMI shares and $4.65 in cash for each EPB unit. Limited partners are receiving some cash, because the act of exchanging their units for Kinder Morgan shares is a taxable event, which could trigger some tax liabilities to the IRS.

The holders of Kinder Morgan Management LLC (KMR) will receive 2.4849 KMI shares for each share of KMR. This will be a tax-free event, because those holders are exchanging one asset type for another.

The deal has to go through some regulatory hurdles, but I doubt it would not finish. The timeline is somewhere by the end of 2014, although in my opinion it might close by the first half of 2015.

Ticker
Price
KMI Shares
Cash
Value of bounty
Spread
Discount
KMP
 $    93.60
2.1931
 $  10.77
 $                   95.27
     0.9825
-1.75%
EPB
 $    40.34
0.9451
 $    4.65
 $                   41.06
     0.9824
-1.76%
KMR
 $    94.50
2.4849

 $                   95.74
     0.9870
-1.30%
KMI at $38.53/share

At the closing prices on Monday, it seems like there is an arbitrage opportunity for investors. It seems that if one believes that the deal in its current form will ultimately be consummated, they could purchase limited interests in KMP, EPB or shares of KMR, and then have those converted into KMI shares when the deal does close. Going forward, I will use the word investor, even though technically, the holders of KMP and EPB units are called limited partners. As a result, those investors will be able to effectively purchase KMI shares at a discount, when all is said and done. You might want to read this article, if you are unsure how each of those tickers differs from each other.

It looks like there is an arbitrage opportunity for those who wish to purchase shares of Kinder Morgan Inc at a slight discount today. If I were to do it, I would go for KMR, since it presents a complete tax-deferral of the arb opportunity. If I went with KMP or EPB, I would have to deal with partnership taxation, and K-1 forms, which scare the hell out of most dividend investors. Or at least the ones that have talked to me over the past seven years.

If I already owned enough Kinder Morgan Inc (KMI) stock in a tax-deferred account, I would simply sell it, and purchase shares of Kinder Morgan Management LLC (KMR). This of course assumes that my position is big enough, so that the commission does not erase the arbitrage opportunity. I would also not do this in a taxable account, because the capital gains taxes will make this arbitrage play not worth it. If you however expect to be in the 10 – 15% bracket for Federal tax purposes, this could mean that your dividends and capital gains will be taxed at zero. State taxes of course could apply however. So here is how it goes: If I had 1000 shares of Kinder Morgan Inc (KMI) in an IRA, I would sell it, and put the proceeds into Kinder Morgan Management LLC (KMR). Whenever the deal is closed, I would end up with approximately 1013 shares of Kinder Morgan Inc.

If I wanted to purchase 100 shares of Kinder Morgan Inc with new money however, I would put the money in Kinder Morgan Management LLC instead, and convert my stake in Kinder Morgan Inc when the deal closes.

The amount of 1.30% might not seem like a lot. However, this line of thinking ignores the basic truth that even a small seed can turn into a mighty oak. In other words, for those who have 1000 shares of Kinder Morgan Inc, the 13 shares could produce a lot of wealth over 40 or 50 years down the road. If you manage to compound those $500 at 10% for 50 years, this could turn into a cool $50,000 that produces $2,000 in annual dividend income at a 4% dividend yield. Those of you who train your minds to search for small, accretive investments, that improve your portfolio outcome, you will do really well over your investment career.

The added bonus in this exercise is that investors who purchase KMR rather than KMI, will likely be eligible for a $1.39 quarterly distribution paid in stock somewhere around November 15, 2014. This would be a tax-deferred dividend reinvestment, which would leave the investor of KMR today with more shares to tender for KMI stock. The tax-deferral of those reinvested distributions is really nice, and could widen the spread and potential accretion effect for those enterprising dividend investors. The yield on KMR is higher than KMI, and the KMR yield is entirely tax-deferred (until you sell KMR). The fact that dividends were automatically reinvested for me with KMR, the fact that distributions didn't cause any tax headaches and the fact that KMR always sold at a discount to KMP, made KMR an ideal investment for me. Unfortunately, once the acquisition closes, I will end up with a lot of Kinder Morgan Inc stock, the dividends of which would be fully taxable under the preferential tax rates for qualified dividend income. Hence, I do not plan on adding new cash to this position for the foreseeable future.

Since I hold most of my Kinder Morgan Inc in a taxable account, and since my dividends and capital gains will likely not be taxed at 0% in the foreseeable future, I would not do this exercise. I also do not plan on adding to any of the Kinder Morgan entities, given the fact that this is my largest position. I present this exercise not to provide you with specific investment advice, but to get you thinking about opportunities to increase wealth. This information is not advice for you to act on. The information I used is believed to be accurate, but could be incomplete. Therefore, please do your own analysis before you make an investment.

Full Disclosure: Long KMI and KMR

Relevant Articles:

Do not despise the days of small beginnings
Kinder Morgan to Merge Partnerships into One Company
Kinder Morgan Limited Partners Could Face Steep Tax Bills
- Kinder Morgan Partners – One Company three ways to invest in it.
Dividends Provide a Tax-Efficient Form of Income


Monday, January 11, 2010

Valuing Dividend Stocks

Few investors these days seem to grasp the idea that stocks represent fractional ownership of real businesses. This is especially difficult to understand as electronic trading has become widespread, and it is now possible to buy and sell stocks and derivatives on these equities within seconds from the comfort of your home. While as a dividend investor I typically look for stocks with a consistent stream of earnings, which translates into a long history of dividend growth, I am always on the lookout to learn something new as well.

While earnings power is essential, it is also important to understand that a business or its assets do have some value, whether as a whole or as a sum of its parts. Most of the times when there is a merger or an acquisition of a company, investors get a price for their holdings from the acquirer. Thus they are able to monetize their partial ownership rights, and their stocks rise in value in the process. Other times the market undervalues companies which hold on for too long to liquid assets, because of the fear that excess cash in the hands of management might not lead to improved financial condition over the long term.

One such company was Magic Software Enterprises Ltd. (MGIC). Magic Software Enterprises Ltd. is an Israeli company which develops, markets, and supports software development and deployment technology and applications. Back in December the company announced that its board of directors has declared a cash dividend in the amount of US$0.50 per share and in the aggregate amount of approximately US$16.0 million. The stock increased in value from $1.87 to $2.23/share after the announcement. The stock is already trading ex-dividend however, which means that investors who purchase the stock today would not be able to receive the special distribution.

At the end of the third quarter of 2009, Magic Software held cash and cash equivalents worth $36.85 million and had total liabilities worth $14.21 million. This was worth approximately 55 cents/share, and that’s without including any of the company’s receivables, fixed assets, intangible assets and the company’s ability to generate future earnings. In addition to that the company has been profitable in 2007 and 2008 and is on schedule to earn money in 2009. What might have triggered the need for special dividend was the sale of the company’s office building for $5.20 million in cash in early December 2009.

At the end of the day it is important to understand that stocks represent fractional ownership of real tangible businesses. An important component of success in investing is also finding the best opportunities at bargain prices as well in addition to diversification and dividend reinvestment. Thus I believe that even if we have another lost decade, there would be plenty of opportunities for investors to make money and for companies to unlock their intrinsic value through dividend raises or special dividends.

Some of the companies which have been able to create consistent value for shareholders over the past few decades include Automatic Data Processing (ADP) and Emerson Electric (EMR). Both stocks currently trade at attractive levels and have well-covered dividends.

Automatic Data Processing, Inc. (ADP) provides technology-based outsourcing solutions to employers, and vehicle retailers and manufacturers. It operates in three segments: Employer Services, Professional Employer Organization Services, and Dealer Services. This dividend aristocrat has raised dividends for 35 years in a row. The stock is trading at 16 times earnings and yields a comfortable 3.20%. The company has a ten year average dividend growth rate of 14.50% per year. Last year ADP raised distributions by only 3%. When the business recovers however, the company would be able to grow distributions in the low double digits. The book value of the assets is $11.23/share.(analysis)

Emerson Electric Co., (EMR) a diversified global technology company, engages in designing and supplying product technology, as well as delivering engineering services and solutions to various industrial, commercial, and consumer markets worldwide. This dividend aristocrat has boosted distributions for 53 consecutive years. The stock is trading at 19 times earnings and yields 3.10%. The company has a ten year average dividend growth rate of 6.50% per year. When the world economy recovers, the company’s diversified business operations should be able to support a dividend growth in the high single digits. The books value of the assets is $11.33/share.(analysis)

Full Disclosure: Long ADP and EMR

Relevant Articles:

- Special Dividends Unlock Hidden Value in Stocks
- Why dividends matter?
- What Dividend Growth Investing is all about?
- 3 dividend increases, more expected in January

Tuesday, July 28, 2009

AT&T/ Centennial Communications Merger Arbitrage Opportunity

Reader Saku tipped me on an interesting merger arbitrage opportunity, which has a large spread for arbitrageurs. In essence, AT&T (T) is acquiring Centennial Communications (CYCL) for $8.50/share, which was announced back in November 2008. The acquisition has been approved by Centennial's stockholders in February 2009 and remains subject to approval by the Department of Justice and Federal Communications Commission and other customary closing conditions. Once the transaction is complete AT&T would sell some assets in Louisiana and Mississippi to Verizon (VZ) for $240 million. If the merger between CYCL and AT&T occurs as planned, the sale of the assets to Verizon would close by 4Q 2009. The deal was expected to enhance AT&T's (T) coverage in Puerto Rico, the US Virgin Islands in addition to the rural Midwest.

Centennial Communications Corp. (Centennial) is a regional wireless and broadband telecommunications service provider serving over 1.1 million wireless customers and approximately 582,200 access line equivalents in markets covering approximately 13 million Net Pops in the United States and Puerto Rico. In the United States, it is a regional wireless service provider in small cities and rural areas in two geographic clusters covering parts of six states in the Midwest and Southeast.

Up until July 13, in 2009 Centennial Communication (CYCL) traded at a small discount of 1% to 5% to the $8.50 offer price. In February 2009, John Paulson showed a 5,000,000-share position in Centennial (CYCL) in his funds 13-F filing with the SEC.
Back on July 8, AT&T announced that it expects to close the deal by the third quarter, because of added regulatory scrutiny. On July 14 however, the stock dropped 9.50% on above average volumes. Currently the stock is trading at $7.38, which is a 13.1% discount to the offer price. What might have been the reasons for this drop?

I found an interesting article from Bloomberg, explaining the reason for the drop: (source)

“Stifel Nicolaus & Co. said the carriers may have to review the terms of the deal. The U.S. Justice Department and the Federal Communications Commission are scrutinizing the transaction. The combined company would control 40 percent of Puerto Rico’s wireless market, which may prompt regulators to force AT&T to divest some assets, Stifel analyst Christopher King said today in an interview. Selling the Puerto Rican wireless business, which accounts for about a third of Centennial’s revenue, may cause AT&T to cut its offer, he said. “We’re clearly in a different antitrust environment,” said King, who is based in Baltimore. “This is certainly the first significant opportunity that the Obama administration will have had in the telecom sector to lay down the law.”
AT&T hasn’t been asked to divest assets in Puerto Rico, said
McCall Butler, a spokeswoman. Steve Kunszabo, director of investor relations for Centennial, didn’t immediately return a call seeking comment.
AT&T, the second-biggest U.S. wireless carrier, and Verizon Communications Inc., its larger rival, swapped assets in May to appease concerns that AT&T’s Centennial purchase would hurt competition.”


While I agree that regulatory challenges are tough to predict, I believe that the small size of Centennial Communications (CYCL) could allow the merger to go through and close by the end of 2009. The problem with Puerto Rico is that it is viewed as a separate US territory, which is considered by regulators as somewhat between a colony and an independent state. Thus, Centennials 33%-40% share of the market there, in addition to AT&T’s market share could require more flexibility for the two carriers when dealing with regulators. The Puerto Rico wireless market is highly competitive however. In Puerto Rico, Centennial competes with five other wireless carriers: America Movil, AT&T Mobility, Open Mobile, Sprint Nextel, and T-Mobile. Thus, AT&T might have to sell other assets in order to appeal to regulators, in order for the deal to go through. I doubt that this would affect the offer price for Centennial Communications (CYCL).

I do believe that AT&T (T) would eventually acquire Centennial Communications (CYCL) at the price, agreed upon in 2008. At current levels of $7.38, the upside is 15.2%. If the deal falls through however, shares of the acquired company would most likely drop to $4. I would put a limit order for a small position in CYCL. It is important not to bet the farm on merger arbitrage opportunities. One of the reasons for the decline in the stock price could also be quick-tempered overleveraged arbitrageurs closing their positions in order to avoid margin calls, which happened with Anheuser Busch and Constellation Energy (CEG) deals.

In the best case I would be looking for a partial exit at somewhere above $8.20 and would evaluate my options later on.

Full disclosure: None for now, but could change in a few days

Relevant Articles:

- Constellation Energy Group (CEG) merger arbitrage opportunity
- Pfizer/Wyeth Merger Arbitrage Opportunity
- A merger arbitrage lesson to learn
- Merck/Schering-Plough Merger Arbitrage Opportunity
- AT&T (T) Dividend Stock Analysis

Friday, April 17, 2009

Special Dividends Unlock Hidden Value in Stocks

Most investors view stocks as lottery tickets – they buy and hope for the greater fool theory to kick in order to sell at a profit. More often than not however these investors lose a lot of money in the stock market, as they never seem to learn that stocks represent small portions of a business, which sells products or services and hopefully earns a decent profit while building on to its asset base.

Many investors have taken a beating recently, especially as the recession and bear market kicked in earlier in 2008. Some are bailing out of stocks completely, while seeking the relative safety of Treasury Bonds or Certificates of Deposit. Some investors however have seen the current bear market as an opportunity to load up on cheap stocks, which are trading below the net levels of cash on their balance sheets. The net-net strategy was popularized by Ben Graham who bought stocks after the Great Depression at steep discounts to the net asset values per shares realizing huge profits in the process.

Imagine a company ABC that has 1 million shares issued and outstanding trading at $0.50/share, has zero debt and no liabilities, and also has $1 million in cash and equivalents on its balance sheet. Now further imagine that the company is at least breaking even in terms of earnings. Would you pay $0.50/share for an asset that has a value of at least $1.00?
Now the answer is not as straightforward since one needs to determine what catalyst would bring the price closer to $1.00. If the company decides to spend the cash on an ill-fated venture, then the value of the stock would drop. However if the company decides to liquidate or pay a special dividend to shareholders, then the stock should be worth more than $0.50/share.

Most recently I have seen several small cap companies announcing a special dividend:

Back on March 16, FortuNet (FNET) announced that it would ask shareholders to approve a special $2.50 cash dividend on its April 17 meeting. As a result the stock price rallied 75.2% in a single day to $2.40/share. FNET earned $0.25/share in 2008 and has almost $2.75/share in total cash and investment securities as of 12/31/2008.

Back on December 5 Eden bioscience (EDEN) announced it would be winding down its operations. The stock rallied 77% on the news. The company had $1.80/share in cash. A potential issue is that winding down operations could cost money.

A company I am currently looking at from a value-investing standpoint is TheStreet.com (TSCM). Currently the online stock market content provider has $72.4 million in its coffers, versus total liabilities of $19 million, for a net $53.4 million or $1.76/share in cash. I like the fact that TSCM is paying out a quarterly dividend of $0.025/share. I would be interested in TSCM on dips below $1.50.

This post was featured on 138th Edition of the Festival of Stocks

Relevant Articles:

- 40 Value Stocks that Graham Would Buy
- Average Durations of Previous Bear Markets
- The Dividend Edge
- Why dividends matter?

Tuesday, April 7, 2009

A merger arbitrage lesson to learn

The big news yesterday was the failed merger talks between Sun Microsystems and IBM. Sun Microsystems (JAVA) lost almost 23% of its value after the news hit the street. JAVA exploded on March 17 after rumors of a potential bid by IBM made Sun’s shares 79% more expensive.

The major sticking point was that Sun Micro believed IBM’s rumored offer of $9.40 to be too low. This news should be a lesson for all would be merger arbitrageurs to never initiate a position in an arb deal before the deal has been announced officially. Without a clear written intent from both companies, there is added uncertainty whether the deal would go through in order for the arbitrageur to close their position at a profit. That’s why arbitrageurs should expect higher risk adjusted returns if they waited for the official announcement of the deal before deciding whether the deal is worth participating in or not.

Another example of a badly timed merger arb play was the talks between Yahoo (YHOO) and Microsoft (MSFT) early in 2008. Back in February 2008, MSFT proposed to acquire YHOO for $31/share, which was a 62% premium to the closing price for the dot com company. After the announcement Yahoo jumped by 48% to 28.38. Check out my analysis of MSFT.

After three months of uncertainties however Microsoft decided that Yahoo (YHOO) valued itself too much and withdrew from negotiations, sending Yahoo shares down 15% for the day. Investors and institutions which bought Yahoo (YHOO) stock around $28.38 expecting to make an easy 9% gain were hugely disappointed.

As always, once the intent of BOTH companies is announced in favor of the deal and all the details have been accepted by both companies, should one consider initiating a merger arbitrage play. Otherwise, you would be speculating, which is not what Ben Graham and Warren Buffett preach as a winning investment philosophy.

This post appeared on Carnival of Personal Finance #200 - Edition of Mini Accomplishments

Relevant Articles:

- Warren Buffett – The Ultimate Dividend Investor
- 40 Value Stocks that Graham Would Buy
- Arbitrage Opportunities – CEG and ROH
- Microsoft (MSFT) Dividend Stock Analysis

Tuesday, March 10, 2009

Merck/Schering-Plough Merger Arbitrage Opportunity

In this tough market, investors are always looking for a way to make a buck. Merger Arbitrage is a strategy where investors could profit from the spread between the current price of the target and the expected price at close of the deal. This could be one strategy where investors could shore their funds during the current market turmoil and still make a buck.

Warren Buffett had a nice discussion on his arbitrage experience with Arcata Corp in the 1980’s in his 1988 letter to Berkshire Hathaway shareholders.

"To evaluate arbitrage situations you must answer four questions:

(1) How likely is it that the promised event will indeed occur?

(2) How long will your money be tied up?

(3) What chance is there that something still better will transpire - a competing takeover bid, for example?

(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?"

The big news yesterday was Merck’s multi billion-dollar deal to acquire Schering-Plough. For each share of Schering, shareholders will receive 0.5767 shares in the new company plus $10.50 in cash. Merck will use $9.8 billion of its own cash for the purchase plus $8.5 billion in short-term financing. The companies expect the deal to close in the fourth quarter of this year, subject to regulatory approval.

The merger is subject to shareholder approval from both companies. The FTC would have to review the deal for overlap in drugs and other products in development or currently sold by Merck and Schering-Plough. The FTC could also force the companies to sell some products before a green light for the merger is given.

Another stumbling block might be the arthritis drugs Remicade and golimumab, for which Schering-Plough acquired the rights to sell it internationally from Johnson and Johnson. Under "change of control" clauses in the companies' partnership agreements, J&J has the opportunity to acquire the full rights to the drugs if Schering-Plough gets taken over. That's why the deal is structured as a reverse merger, where Schering-Plough will be the surviving company under the Merck name.

Investors who believe that the merger will go through could profit by purchasing Schering-Plough shares and selling short 57.67 MRK shares for every 100 SGP shares bought. At the current prices for Merck (MRK) and Schering (SGP), which yesterday closed at 20.99 and 20.13 respectively, investors could earn a 12.30% return by the end of the year through this arbitrage opportunity.

Another pharma arbitrage play to watch is Pfizer/Wyeth Merger Arbitrage Opportunity. Pfizer (PFE) will pay $33 in cash plus 0.985 shares of Pfizer stocks for each share of Wyeth (WYE). On Monday Wyeth closed at $40.76, which is 10.30% lower than the combination of Pfizer stock and cash, at the current price for Pfizer at $12.63.

In a document filed with the SEC several reasons why the Pfizer/Wyeth Merger Arbitrage Opportunity might not go through were listed:

“ There is the possibility that the merger does not close, including, but not limited to, due to the failure to satisfy the closing conditions; Pfizer's and Wyeth's ability to accurately predict future market conditions; dependence on the effectiveness of Pfizer's and Wyeth's patents and other protections for innovative products; the risk of new and changing regulation and health policies in the U.S. and internationally and the exposure to litigation and/or regulatory actions. the ability to obtain governmental and self-regulatory organization approvals of the merger on the proposed terms and schedule; the failure of Wyeth stockholders to approve the merger”

It would also be interesting to see if Merck (MRK) will continue paying its current rich dividend to shareholders and won’t cut it, which was what Pfizer (PFE) did when its merger with Wyeth (WYE) was announced.

Full Disclosure: None

Relevant Articles:

- Pfizer/Wyeth Merger Arbitrage Opportunity

- Is Pfizer (PFE) a value trap for investors?

- Dow Chemical (DOW) To Acquire Rohm and Haas (ROH)

- Anheuser-Busch (BUD) Deal Finalized



Tuesday, January 27, 2009

Pfizer/Wyeth Merger Arbitrage Opportunity

Yesterday, the big news that moved markets was Pfizer’s 68 billion dollar acquisition of rival Wyeth. Pfizer will pay $33 in cash plus 0.985 shares of Pfizer stocks for each share of Wyeth. At Monday Wyeth closed at $43.39, which is 10.30% lower than the combination of Pfizer stock and cash, at the current price for Pfizer at $15.65.

Warren Buffett had a nice discussion on his arbitrage experience with Arcata Corp in the 1980’s in his 1988 letter to Berkshire Hathaway shareholders.

To evaluate arbitrage situations you must answer four questions:

(1) How likely is it that the promised event will indeed occur?
(2) How long will your money be tied up?
(3) What chance is there that something still better will transpire - a competing takeover bid, for example?
(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

1. The next step in the process is that Pfizer will file with the SEC a Registration Statement on Form S-4 that will include a proxy statement of Wyeth that also constitutes a prospectus of Pfizer. Wyeth will mail the proxy statement/prospectus to its stockholders. The transaction is subject to the approval of Wyeth shareholders, and other customary closing conditions. The deal is likely to be reviewed by the Federal Trade Commission, which typically handles pharmaceutical acquisitions.

The transaction will be financed through a combination of cash, debt and stock. A consortium of banks has provided commitments for a total of $22.5 billion in debt, $22.5 billion in cash and 23 billion in equity. The deal is being financed by five banks: Bank of America Merrill Lynch, Barclays, Citigroup, Goldman Sachs and J.P. Morgan Chase.

2. Pfizer and Wyeth expect the transaction to close at the end of the third quarter or during the fourth quarter 2009.

3. Given the size of the deal it is unlikely that another suitor will come after Wyeth. One potential suitor that comes to mind could be Novartis (NVS). which will experience a similar problem just like Pfizer between 2011 and 2012, as several prominent drugs such as Diovan, Zometa,Femara, Lescol and Exelon which accounted for over one fifth of the pharmaceutical company’s 2007 sales will face US patent expirations.

4. The proposed transaction is subject to customary closing conditions, including approval by the stockholders of Wyeth, notification and clearance under certain antitrust statutes. In addition, the proposed transaction is subject to Pfizer's financing sources not declining to provide the financing due to a material adverse change with respect to Pfizer or Pfizer failing to maintain credit ratings of A2/A long-term stable/stable and A1/P1 short term affirmed. There are
no other financing conditions to closing in the merger agreement. Pfizer is financing the $22.50 billion debt with a jumbo one-year bridge loan and almost all the cash on its balance sheet.
After one year however, that bridge loan will come due and will have to be traded in for permanent financing, which could be jeopardized if the credit crunch hasn’t loosened by then.
After the deal was announced Fitch Ratings downgraded Pfizer's credit rating to 'AA' from 'AA+,' and placed the company's ratings on a negative watch. Moody's Investors Service and Standard & Poor's are reviewing their ratings on the acquirer. In the Pfizer loan agreement for the takeover, the banks can step back if Pfizer’s credit rating falls five notches below AAA to A or A2. If Pfizer’s credit rating falls enough for the banks to decline to finance the deal, Wyeth could potentially walk away with $4.5 billion.

In a document filed with the SEC there were several reasons why the deal might not go through
“There is the possibility that the merger does not close, including, but not limited to, due to the failure to satisfy the closing conditions; Pfizer's and Wyeth's ability to accurately predict future market conditions; dependence on the effectiveness of Pfizer's and Wyeth's patents and other protections for innovative products; the risk of new and changing regulation and health policies in the U.S. and internationally and the exposure to litigation and/or regulatory actions. the ability to obtain governmental and self-regulatory organization approvals of the merger on the proposed terms and schedule; the failure of Wyeth stockholders to approve the merger”

This would be an interesting deal to watch. Wyeth is trading at $43.39, Pfizer at $15.65, and the value of each WYE share if tendered by PFE today is $48.41. In the event that the deal closes as planned by late 3Q or early 4Q 2009, arbitrageurs could make as much as 11.50%.

For updates on the merger, check out this page.

Relevant Articles:

- Pfizer’s deal with Wyeth could be a blessing for shareholders, not as good for long term growth.
- Is Pfizer (PFE) a value trap for investors?
- Dividend Aristocrats in danger
- Constellation Energy (CEG) Merger Arbitrage Opportunity.

Tuesday, October 28, 2008

Constellation Energy (CEG) Merger Arbitrage Opportunity

One of the four techniques implemented by Benjamin Graham was merger arbitrage. There’s been some good evidence that this strategy has worked for several decades for some value investors such as Graham and Buffett, producing double digit returns.

Buffett had a nice discussion on his arbitrage experience with Arcata Corp in the 1980’s in his 1988 letter to shareholders.

To evaluate arbitrage situations you must answer four questions:
(1) How likely is it that the promised event will indeed occur?
(2) How long will your money be tied up?
(3) What chance is there that something still better will transpire - a competing takeover bid, for example?
(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

This leads us to the potential acquisition of Constellation Energy by Berkshire’s MidAmerican Holdings. George from Fat Pitch Financials was the first to alert his readers on this opportunity. The merger has already been announced in September at a price of $26.50/share in cash. In addition, MidAmerican provided an immediate $1 billion cash infusion to Constellation Energy through the purchase of preferred equity. The definitive agreement has been approved by both companies’ boards of directors and is subject to, among other things, shareholder and customary federal and state regulatory approvals.

The transaction is expected to close within nine months from September 19th announcement date. The agreement expires nine months after its execution but may be extended by either company for up to three months.

If the deal does not materialize for some reason or another the stock could easily drop precipitously, as the company might face a drop in its debt ratings and loss of confidence from its trading partners. I do believe however that if the deal with Midamerican were to be canceled, EDF might still step in and make a competing offer, but the terms might not be as good for CEG’s shareholders. EDF did offer $35/share previously, but Constellation’s board rejected the offer and chose Berkshire’s MidAmerican Holdings offer instead. Given the ample liquidity that Berkshire Hathaway has at the moment I do believe that the merger has a higher chance of occurring.

I would be considering purchasing CEG on dips below $23.50. One definitely has to be nimble with this position however; therefore I would look into exiting some or all of my positions in CEG on spikes above $25.50. This is highly speculative position, which is geared towards absolute performance. CEG currently pays a quarterly dividend of $0.4775/share, which makes up for an annual yield of 8.20%.

For updates on Constellation and MidAmerican check out this website. In addition to that check the PRELIMINARY PROXY STATEMENT AMENDMENT filed with the SEC from this link.

Full Disclosure: I am long CEG

Relevant Articles:

- Constellation Energy Group (CEG) merger arbitrage opportunity
- Dangers of the Greedy Limit Order
- Berkshire Hathaway Historical Total Return Performance
- Buffett's Berkshire Hathaway Stock Portfolio Holdings
- Warren Buffet - The richest investor in the World

Sunday, July 13, 2008

Anheuser-Busch (BUD) Deal Finalized

Reuters and WSJ today reported that BUD agreed to be acquired by Belgium Based Interbrew for a little under 50 billion dollars. The $70/share bid would create the largest brewing company in the world.

BUD shares rose $5.29 to close at $66.50 on Friday, after reports from WSJ that InBev has increased its offer to shareholders by $5/share to $70.

I would consider selling half of my stock on Monday morning at the open, as I expect a gap up which would be close to the offering price. I would keep the other half and tender it later. You could read my dividend analysis of Anheuser-Busch (BUD) here.

This acquisition, just like the recent acquisitions of ROH and WWY strongly reiterates my point that solid dividend growers are a great long-term investment in general. The only issue with acquisitions is finding new opportunities from the shrinking supply of quality dividend opportunities out there.

Thursday, July 10, 2008

Dow Chemical (DOW) To Acquire Rohm and Haas (ROH) for $78/Share

Rohm and Haas Company (NYSE: ROH) entered into an agreement with The Dow Chemical Company (NYSE: DOW), under which Dow will acquire all of the outstanding shares of Rohm and Haas common stock for $78.00 per share in cash. Shares of ROH closed at $44.83 yesterday. The agreement provides that Rohm and Haas Company will retain its Philadelphia Headquarters location, and continue to do business under the Rohm and Haas name. Additionally, Dow will contribute a number of specialty chemicals business segments to the Rohm and Haas portfolio which have greater synergy with the Philadelphia Company’s established strengths. Source: StreetInsider

My dividend growth stocks are getting bought out by competitors as they present stable corporations with a nice moat. The first one that is in talks to be bought out is BUD. Now ROH is going to be bought out by a consortium of a Kuwait Sovereign Wealth Fund, Buffet and Dow Chemical. I was only able to accumulate a half position in ROH, but nevertheless now I have to re-allocate the funds accross the rest of my portfolio. You could check my analysis of ROH here.

At the time of this weriting ROH is up over 65% from yesterday's close. I would consider selling half of my position shortly in order to lock in a gain. The market price is about 5% lower than the offer price at $78. The companies have said they hope to complete the deal by early 2009. I would keep my other half of the position to tender it by that time.

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