Lunch Is for Wimps
3 Pending Buyouts as Cash Alternative
- M&A deal spreads typically trade 3-4 times the “risk-free rate” of the U.S. 10-yr Treasury Note
- Several large cash-only transactions trade at annualized spreads above 5%
- Global M&A averaging 3,000 transactions/month offer multiple arbitrage opportunities
- Quality transactions with high probability of completion present an alternative to low yielding short-term debt
”No interest” is one of those memorable expressions from Wall Street’s go-go years of the late 80s. With two dismissive words, Masters of the Universe like Gordon Gekko could shoo away block-trading brokers and go back to their screens without missing a beat. Funny I actually uttered them at my neighborhood bank last week when a teller offered me a 91-day certificate of deposit at 0.15%. No interest indeed. Taking me literally, he suggested I could double the return to 0.30% by going out to 15 months. I paused for a moment and realized I’d need to wait four years to earn a full percent… no interest! I may not be Gordon Gekko, but I work too hard to watch my cash do nothing. CDs are for wimps.
Mr. Gekko was known in his day as a risk arbitrager, Hollywood’s version of real-life deal junkies like Boesky and Icahn. The term derives from exploiting pricing differentials for announced takeover deals. When an acquirer announces its intention to purchase another company in an M&A transaction, arbitragers typically buy the target and sell the acquirer in a ratio which reflects the terms of the deal. If for example A is buying B, offering to pay 2 shares of its own stock for every share of B, arbitragers would buy one B share and sell two A shares. The opportunity to profit arises because B will generally not trade exactly at 2x A, but instead at a slight discount. This so-called “deal spread” reflects uncertainty of obtaining all necessary regulatory approvals, shareholder support and time to completion. Even the simplest deals often require several months, and deal spreads narrow over time as the two parties come closer to completion.
Deal Spreads and CDs
Deal spreads and CDs actually have more in common than you might think. While some M&A transactions face significant regulatory hurdles, like Anthem’s current bid for Cigna, most announced deals are ultimately completed. Traders price spreads between 3-4 times the benchmark risk-free rate of return, which equates to an annualized rate of 4-6% with the 10-yr Treasury at 1.5%. So for the professional investment manger eager to earn a return on cash, risk arbitrage presents an alternative to holding short-term assets like commercial paper, certificates of deposit, 6-month T-bills and near-dated corporate bonds. It doesn’t pay the 6-8% returns available on junk bonds, then again it sure beats the negative rates in Europe and Japan. For global asset managers in search of yield, solid M&A transactions with a high probability of closing present a legitimate solution. In addition, healthy M&A volumes present multiple choices.
Keep It Simple
Most large money-center banks and diversified hedge funds include risk arbitrage within their suite of services, though often times it’s viewed as its own designated asset class rather than as a cash alternative. This is unfortunate. By focusing on plain vanilla, cash-only transactions with a high degree of probability for completion, smaller asset mangers could shift a portion of their cash equivalent holdings to select M&A transactions and earn additional return for clients at reasonable incremental risk. I offer three specific examples of cash-only deals which offer annualized returns averaging 5.03%.
(Note: Since there is no stock component to a cash-only bid, the deal spread is simply the difference between the current stock price of the target and announced/agreed upon takeout price. These are truly plain vanilla transactions. In addition, these three have a high probability of completion.)
1. Microsoft / LinkedIn (MSFT / LNKD)
LNKD currently trades at $192.05, a discount of $3.95, or 2.02% to the takeout price. As the deal is expected to close on or before 12/31/16, this equates to an annualized return of 6.03% Bloomberg calculates a 94.47% probability of a successful deal closing.
On June 13 MSFT announced an all-cash acquisition for LNKD at $196.00 per share. The total deal value is $24.3B, which represents the largest technology transaction YTD. At 51x estimated earnings, it is also the largest multiple of earnings ever paid in the sector for deals greater than $5B, per Bloomberg data. As a result, there is very low likelihood of dissident LNKD shareholders asking for a higher price, or additional bidders derailing completion. This is a very high quality transaction.
- The boards and shareholders of both companies have approved the transaction.
- Miscrosoft has already fully funded the purchase price with a combination of cash and bonds.
- High quality advisors on both sides. Allen & Company is advising LNKD, Morgan Stanley is advising Microsoft. White & Case is representing LNKD legally, Davis Polk is representing MSFT. Deloitte serves as the accountant to both companies.
- Standard Hart-Scott-Rodino approval from DoJ is pending, though expected. Additional information requested by government lawyers is the only potential snag to timing, though LNKD has no competitor and MSFT is not in the business so anti-trust issues seem unlikely.
2. Danone / WhiteWave (BN FP / WWAV)
WhiteWave Foods currently trades at $55.40, a discount of $0.85, or 1.50% to the takeout price. As the deal is expected to close on or before 12/31/16, this equates to an annualized return of 4.50%. Bloomberg calculates a 91.96% probability of a successful deal closing.
Yogurt maker Danone of France announced its second largest-ever acquisition on July 7, 2016, offering $56.50 for all outstanding shares of specialty food producer WhiteWave Foods Company. Its products include LandOLakes butter and Silk brand almond milk. WhiteWave’s organic growth of 10% is double that of Danone, making it a highly attractive target worthy of the 23% deal premium paid by Danone.
- The boards of both companies have approved the transaction.
- WhiteWave shareholders will vote 10/26. Additional approvals are required from the European Commission (10/24) and DoJ under HSR (9/4)
- Financing is already arranged using debt.
- High quality advisors (Goldman Sachs for WWAV, Lazard for Danone).
3. Pfizer / Medivation (PFE / MDVN)
Medivation currently trades at $80.25, a discount of $1.25, or 1.53% to the takeout price. As the deal is expected to close on or before 12/31/16, this equates to an annualized return of 4.59%. Bloomberg calculates a 92.80% probability of a successful deal closing.
Medivation is truly the Belle of the Ball, having first received a bid of $58/share from Sanofi in April, and having caught the eyes of multiple rumored suitors along the way (AstraZeneca, Celgene and Gilead). Alas, the San Francisco-based biomedical company looked past flashy Europeans and agreed just last week to tie the knot with New York’s own Pfizer. Given the deal’s valuation multiple of 62 times earnings and 15 times sales, cash-strapped Europeans might not have been able to afford fair Medivation anyway. Pfizer’s pending patent expirations make Medivation’s triple patent-protected treatment for prostate cancer far too tempting to resist, and it paid quite a premium to make the magic happen.
- The boards of both companies have approved this transaction.
- Additional approvals are required by DoJ under HSR (10/20), though there is no drug overlap.
- PFE will fund the acquisition with debt, raising its Net Debt to EBITDA from 1.3x to 2.0x, which is still less than the average for the S&P 500.
- Evercore and J.P. Morgan are advising Medivation. Guggenheim and Centerview are advising Pfizer.
- As this deal was announced fewer than 20 days ago, Bloomberg cannot yet calculate probability of closure –though the tightness of the spread indicates very strong likelihood of completion on or before 12/31.
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