October 29, 2010
Hostile Deals and Business Risks: More on BHP and Potash
BHP Billiton's hostile bid for Potash Corporation of Saskatchewan continues to provide interesting lessons for M&A buffs. You can’t underestimate the power of a hostile deal, especially a cross-border one with regulatory uncertainty, to raise enormous amounts of risks for both sides.
For Potash Corp this week has brought both good and bad news. The good news is, potash (the mineral) is in high demand, with Potash Corp reporting stellar quarterly profits. The bad news is that, in a weird twist not often seen in hostile deals, the stock of Potash Corp may not be trading as high as it should be (i.e. the fundamental value isn’t reflected in the current stock price) because of the uncertainty surrounding the BHP bid. In fact, Potash’s Q3 investor presentation spends much time driving home this point, providing a “hypothetical unaffected stock prince analysis” and honing in on the inadequacy of BHP’s offer.
Potash Corp investors that are hoping that as a result of the company's strong earnings BHP would raise its offer may not see that happening anytime soon. Recent reports indicate that, in addition to Saskatchewan, the Canadian federal and other provincial governments may get in the way of any possible takeover by a non-Canadian buyer. Despite the fact that BHP’s offer is likely too low at the moment in light of the improving trends in fertilizer prices, based on statements (“I think we're going to get screwed” ) by a source allegedly close to BHP, it appears raising the offer is not likely at the top of their list given the tense negotiations with the Canadian government. Of course, BHP issued a statement trying to distance itself from this comment, stating that "We have absolute confidence in the integrity of the Investment Canada process. We continue to have ongoing negotiations with the Investment Review Division, but we do not comment on these discussions in the media.” We will see on November 3rd when the Canadian authorities complete their review of the bid.
BHP and its management are under a lot of presssure with this deal. In addition to the problems they are encountering with the Canadan government, if they lose this deal, it will be the second big hostile deal that they have failed to complete in the last two years. Furthermore, losing out on the Potash deal will be painful and costly given the amount of resources they have devoted to it over the past several months.
In the meantime, Potash Corp’s CEO is also trying to calm things down, indicating that the company is looking for a white knight and has engaged in “very active conversations about alternatives to BHP’s hostile offer.” Given the way the things are going in Canada with the BHP bid, it will be interesting to see whether these other options involve foreign buyers.
October 27, 2010
M&A Swap Games
WSJ explains an swaps strategy for M&A arbs. The long and short of it: use credit derivatives - and not equity - to bet on an acquisition:
Take the acquisition of packaging manufacturer Pactiv, which is being funded mostly with debt. Pactiv's shares have risen 38% since news of a deal broke in May. But the company's credit-default swaps have more than tripled: Five-year insurance on $10 million of debt costs $425,000 a year, compared with $140,000 in May, according to Markit.
What I think is interesting about this strategy is that when you start buying CDS' you'll continue to have equity-like exposure to the company after it goes private. Of course, one motivation for going private is that managers is that once you're private you no longer have to worry about the public markets and the short-term activist investors. Well, if you are relying the debt markets to fund business or your acquisition, going private may not be quite the quiet have you expected.
Firms still hoarding cash
According to Reuters, firms are still hoarding nearly $1 trillion in cash with no plans to spend it:
Nonfinancial U.S. companies are sitting on $943 billion of cash and short-term investments, as of mid-year 2010, compared with $775 billion at the end of 2008, Moody's said. This would be enough to cover a year's worth of capital spending and dividends and still have $121 billion left over, it said. ...
Meanwhile only 20 companies hold a large portion of corporate cash balances, with $346 billion on their balance sheets, or 37 percent of the total, Moody's said.
Cisco Systems (CSCO.O) has the largest cash balance, at $39.86 billion, while Microsoft (MSFT.O) is second with $36.79 billion, Moody's said. Google (GOOG.O) has the third-largest balance with $30.06 billion, followed by Oracle (ORCL.O) with $23.64 billion and Ford Motor Co (F.N) at $21.89 billion.
Technology companies held the most cash as a sector, at $207 billion, followed by pharmaceuticals with $124 billion, energy at $105 billion, and consumer products with $101 billion, Moody's said.
What's preventing the spigot from turning on this potential private sector stimulus? Lack of confidence.
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October 26, 2010
Insider trading on the railroad ...
Andrew Ross Sorkin flags this recent insider trading prosecution. It's of a breed of cases where the SEC is pursuing its "level playing field" theory of insider trading. Traditionally, there has to be a breech of a fiduciary duty tied to the trading in order to lead to liability of the insider trading laws. The SEC, obviously, hates that. They have pushed for years to get the court to adopt a level playing field theory that would permit prosecutions even in the absence of a fiduciary obligation. Such was the case last year in SEC v Dorozhko. That was the case of a hacker who stole inside information and was then prosecuted for trading on it. Clearly, hacking is a bad act. But, was it insider trading? The Second Circuit thought so.
Now comes the SEC's prosecution of this group of 5 railway engineers, railyard workers, and their families. Their crime? According to Sorkin, they were a little too observant for their own good.
(a) in early March 2007, FECR’s Chief Financial Officer requested that Gary Griffiths prepare a comprehensive list of all of the locomotives, freight cars, trailers and containers owned by FECR, along with their corresponding valuations, which she had never requested before;
b) Gary Griffiths became aware of the unusual number of Hialeah yard tours, which began on March 15, and he believed that the tours were being provided to investment bankers who were considering buying or investing in FECI; and
(c) shortly after the tours began, yard employees began asking Gary Griffiths whether FECI was being sold and whether their jobs would be affected by any such sale.
I don't know. It strikes me as a bridge too far. Although, this group did have the sense to go big - scoring $1.6 million in profits. Anyway, I don't imagine the SEC has exhausted its supply of inside-trading investment bankers to go after. It's a little odd that they would focus on this crew.
October 25, 2010
Nationalism and a Shakedown? More on BHP Billiton and Potash
As devoted readers know, we’ve spent a lot of time covering BHP Billiton’s hostile bid for Potash (see for example this, this, and this). The deal is a classic example of cultural issues in cross-border transactions and the risks that arise in deals where government approval plays an important role. Not only are the parties dropping cash on the people of Saskatchewan, but the provincial government, as Brian noted last week, is wading deeply into this deal. In addition to last week’s shenanigans, the Saskatchewan Premier Brad Wall is playing the nationalist card in today’s press release urging the Canadian federal government to block the deal, stating that BHP’s former Chair views Canada as a “Branch Office” and that
"[I]t's up to our federal government to ensure we retain Canadian control of our natural resources and that we don't become a ‘branch office,' like BHP apparently sees us," Wall said. "Mr. Argus' words and BHP Billiton's apparent view of Canada should give the federal government plenty of pause as it considers its response to the largest foreign takeover in Canadian history. If Australian business leaders like Mr. Argus are concerned about ceding too much control of Australia's natural resources to foreign control, shouldn't our government feel that same concern about Canada's resources?"
Some conservatives in Canada are now accusing Saskatchewan of becoming the next Venezuela (going a bit overboard, no??) for allegedly asking BHP to pay a billion dollars of potential lost taxes up front…Let the fun continue.
October 24, 2010
More on Appraisal Arbs
George Geis has posted his new paper, An Appraisal Puzzle, on SSRN. It's forthcoming in the NW. L. Rev. It deals with the issue of how the problem of identity ambiguity means that almost anyone can seek appraisal. Since appraisal statutes only deal with record holders, beneficial holders can still get appraisal, even if they voted in favor the transaction in question. This is a sticky issue!
The division of power between majority and minority shareholders raises a fundamental tension for corporate law scholars. Awarding minority owners too much say can hinder effective decision making and introduce holdout problems. But naked majority rule only breeds a different malady by handing controlling shareholders the power to steal from minority owners. This governance conflict plays out in a variety of contexts but presents itself most explicitly during freezeout mergers.
Appraisal rights are a statutory attempt to deal with this problem. These laws do not directly prevent freezeouts; rather, they impose a liability rule where minority holders can demand fair value for their shares when they object to a deal. Unfortunately, this remedy functions rather poorly, and legal scholars have mostly scoffed at appraisal rights for the last half-century.
Interestingly, however, several recent developments in the back offices of Wall Street and the courthouses of Delaware have created a new appraisal puzzle. The problem relates to identity ambiguity. Appraisal statutes are written to cover record holders (the direct owners listed on a firm’s books). Yet under modern securities settlement practices the identity of these clearinghouse owners no longer changes during the sale of stock. And recent precedent now permits beneficial owners (the real investors) to obtain appraisal even if they purchase shares after voting rights on the merger have been severed from the stock. This introduces what I will call amplified appraisal claims, where a large number of investors can seek appraisal - each insisting that they have claim to a smaller pool of “qualified” shares. Such a development has the potential to turn the dynamics of a freeze-out merger on its head. This Article describes the appraisal identity puzzle, analyzes the theoretical implications for majority and minority shareholders, and proposes a normative response.