Celesio – why merger arbitrage is hard business

Let’s start with a few quotes from yesterday’s post:

a) It is almost 100% assured that the bid goes through, there is now a “floor” under the stock price at 23,50 EUR

and

I have written above that this was a “Low risk” bet. In reality, I do not know if it was high risk and I was very very lucky or if it was indeed low risk. In statistics, one would call this a “beta error”, assuming that one was right but in reality the probabilities were very different. For me the best way to handle this is to do only small “bets”, keep track of assumptions and outcomes. Systematic “beta errors” in investing in my opinion are very dangerous as this will inevitable lead to some disastrous outcomes in the long run (Bill Miller).

Very rarely, one gets such a direct feedback from the market. McKesson said yesterday around 7 pm that they did not reach the 75% threshold and dropped the bid.

So this was clearly no a low risk M&A arbitrage situation but a high risk one and I was very very lucky to exit just in time.

McKesson themselves seems to be surprised as well:

“This is fresh news to us. We obviously had the support of the management team, we had the support of the family, which obviously was a significant holder, we had the support of Elliott, which was one of the vocal players in this process,” he said. “The best I can speculate is that people either forgot the tender date or they somehow believed that there is more on the other side of this.”

Let’s quickly check the facts:

In their 9th notification, dated January 9th, 2 pm, McKesson reported the following:

As of the Notification Reference Date, based on the regular conversion price, the aggregate number of Celesio-Shares held by the Bidder and/or persons acting jointly with it plus the number of Celesio-Shares for which the Takeover Offer has been accepted plus the number of voting Celesio-Shares which can be acquired through instruments pursuant to section 25a WpHG amounts to 106,213,544 Celesio-Shares; this corresponds to approximately 62.44% of the currently issued share capital and the currently existing voting rights in Celesio. In relation to the acceptance threshold in section 13.1 of the offer document the aggregate number amounts to 107,617,021 Celesio-Shares, which corresponds to approximately 52.94% of the share capital and the voting rights in Celesio on a fully diluted basis.

This was a significant increase against the 44,88% (fully diluted) a day before.

How much did Elliott own ?

This is from their official “recection” notice as of December 23rd:

Elliott Associates, L.P. and Elliott International, L.P. together with affiliated entities (“Elliott”), which own or have an interest economically equivalent to over 25% of Celesio AG (1)
(1) Calculated in accordance with Section 25a of the German Securities Trading Act (Wertpapierhandelsgesetz/WpHG), in connection with Sections 21, 22 and 25 WpHG

Elliott did report surpassing the 25% threshold in late November 2013.

If I read this correctly, they owned 25.1% on a non-diluted basis.

So let’s do quickly the math with what we have available:

  Undiluted Diluted
McK 107,617,021 62.44% 52.94%
Elliott 42,803,603 25.16% 21.06%
Total   87.60% 74.00%
       
Celesio      
Shares undiluted 170,100,000    
Shares diluted 203,281,113  

So this is interesting: Even with Elliott tendering its full stake, McK was still short 1% to their threshold on a diluted basis.

Could it be that this whole thing was just an accident ? No super-clever play by Elliott but rather a stuoid one ? Were other people assuming like myself that the offer period would be extended ? I don’t know, but I think it would have been better if MCK had said something about the offer period.

Looking back at the Rhoen chart after the first bid failed, one can expect the stock price to be very very volatile:

Anyway, I will watch this from the side line and will be extra carefull with the next M&A arbitrage situation….

7 comments

  • Ok…again I sold today @24. For me it was almost clear that the deal will go through in a second step…nice second chance for me due to first round failure…Thanks again to MMI.

  • Accodring to some articles CEO John Hammergren only learned of the failed deal on the Street [sic!]. So being equipped with M&A lawyers in some cases doesn’t provide you with a significant edge. I do not see why the Celesio deal is an example why one needs M&A lawyers…

    In this case, the game theoretical outline was obvious to many, yet the players obviously faced a “coordination problem”.

  • why “ouch”? I am still almost convinced that the deal with go through…especially because of Elliots involvement and because of the very tight first failure. You can call me stupid, but I bought back 50% of my position @22,88 and would double to 100% in case of a drop below 20. However I consider such a drop as very unlikely.

    Anyhow I made a nice little profit before…with selling @24…lets see if I have to give back this money :-)….

  • Ouch – a schooling. Most risk arb shops tend to have M&A lawyers on staff. That is who you are competing against here. They read all the documents and know the caselaw too. If you didn’t read the merger agreement and note that 75% agreement was required then the risk/return here was terrible. Reminds me of that spin off where the record date pre-dated your purchase. The best investors get the little details correct or stick to what they do best. Risk arb ain’t your bag – unless you are an M&A lawyer stay away. Read the deal professor’s blog on dealbook to get a feel for the level of knowledge to do well in the space (you usually need leverage too).

    Keep up the excellent blog.

    • Thanks for the comment. I do not fully agree however. From personal experience, i can tell you that a big team with a lot of lawyers does not guarantee success. In my opinion, there is a lot of game theory at work as well. For me “sticking to what I do best” is too boring. I always have learned best by try and error.

      mmi

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