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Summary

  • This was Rangeley Capital's largest investment.
  • Successful deal consummation would net NXY's holders an annualized yield of over 24%.
  • There are solid reasons to believe that the deal is safe and likely to be successfully completed.

Author Update Dec. 15, 2014, 6:15 AM

This deal was successfully consummated, netting investors over 24% annualized yield from the time of this article’s publication until the close. What similar opportunities are available today? One worth researching is COV, which is in the process of being acquired by MDT. Today, there is a merger arbitrage spread of over $4 per share which is unjustified by any deal risk. The deal has secured US, Canadian, European, and Chinese antitrust approvals. MDT successfully completed a $17 billion multi-tranche bond offering (+95 to +170 by BAC and JPM). At each step, the buyers fully lived up to their efforts duties. Despite political noise regarding such tax inversions, this appears to be an attractive 28% annualized return for the holidays.

A long in Nexen Inc (NXY), which last traded at $26.70, is a simple, one-decision investment idea that offers a 24% annualized return without high risk.

Target

Ticker

Value

Spread

Closing

Return

Nexen

NXY

$27.50

$0.78

1/31/13

24%

CNOOC Limited (NYSE:CEO) is in the process of acquiring NXY for $27.50 in cash. They have successfully secured the key regulatory approval in Canada and are awaiting the US approval from the Committee on Foreign Investment in the United States (CFIUS). While I am using a late January closing estimate, it is quite possible that the US review and the subsequent deal closing are able to wrap up somewhat earlier than that. Since this is an all-cash merger, you can buy your shares and go on vacation - this idea does not require an equity hedge and it does not require that you remember to tender your shares. It does not even require that you deal with currency issues since NXY trades in US dollars on the NYSE.

Where is the safety? Since the Canadian approval was announced, additional information has come to light in terms of the steps that CNOOC has been willing to take to appease Canadian regulators. In short, they made serious commitments to Canada in terms of long-term reporting, employment, and governance. It would be surprising if CNOOC was willing to take such steps unless they had the information and judgment that they would also be getting US approval.

Since CNOOC is a state-owned enterprise, this is the kind of deal that generates political harangues and press. But this deal is unlikely to be blocked. In practice, CFUIS is mostly used for protectionism and for corporate defenses in unsolicited bids. In this deal, competitors are not complaining and the deal is being done on a friendly basis. There does not appear to be any legitimate national security issues that would delay the deal.

Why is the spread there? NXY is currently up over 80% this year after the substantial premium that CNOOC is paying. Many of NXY holders are tax-paying Americans who are facing a massive tax hike in the New Year. While the last $0.78 is prospectively attractive, there is a significant after-tax difference between shareholders (such as the author) who have owned NXY and are sitting on a taxable gain and new shareholders who do not face the same tax issue. So, there will probably be some tax-related NXY selling over the next few weeks that will keep this spread substantially wider than it would otherwise be. This spread does not represent the risk associated with probabilistically weighted outcomes; it represents rational tax-sellers who leave you with a bargain worth exploiting for profit.

But what if I'm wrong? While we are using a 95% probability of a deal closing, there is always some probability that CFIUS is unwilling to clear it. What then? This is the major remaining deal hurdle, but it is also the most interesting part of the investment. That is because CNOOC would probably place the US assets in a trust and close the deal anyway. So, even if CFIUS approval is a coin flip, the coin looks like this: heads = $27.50 and tails = $27.50. Not a terrible wager for a price of $26.70.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: The author was long NXY before it was de-listed.

Source: A 24% Annualized Return For The Holidays With NXY