Despite the notion that times are tough, mergers are still happening. If you look back at what we noted, the top 20 companies by market cap had over $335 billion in raw cash that could be used for acquisitions and dividends. Two of those are in deals noted herein. We are seeing some significant merger-arbitrage spreads in five of the existing mergers that are currently in the pipe. These deals are as follows:
- Centennial Communications Corp. (NASDAQ: CYCL) by AT&T Inc. (NYSE: T);
- Harleysville National Corp. (NASDAQ: HNBC) by First Niagara Financial Group (NASDAQ: FNFG);
- Patriot Capital Funding Inc. (NASDAQ: PCAP) by Prospect Capital Corp. (NASDAQ: PSEC);
- Sun Microsystems Inc. (NASDAQ: JAVA) by Oracle Corp. (NASDAQ: ORCL);
- Virgin Mobile USA Inc. (NYSE: VM) by Sprint Nextel Corp (NYSE: S).
We have provided specific background and added in some color to highlight the risks and chances of closure of each deal. There are some significant opportunities here in some of these deals, and some significant risks in others.
Centennial Communications Corp. (NASDAQ: CYCL) is still being acquired by AT&T Inc. (NYSE: T) in a deal that has taken almost forever to complete. This $8.50 cash buyout has been on the books since last November and has faced multiple delays and extensions. Centennial shareholders have approved the deal and AT&T said recently that it now anticipates a Q4 closing date because of delays. The premium or merger-arbitrage spread today is close to 7.5%, which is frankly a concern. Centennial used to trade north of $10.00 in the year before the deal was announced, but shares also crashed to as low as under $2.00 last October. This is being held up by an FCC review and there are still discussions with the DOJ. Now that AT&T is effectively the old AT&T, SBC, BellSouth, and Cingular combined, it looks like Uncle Sam is giving this one more scrutiny. The deal size here is not even $1 billion.
Harleysville National Corp. (NASDAQ: HNBC) is in a deal to be acquired by First Niagara Financial Group (NASDAQ: FNFG) in an all-stock deal valued at $237 million at the time the deal was announced. This is a score for First Niagra as it gets to add the 80+ branches along with the old 50+ branches it acquired from PNC. The spread here is significant and one which many leave significant arbitrage opportunities for those who can take advantage of it. There may be some very unhappy Harleysville holders that are buried in this as it used to be a $20.00 to $25.00 stock, but the bank was in need of capital and the all-stock deal does allow for future upside. The ratio is 0.474 FNFG shares per HNBC share, which comes to an implied price of $6.176 versus a $5.75 price of Harleysville shares today. This spread here is over 7.4% as the result of a share price-drop today and the deal is expected to close in Q4.
Patriot Capital Funding Inc. (NASDAQ: PCAP) is a stock buyout by Prospect Capital Corp. (NASDAQ: PSEC) that still has a 5.6% merger-arbitrage spread. The deal is expected to close in October and the share ratio was 0.3992 shares, coming to an implied price today of $4.117 versus a current share price of $3.90 for Patriot Capital. Prospect is paying off $110.5 million in Patriot debt and this aberration may be part of a disappointing Prospect earnings report on Monday.
Sun Microsystems Inc. (NASDAQ: JAVA) has a fairly wide spread on the surface in the $9.50 cash buyout by Oracle Corp. (NASDAQ: ORCL). The $9.14 price leaves 4% to the $9.50 price, and this is because of the European Commission giving it an in-depth review on concern that it could hurt competition. The kids running the E.U. antitrust department have not taken into consideration that Sun HAS TO become part of a larger company unless it wants to convert to a not-for-profit entity. Sure, they gave Java for free for far too long but the company cannot effectively generate steady profits on its own. We expect that the E.U. will come to its senses considering that the U.S. DOJ has cleared it. The risks here are a perpetual review by the E.U. and that may give the arb-spreaders some pause.
Virgin Mobile USA Inc. (NYSE: VM) is in a strange spot in the acquisition agreed to by Sprint Nextel Corp (NYSE: S). There is a huge wild card in this deal, actually two wild cards…. There have been rumors that drove Sprint shares through the roof a week ago noting that Deutsche Telekom (NYSE: DT) is looking into Sprint to decide if it wants to make a deal to capture a large network to bolster its market share for T-Mobile. The second wild card is that iPCS Inc. (NASDAQ: IPCS) has been in a long battle with Sprint and it added in another suit in Illinois specifically to block the Sprint acquisition of Virgin Mobile USA. There is a third wild card in that we do not expect a deal to close until late Q4 or into 2010 even if these two big situations get themselves worked out. Then there is the issue of a deal collar with an exchange ratio of 1.0630 to 1.3668 Sprint shares per Virgin share. Merger-arb spreaders that have significant fortitude and gumption can clip a spread here north of 11%. But that is a showing that the deal is not a slam dunk and a sign that many feel it could just like trying to take a piece of cheese off a mousetrap.
As a reminder, generally speaking, the higher the arbitrage-spread is, the higher chance that there is of the deal not happening. That is not a golden rule but is definitely what you want to keep in mind when considering any trades in the land of merger-arbitrage. Again, here is that $335 billion in raw cash that the largest companies have on hand that could be used for deals.
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Jon C. Ogg
September 18, 2009