I’ve been meaning to write this post for a few days now. I’m not sure if this is something that everyone will be interested in, but it has (and has had) my full attention for the last few weeks. I’m writing this on my lunch break, and probably won’t have time to go back through and add supporting links, pics, etc., until sometime later. Here are the basics:
I’ve talked before on this site about several particular market beating strategies that are used by value investors. One specific market beating strategy is investing in mergers and acquisitions. The basic premise is this: a company will sometimes takeover another company in order to have access to their growth, technology, assets, etc. When one company targets another for takeover, they realize that they’ll have to pay a premium in order to buy the entire company. This premium is for a couple reasons, (a) a company is worth more if control of the company comes with it (i.e. an entire company is worth more than a portion of a company), and (b) because shareholders would have no reason to approve a transaction at or below the current market price of their shares (if they wanted to sell at market, they wouldn’t have shares to vote).
Since buyouts are almost always (not always = Jones Soda) above the market price, investors can sometimes make money by investing in these deals. Of course, outsized returns usually coincides with additional risk. It’s very difficult to invest based on what are essentially rumors. I refer to them as rumors because once they announce a buyout offer, there’s very little incentive for shareholders to sell below (or much below) the price of the buyout offer. This makes fewer shares available for purchase and quickly drives up the market price to at or around the deal price. At this point, your opportunity is basically gone. And to invest before an offer has been made is to invest based on rumors. And rumors are risky. So I don’t invest in deals that I feel are simply rumored to occur without any substantiation. An individual investor is at a significant disadvantage to Wall Streeters when it comes to following the rumor mill. You aren’t plugged in to the pulse of the street the way they are.
There are, however, certain types of deals that I will invest in. There are deal situations that carry substantially less risk than simply following Wall Street rumors. The main type of deal that catches my eye is a buyout offer that has been rejected for being too low. This should lead you to take a closer look at the deal and the company. The company may not be interested in selling for a number of reasons, both good and bad (see Yahoo!’s snub of Microsoft). The reason you’re looking for is because the buyout offer is too low. You’re looking for companies that are significantly undervalued, and still likely to be taken over.
Often, you’ll see an activist investor (one of the best catalysts for a stock) involved in a rejected buyout offer. In late 2009, for instance, Facet Biotech (FACT) was approached with an offer to buy the company for $17.50 per share. The shares quickly rocketed to that level. Seth Klarman famously spoke with the board and advised them that the offer was too low, and that the company was worth more. The board agreed. That same board had previously rejected a lower offer as well. Then, in early March, 2010, Abbott Labs (ABT) offered to buy the company for $27 per share. If you had bought on any of the previous buyout offers and simply held the company, you could have walked away with a tidy profit. Fueling your confidence in buying into the company around $17.50 would be Klarman’s belief (demonstrated by his ownership of nearly 5 million shares) that the company was worth more. You should, of course, be independent and do your own research with regard to valuation. If you have Seth Klarman and a company’s management telling you they aren’t selling the company because it’s worth more, you’re probably on the right track.
Which brings us to an opportunity I’ve been following since early February, and buying over the last couple weeks. General Growth Properties (GGP) is a real estate investment trust that primarily engages in owning and managing malls and other real estate. They are currently in the midst of a reorganization bankruptcy, as opposed to a liquidation bankruptcy. A reorg basically means that they couldn’t pay their creditors and sought bankruptcy protection to attempt to work out deals with creditors that allow them to get paid and the company to remain in business.
At one point in the process, Simon Property (SPG) offered to buy GGP for $9 a share in a deal that would give cash to the unsecured creditors and allow SPG to take control of GGP’s portfolio of assets. Simon owns quite a few malls as well, and there would certainly be some synergy if this deal were made. GGP promptly (wisely) rejected the buyout offer. This would have been a good time to take a look at the stock.
When a company files for bankruptcy protection, they’re required to submit a plan that explains how the company will pay their creditors while remaining viable. Everyone would prefer that the company survives. The creditors get paid, the company continues to generate cash, employ people, and theoretically create wealth.
As the date the plan had to be filed rapidly approached, GGP needed financing from one source or another. Seeing an opportunity, the largest shareholder in the company (Pershing Square) teamed with the largest unsecured creditor (money manager Bruce Berkowitz via Fairholme Capital) and Brookfield Asset Management (BAM) in a deal that would inject capital split GGP into two separate entities. One entity would hold all the “good,” cash generating assets and trade for $10 per share, while the other would contain all the “bad,” non-cash generating assets and trade for $5 per share. Ultimately, this injection of capital would value GGP at about $15 per share. The deal also allowed Pershing and Fairholme warrants to buy the new stock at $10 and $5. The warrants indicate, to me, that Fairholme and Pershing believe that the company is or will be worth substantially more in the future.
This is about the time I decided to invest, at about $14.50 per share. One of the great things about the Fairholme/Pershing offer is that it set a floor for what the stock will likely be worth initially if the company emerges from bankruptcy as a stand alone and is not taken over. That floor is $15. The deal also left open the possibility that GGP could be taken over by someone else.
On Tuesday, at about the time the market was going to close, unidentified sources indicated that Simon was preparing to make another bid. The bid, will, presumably, be at least worth more than $15 per share. I purchased more in after-hours trading on Tuesday at a cost of about $15.19/share. Then I purchased more the next day at about $15.80 per share. The average cost of all my shares, since I didn’t buy evenly, is about $15.49.
I have no idea what the Simon offer will be. I have seen speculation all over the board. If I had to guess, and I’m purely speculating, I would put the price in the $19-20 range. Of course I’d like it to be higher. And of course, it could definitely be lower. The share price closed at $16.38 in after-hours trading today. Allegedly, something will happen before the end of next week, when the reorg plan is now due.
Of course, there are risk factors involved in this deal. The primary risk factor at this point is that talks break down and Simon does not bring another offer to the table. The good news is that GGP has a safety net in place, which helps their negotiating position. It’s also possible that another bidder will emerge. GGP reportedly is in the process of doing their due diligence on Simon’s stock, and any deal would probably include a combination of cash and stock – since most of the creditors would prefer to have cash.
Hopefully this gave you some insight into how merger arbitrage works, and, as a practical matter, how it can benefit an individual investor. I’ll try to do better next time. Anyone have any thoughts on this deal? Leads on others? Donate half your profits to the site and thanks for reading!
Disclosure: Long GGP. No other positions in any securities mentioned.
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