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Lately, I’ve been focusing on trying to take advantage of the volatility by picking up shares of companies undergoing merger agreements. You may recall that I made passing mentions of purchasing Emmis Communications (NASDAQ:EMMS). If not, it’s probably because I forgot to post my June portfolio update.

I bought a good size position of this stock at the end of June at $2.17 but sold out completely at $2.20. Break even after you include fees.

Disappointing result but it was a decision that I had to make in order to stay disciplined.

Emmis Corporation Merger Arbitrage Details

  • Type: Going private acquisition via tender offer
  • Acquirer: JS Acquisition & Alden Global Capital
  • Target: Emmis Corporation
  • Announced date: April 26, 2010
  • Closing date: September 30, 2010
  • Closing value: $2.40
  • Last price: $2.20 at time of writing
  • Profit: 9% upside excluding fees

EMMS originally announced plans to be taken private by JS Acquisition, which is a company formed by the CEO of EMMS himself.

Completion Conditions

A majority of common A, B and 6.25% Series A Cumulative Convertible Preferred Stock stock must be validly tendered.

Herein lies the problem.

Merger Events

Seeing as how the CEO, Jeff Smulyan, holds most of the common shares, votes for the common isn’t a worry. The issue is the preferred stock.

One of the rules of merger investing is to make sure that opposing parties with sizable positions are not in a position where they can block the transaction.

In this merger arbitrage, there is no single preferred stock holder that can do this, but a group of holders acting together is a different story.

This group has signed a lock up agreement, where each will vote against the exchage of preferred stock for a new debt issue. The activist group in the lock up agreement hold a total of 969,858 preferred stock. Some funds could have easily bought more without the total being updated on the documents yet. This is more than a third of preferred stock, which is enough to block the transaction from being completed.

A good summary of the situation can be found in this article.

Activists

The preferred stock are selling in the open market for just under $22 but under the deal, holders are expected to receive 60% of face value.

This current situation with the lock up agreement is a fight to get Smulyan to raise the price. Smulyan already tried to take the company private before 2006 at a higher price and the activists must believe that they have the cards to get Smulyan to up his bid.

Probabilities

You can obviously see two sides here.

  • 1. Activists can force Smulyan to increase the buyout offer and reward both commons and preferred stock holders.
  • 2. Smulyan could easily walk away and live to fight another day.

Number 2 is why I sold out. I’ve made plenty of mistakes before, and before the lock up agreement was formed, EMMS was looking like a sweet 10% gain with very high chances of closing.

Now, in my opinion, the closing probability has decreased considerably. Gain potential “could” increase but the downside has gone up way too high for my liking.

With the tender deadline set for August 2, there is still a couple of weeks to keep an eye on the developments in case talks are positive.

The optimist and “gambler” in me wants to hold a small position but I wont be making any bets based solely on who I think will win.

Unlike a bankruptcy situation, there is no equity committee to lay out fundamental analysis or a judge to rule objectively in favor of the winner. Smulyan can easily withdraw the bid and walk away.

But what about you? Do you think that the parties involved make a good case for the bid being increased?

Disclosure: No holdings at time of writing.

Source: A Look at Emmis Communications' Merger Investing Play