Heard on the Street: Deal Spreads You Can Drive a Truck Through
April 07 2020 - 4:27AM
Dow Jones News
By Stephen Wilmot
On paper, it is a sensational time to invest in companies about
to be bought out. In practice, even the best-laid merger plans are
up in the air.
A popular investment strategy, risk arbitrage, involves betting
on the gap or "spread" between a takeover offer and the stock
market value of the company being taken over. Following last
month's market meltdown, spreads on the auto industry's biggest
deals are mouth-wateringly wide.
The value of Fiat Chrysler, for example, is less than half that
of its merger partner Peugeot once dividends and other
distributions agreed by the auto makers are factored in. If the
companies complete their 50-50 merger on the terms agreed last
December, Fiat Chrysler's shareholders will get half the combined
company by providing just 31% of the equity. It should be a
no-brainer to buy Fiat Chrysler's stock and cover the position by
selling Peugeot's short. This apparent pricing anomaly didn't exist
even a month ago.
But there is a problem: Investors can't short Peugeot right now.
The stock trades on the Paris exchange, and the French market
regulator banned short selling for 30 days in the heat of the
selloff last month. Given that the merger isn't due to complete
until early next year, following a lengthy antitrust review, buying
Fiat Chrysler stock without cover is a very risky play given
consumer lockdowns.
Then there is the thorny question of whether the deal math will
have to be revisited. Both companies agreed to pay their
shareholders a EUR1.1 billion dividend for 2019. In the economic
shutdown, with companies burning through cash they can't replace
through sales, such payouts seem like a very bad idea. On Friday,
both companies postponed their annual general meetings, and thus
their dividend decisions, until June.
A bigger question concerns the EUR5.5 billion special dividend
due to Fiat Chrysler shareholders before completion. Depending on
just how badly this year pans out, this also might seem unwise --
in which case the way the transaction's benefits are split could
look very different. Fortunately, the companies won't need to
address this question until the end of the year, by which time the
scale of the current economic crisis should be clearer. However,
all this uncertainty means that enticing deal spread is at this
point little more than a spreadsheet fiction.
In other cases, the very question of whether a merger will
happen is open. In January, car parts supplier BorgWarner made an
all-stock offer for Delphi Technologies, the rump of the old
General Motors components business. Then, last week, BorgWarner
publicly accused Delphi of breaching the terms of their agreement
by drawing down a $500 million credit facility in full -- as many
companies are doing to maximize their cash balances in the
shutdown. If Delphi doesn't correct the situation, its suitor
claimed the right to call off the engagement. Delphi stock plunged,
opening a gap for arbitragers, but jumping in hardly seems a sure
bet.
Most extreme is Navistar International, the U.S. truck
manufacturer that sells the International brand. In January,
minority shareholder Volkswagen, through its listed truck unit
Traton, offered $35 a share for the stock it doesn't already own.
Having traded at a premium to the offer for all of February, the
stock closed at $16.69 on Monday. If the deal goes ahead on
existing terms, investors will more than double their money.
Navistar may be worth a gamble: Volkswagen will eventually want
control, and the spread may have been blown out of proportion by
hedge-fund deleveraging. But this is a game that needs to be played
with extreme caution. The old arbitragers' world of small, fairly
certain gains has given way to one of potentially huge but highly
uncertain ones.
Write to Stephen Wilmot at stephen.wilmot@wsj.com
(END) Dow Jones Newswires
April 07, 2020 05:12 ET (09:12 GMT)
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