Merger Review: Puget Energy 21 comments
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The Puget Energy (PSD) merger has finally been approved on December 30, 2008. After more than a year since I first got wind of this deal, the entire deal is expected to close in 2 weeks for $30 cash. Surprisingly, PSD is still trading at a discount to its final closing price. It is currently at $27.50. This still leaves room for a 9% gain with all uncertainty eliminated.
Regarding my last post on PSD, let’s take a step back and review what happened, how I went about doing things, what went right and what went wrong.
Due Diligence
Here is a list of what was involved in my due diligence of PSD (a reference for new readers and future mergers):
A. Before purchasing any shares the important thing is that the conditions and state of the merger satisfies the following checklist. Also see this post to get started if interested in mergers.
- Due diligence by all parties
- Financing and regulator approval
- Get preliminary shareholder sentiment (or controlling shareholder approval)
- Obtain regulator (SEC, FCC, any and all) approval
- Get final shareholder approval at a meeting called for that purpose
- Insiders continually vesting or buying shares
B. Throughout the past 3 months of following the deal closely, I have been keeping up to date with all filings submitted by PSD to the SEC via RSS.
C. Read each annual report and quarterly report since the merger announcement to see whether there were any changes in the verbiage. Also read the proxy and other documents to understand the structure of the deal. This was a cash deal so it was straightforward.
D. I also spoke directly with investor relations of PSD and got the impression that she was not worried about the deal at all.
E. Documented my reasoning and thoughts so that I had something to refer back to and remind myself if the price went down and I started getting emotional.
F. Went to the Washington UTC website and quickly browsed and read the concluding statements of the filing documents of involved parties. This part was what helped me drown out noise, stay focused and to draw up conclusions and scenarios.
G. Assign odds to the merger. If you don’t know what the odds of winning are, don’t even consider playing.
What Went Right
I must say that I was lucky with this deal. Lucky because utility merger approvals are very unpredictable with lots of opposition, lucky because Washington State has a history or killing deals at the last minute, lucky because the markets ignored the facts and depressed the prices heavily in our favor.
It was also a good thing that this deal was in my backyard and I had knowledge of the geography and makeup of the state and its affairs. Had PSD been in another state, my level of uncertainty would have been much higher. So if a merger is announced in your home state, always be sure to keep your eye on it. This is where you have home court advantage, something Wall Street will never know.
Wall Street not knowing = fear and uncertainty in the markets = good chance to pick up deals.
Add to that the buyer being an Australian company I was familiar with and it made the perfect arbitrage for me in 2008.
What Went Wrong
I had originally assumed the merger would take a week or so to close but I was completely off on this part. It ended up being 2-1/2 months. Although the upside gain more than compensated for the time, the period in which cash was held up was far too long and led me to miss out on better buying opportunities of Schnitzer Steel (SCHN) (up 100%) and Hansen (HANS) (up 40%) which I had on my watch list.
What I will do differently next time is to think about the min and max timeframe for completion just as we think about the min and max value of a company.
Asset Allocation
Back in September I had bought shares, and just after the crash I sold it all while still ahead because I wanted to buy something else that got hammered.
Eventually the price went lower to its pre-merger levels and I bought again, more this time. A couple weeks later, it went down to 10% below my purchase price on no news and I could sense people and some readers getting nervous. I doubled down at this point by selling my worst ideas. I didn’t want to make the same mistake I made with the Aquila merger by not investing enough to leave a decent profit after fees and taxes.
Puget Energy Coverage Closed at Old School Value
I am glad to say that on the last trading day of 2008, the announcement has lifted my sagging portfolio to a reasonable finish. The arbitrage helped keep my portfolio steady during the wild volatility as well as adding a nice return to my performance without having to speculate.
With 2009 expected to be worse than what we are going through now, I expect mergers to slow down further and fail more often. My decision to be involved in one merger at a time and focus on details has turned out to be safe and I will stick to this in the future.
Disclosure: I own shares of PSD at time of writing
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This article has 21 comments:
I was just curious about two things:
1. Bloomberg states the deal is "subject to 78 commitments and conditions." Have you looked at these subject items and are they pretty standard?
2. How is it that you are estimating the deal to close in two weeks?
It's even been mentioned in the last filing that upon approval, the merger will close in 2 weeks. That's why there was a press release stating that the deal will not be completed until 2009.
Also, those 78 commitments have been agreed upon for many many months. I have read through it and its stuff like, "PSD assures it will maintain its level of service", "PSD will work with involved parties to ensure fairness" etc etc.
@ User,
Macquarie had the financing in place for well over a month now. It's always been the public counsel trying to delay things and I'm not in the least bit worried about the 30 day appeal because it is just another excuse for the public counsel to try and use another delay tactic which shouldnt work anymore.
The market has no clue since it doesn't read the statements and the public hearing filings.
They said the deal was going to be difficult to pass given a 30% spread, but that was overcome quite easily except for the unnecessary delays.
Much thanks for your due diligence and pouring through the details of available documents. (I am rather new to Merger Arb but intrigued by the spreads in today's markets.)
I am less concerned with the exactness of closing date (i.e. two weeks) than the deal closing period. If the deal were to close in the next two quarters I'd say the current return is extremely attractive.
As for the spread, I've noticed larger than average spreads in general in the market over the past quarter. And actually, it makes sense. I imagine contributing factors are 1) an extremely risk-averse market 2) huge 2008 "broken deal" volume 3) difficult credit markets for deal financing and the over publicized 4) historic uncertainty/volatility... weakness. I noticed the MER-BAC deal had 18% spread two Thursdays before the deal closed (of course it was on a day the market feared Citi would collapse) and that was a deal our very government (Treasury) would make sure got done.
Anyway, again, I'm very grateful for your work on this deal and sharing it with us; It influenced my investment decision and I'd be appreciative of any updates.
On Jan 02 02:01 PM Jae Jun wrote:
> @ Marc,
>
> It's even been mentioned in the last filing that upon approval, the
> merger will close in 2 weeks. That's why there was a press release
> stating that the deal will not be completed until 2009.
>
> Also, those 78 commitments have been agreed upon for many many months.
> I have read through it and its stuff like, "PSD assures it will maintain
> its level of service", "PSD will work with involved parties to ensure
> fairness" etc etc.
>
> @ User,
> Macquarie had the financing in place for well over a month now. It's
> always been the public counsel trying to delay things and I'm not
> in the least bit worried about the 30 day appeal because it is just
> another excuse for the public counsel to try and use another delay
> tactic which shouldnt work anymore.
>
> The market has no clue since it doesn't read the statements and the
> public hearing filings.
>
> They said the deal was going to be difficult to pass given a 30%
> spread, but that was overcome quite easily except for the unnecessary
> delays.
Obviously PSE wont be challenging and I think the Commission has had enough of the public counsel from what I read in the filings.
But is not the UTC order approving the settlement an administrative agency order from which a party may appeal to the circuit court? Assuming that public counsel has the right to appeal and exercises it, would the pendency of an appeal in the circuit court preclude the deal from closing while the appeal is resolved?
Court proceedings in a circuit court can take time and the losing party usually can appeal the trial court ruling to a higher court.
On Jan 04 02:16 PM Jae Jun wrote:
> The last 8-k filing mentioned that the only company to not have submitted
> their approval was PSE (subsidary of PSD).
>
> Obviously PSE wont be challenging and I think the Commission has
> had enough of the public counsel from what I read in the filings.
>
>
Another reason for the wide spread is the following: According to the merger agreement, the Acquirers' liability is capped at $130MM if they were to breach the agreement. This means that if the Acquirers did not feel like completing this deal -- for whatsoever reason -- they are liable to pay $130MM to Puget, but not a penny more. Recently, deals that have blown up frequently contained a similar clause, whereby the purchaser had an option to walk away by paying a nominal break-up fee. With the stock market having raced to the bottom, most deals that were cut months ago now appear highly overpriced. What have acquirers done to compensate for their ill-timed dealmaking? They have simply walked away because they were allowed to under the merger agreement. Were it not for this seemingly innocuous clause in the Puget merger agreement, I believe the spread would be much tighter.
Having said that, I believe that this deal is not only highly likely to close, but close by January 22nd 2009, for the following reasons. If you listened to the Commission hearings in Sepember/October as well as read the hundreds of pages of WUTC briefs filed by the Joint Petitioners (Puget and the Acquiers), which I did, you will see that the Acquirers were simply "pounding the table" on wanting to complete this acquisition. Keep in mind that this was as recently as October when the financial world seemed to come to a screeching halt. Even at the height of the financial market meltdown, the Acquirers were adamant that they had the financial flexibility to not only complete the acquisition, but also fund billions of dollars of capital expenditures for the next five years -- something that Puget, without this buyout, will find extremely difficult to to. Acquirers were also adamant that the terms of the "ring-fencing" provisions, which provide a margin of safety to the well-being of the "Opco" (the operating utility), are the best such provision of any similar transaction in modern history -- and the WUTC staff singularly agreed with this argument. Here we are -- less than 3 months after the hearings and the briefs and the financial world has gotten a little calmer -- I would argue that if the Acquirers were adamant on wanting to acquirer Puget in October, I think they would want to acquire Puget today.
To elaborate on this important point, I spoke with a respresentative of Macquarie who is close to this deal. He agreed that "nothing has changed" since the hearings were held and the briefs were filed in October.
So an obvious question that comes up on all of this: Why would the Acquirers want to acquire Puget for an inflated price of $30/shr? First of all, the Acquirers are infrastructure investors,. Not only do they own Duquesne Power & Light in PA, they own water utilities, highways, bridges and tunnels all over the world. Puget is a regulated business that they want to own for the long-term. Many people view Puget as a typical LBO. That is not entirely correct. The Acquirers are putting up $3.3 billion in equity capital for Puget, nearly 50% of the enterprise value of the company. That is a lot more equity than your garden variety LBO that has 20% equity. What that means is -- the Acquirers are willing to accept a lot lower internal rate of return on their equity than a typical LBO. I believe this is because regulated businesses such as Puget generate highly predictable cash flows, and therefore, the hurdle rate on such stable cash flow stream is correspondingly lower. The Macquarie representative confirmed that this was the case.
Without further rambling --- the point is, I believe Puget acquisition, although expensive by today's utility valuation standards -- fits the profile of what the Acquirers are looking for. If they walked away from this, it will take another 1 1/2 years for them to acquire another utility -- any utility --in the U.S. Is that worth it even though they would be able to buy the next one a bit cheaper? By the time they complete their next purchase, who knows, utility valuations may come back up...
By the way, there was nothing in the WUTC Order that anyone should be comcerned about. It's a long document, but there is nothing substantively different than the multi-party settlement that Puget signed along with the Staff back in July. I would be shocked if Macquarie tries to put a negative spin on the WUTC Order conditions. As far as I know, they should be giving each other high fives since they got pretty much everything they were looking for in the Order.
I hope this helps if you are wondering why the PSD spread is so wide. It is wide for the reasons I explained above. But it being wide presents a huge opportunity to make 10.5% in a week and a half.
One final point -- if you want to own PSD stock, you should look at PSD Jan $25 calls. They are much better risk/reward than the stock (for reasons I won't go into here..) If you want to be really technical, you should buy those options and short the stock. If you get the "delta" right, you will make money if the deal completes, AND you will make money if the deal falls apart and the stock goes to $17.00 as long as this binary event happens before the option expiration next Friday.. (What a beautiful arbitrage..!!) Because, as much as I think the deal will get done, what if I'm wrong? I wouldn't want to get carried out in a stretcher...
Now go and make some money........
**********************...
thanks! I breezed through the WUTC filings and came to the same conclusion.
Although I'm not singing at the moment, Im confident that the probability of the deal closing is much higher than it the case for it failing.
If PSD trades to $17/shr upon a deal bust, and you make $30 plus $0.25 in dividends if deal closes, that implies an 86% market-implied probability of this deal closing. (At the current PSD price of $28.45.) What that means is unless you have greater than 86% confidence level of deal completion, you should sell every share that you own. Are you greater than 86% confident?
On Jan 09 12:26 PM Jae Jun wrote:
> MTJ489
>
> thanks! I breezed through the WUTC filings and came to the same conclusion.
>
>
> Although I'm not singing at the moment, Im confident that the probability
> of the deal closing is much higher than it the case for it failing.
On Jan 08 06:26 PM MTJ489 wrote:
> The WUTC order provides a scathing commentary about how much the
> Public Counsel has been off the mark in its arguments. Apart from
> Commissioner Jones' dissent, WUTC's majority view was that the deal
> was entirely consistent with the public interest and will not harm
> ratepayers. Against this backdrop, I doubt that the PC will appeal
> the decision. I think the more likely scenario would be that the
> Acquirers (the investor consortium) will seek to clarify the WUTC's
> order by filing a petition. This will have the effect of delaying
> the closing by weeks or months. And, as everyone knows, pending
> mergers don't age like fine fine, so any delay beyond the normal
> 15 days following the "Final Order" (as defined in the merger agreement),
> which comes up on January 22nd, will not be viewed well by the market.
> I believe that this is one of the reasons that the spread is trading
> wide.
>
> Another reason for the wide spread is the following: According to
> the merger agreement, the Acquirers' liability is capped at $130MM
> if they were to breach the agreement. This means that if the Acquirers
> did not feel like completing this deal -- for whatsoever reason --
> they are liable to pay $130MM to Puget, but not a penny more. Recently,
> deals that have blown up frequently contained a similar clause, whereby
> the purchaser had an option to walk away by paying a nominal break-up
> fee. With the stock market having raced to the bottom, most deals
> that were cut months ago now appear highly overpriced. What have
> acquirers done to compensate for their ill-timed dealmaking? They
> have simply walked away because they were allowed to under the merger
> agreement. Were it not for this seemingly innocuous clause in the
> Puget merger agreement, I believe the spread would be much tighter.
>
>
> Having said that, I believe that this deal is not only highly likely
> to close, but close by January 22nd 2009, for the following reasons.
> If you listened to the Commission hearings in Sepember/October as
> well as read the hundreds of pages of WUTC briefs filed by the Joint
> Petitioners (Puget and the Acquiers), which I did, you will see that
> the Acquirers were simply "pounding the table" on wanting to complete
> this acquisition. Keep in mind that this was as recently as October
> when the financial world seemed to come to a screeching halt. Even
> at the height of the financial market meltdown, the Acquirers were
> adamant that they had the financial flexibility to not only complete
> the acquisition, but also fund billions of dollars of capital expenditures
> for the next five years -- something that Puget, without this buyout,
> will find extremely difficult to to. Acquirers were also adamant
> that the terms of the "ring-fencing&... provisions, which
> provide a margin of safety to the well-being of the "Opco" (the operating
> utility), are the best such provision of any similar transaction
> in modern history -- and the WUTC staff singularly agreed with this
> argument. Here we are -- less than 3 months after the hearings and
> the briefs and the financial world has gotten a little calmer --
> I would argue that if the Acquirers were adamant on wanting to acquirer
> Puget in October, I think they would want to acquire Puget today.
>
>
> To elaborate on this important point, I spoke with a respresentative
> of Macquarie who is close to this deal. He agreed that "nothing
> has changed" since the hearings were held and the briefs were filed
> in October.
>
> So an obvious question that comes up on all of this: Why would the
> Acquirers want to acquire Puget for an inflated price of $30/shr?
> First of all, the Acquirers are infrastructure investors,. Not only
> do they own Duquesne Power & Light in PA, they own water utilities,
> highways, bridges and tunnels all over the world. Puget is a regulated
> business that they want to own for the long-term. Many people view
> Puget as a typical LBO. That is not entirely correct. The Acquirers
> are putting up $3.3 billion in equity capital for Puget, nearly 50%
> of the enterprise value of the company. That is a lot more equity
> than your garden variety LBO that has 20% equity. What that means
> is -- the Acquirers are willing to accept a lot lower internal rate
> of return on their equity than a typical LBO. I believe this is
> because regulated businesses such as Puget generate highly predictable
> cash flows, and therefore, the hurdle rate on such stable cash flow
> stream is correspondingly lower. The Macquarie representative confirmed
> that this was the case.
>
> Without further rambling --- the point is, I believe Puget acquisition,
> although expensive by today's utility valuation standards -- fits
> the profile of what the Acquirers are looking for. If they walked
> away from this, it will take another 1 1/2 years for them to acquire
> another utility -- any utility --in the U.S. Is that worth it even
> though they would be able to buy the next one a bit cheaper? By
> the time they complete their next purchase, who knows, utility valuations
> may come back up...
>
> By the way, there was nothing in the WUTC Order that anyone should
> be comcerned about. It's a long document, but there is nothing substantively
> different than the multi-party settlement that Puget signed along
> with the Staff back in July. I would be shocked if Macquarie tries
> to put a negative spin on the WUTC Order conditions. As far as I
> know, they should be giving each other high fives since they got
> pretty much everything they were looking for in the Order.
>
> I hope this helps if you are wondering why the PSD spread is so wide.
> It is wide for the reasons I explained above. But it being wide
> presents a huge opportunity to make 10.5% in a week and a half.
>
>
> One final point -- if you want to own PSD stock, you should look
> at PSD Jan $25 calls. They are much better risk/reward than the
> stock (for reasons I won't go into here..) If you want to be really
> technical, you should buy those options and short the stock. If
> you get the "delta" right, you will make money if the deal completes,
> AND you will make money if the deal falls apart and the stock goes
> to $17.00 as long as this binary event happens before the option
> expiration next Friday.. (What a beautiful arbitrage..!!) Because,
> as much as I think the deal will get done, what if I'm wrong? I
> wouldn't want to get carried out in a stretcher...
>
> Now go and make some money........
>
> **********************...
>
>
On Jan 09 12:42 PM MTJ489 wrote:
> Jae --
>
> If PSD trades to $17/shr upon a deal bust, and you make $30 plus
> $0.25 in dividends if deal closes, that implies an 86% market-implied
> probability of this deal closing. (At the current PSD price of $28.45.)
> What that means is unless you have greater than 86% confidence level
> of deal completion, you should sell every share that you own. Are
> you greater than 86% confident?
>
>
>
>
>
> On Jan 09 12:26 PM Jae Jun wrote:
If you were long the calls, and short the PSD stock, and if there is a binary outcome before the Jan expiration, you can make money if the deal closes, AND make money if the deal busts. This is possible because the risk/reward on the options is better than the stock. So if you get the "delta" right, you can profit in both scenarios. But this gets a bit tricky due to the short timing, etc...
On Jan 10 09:46 AM mwm711 wrote:
> Excellent analysis. If the deal is supposed to close by 1/22/09 is
> there a potential problem with buying January calls that expire on
> 1/17/09?
They way I read the WUTC's order, PC would have had to move for a stay within a request for reconsideration which it did not do. The filing of an appeal in the circuit thus could not operate as a stay. Also PC's statement after the WUTC order did not sound like a party intent on appealing which it did not at least before the WUTC.
If the deal doesn't close before 1/21/09 then does not PSD have to pay .25 dividend?
I hope to write about another deal that I have been looking into lately. Lots of fear in this one which also seems to be ridiculously mispriced.