Merger Arbitrage Opportunity With 20% Profit Potential

Dec.18.12 | About: ECB Bancorp (ECBE)

On 25-Sep-12, Crescent Financial Bancshares (CRFN) announced it would buy ECB Bancorp (NYSE:ECBE) for 3.55 shares of CRFN for each share of ECBE (no adjustment or dividend from either company).

On 21-Nov-12, CRFN filed its S-4 statement, before the agreed 24-Nov-12 deadline (one of the conditions for the CRFN/ECBE transaction). On 3-Dec-12, CRFN merged with VantageSouth, which was another condition for the CRFN/ECBE transaction. CRFN and ECBE have guided to closing the transaction in Q1 2013.

The transaction makes a lot of strategic sense for CRFN and it is financially attractive (day one accretive to CRFN tangible book value ("TBV") and EPS) and it also makes sense for ECBE shareholders as it (NYSE:I) provides an attractive 44% premium (using current CRFN share price) and (ii) solves the issue of ECBE's requirement to otherwise raise capital to repay TARP (which would obviously be negative for ECBE shareholders). While the transaction values ECBE below TBV (74% TBV 2012E), it still looks very attractive based on current analyst estimates for ECBE's 2013 and 2014 EPS (implied P/E of 35.5x and 17.8x for 2013E and 2014E, respectively at time of announcement).

The remaining conditions for this deal to close are:

  • ECBE shareholder approval
  • CRFN shareholder approval
  • Regulatory approvals, tax opinion, employee and director related agreements (non-compete, resignations), no material adverse effects

Given the attractiveness to ECBE and CRFN shareholders it is very likely that 1) and 2) will get done. Note that CRFN is majority owned by Piedmont Community Bank and ECBE directors and related parties own around 27% of ECBE.

The third condition is nothing special in the context of such a transaction and there is no reason to assume that any of these conditions will not be met. Also note that on 30-Oct, ECBE reported good Q3 results with a more than 200% increase in net income yoy, and the company said that it is seeing stabilization in its market. These results and the continuing improvement in the US housing market make a material adverse change unlikely.

So, overall this is a pretty safe transaction.

However, it appears that due to low liquidity and maybe due to difficulties to find CRFN borrow, this transaction is trading at a 20% spread. This is more attractive than spreads of most other transactions with comparable conditions (i.e. excluding complex transactions with anti-trust and/or financing risks etc.)

So, if an investor would short 3.55 shares of CRFN for every 1 share of ECBE, she/he could earn a very low risk profit of 20% (on the amount invested in ECBE) within around 3 months.

As with any merger arbitrage trade, there is always a small risk that a deal falls apart. Since ECBE's Q3 results were positive, it is likely that ECBE shares would not decline all the way down to where they traded before the transaction was announced and so the downside would probably be lower than the -16% which it would take to trade at pre-announcement price. In the context of a 20% upside and high probability of completion, I find this an attractive risk/reward proposition.

Disclosure: I am long ECBE. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.