On August 15, 2011, Google Inc (GOOG) and Motorola Mobility (MMI) announced an industry changing acquisition (press release). While market watchers knew that the Internet search company was in the market for intellectual property, most will agree that the $12.5 billion cash acquisition of MMI is a bold and surprising move. Up until today, most of the Google buyout speculation centered on InterDigital Inc (IDCC). The Internet search engine's business model seemed to refrain from hardware, but this could be a game changer. Google shareholders should be especially happy with the buyout price.
As we discussed in our July 31, 2011 article, "5 Speculative Special Situation Stocks With Lots of Upside Potential," Motorola Mobility's stock could appreciate "50% or more" on a sum-of-the-parts valuation if it were able to monetize its patent portfolio. But even we are surprised by the turn of events. The $40 per share buyout represents a 79% premium from the July 29th closing price of $22.38.
But considering the market enthusiasm for Google's move and the technology giant's proven interest in purchasing mobile device related intellectual property, why is MMI's stock price trading at a meaningful discount to the cash deal price? Based on a $38.12 close, the stock trades at a 4.93% discount to the buyout price and that does not account for the possibility of a competing bid from a plethora of potential strategic suitors. Under the current deal and market conditions, this seems like an risk arbitrage yield. But before investors jump in head first, we think they should consider this list of possible stock market concerns about the deal.
POSSIBLE STOCK MARKET CONCERNS
1. Funding Concern: This is a common risk to buyouts, especially during volatile market environments, but this is not the case in this instance. GOOG sits on a massive stockpile of excess liquidity. As of June 30, 2011, the search giant had nearly $40 billion in excess cash and investments. Considering the low leverage and high margins inherent in their business model, Google will easily finance this all cash deal.
2. Bad Strategy Concern: This can be an issue when the acquisition payment is made in the stock of the acquirer, but this is a $40 per share cash offer, the wisdom of the deal should not affect the price of the target company's price prior to closing. In cash deals, we assume that the checks will cash before the acquirers realize their misguided efforts (if they are indeed misguided). If that assumption holds, then this concern should not affect the target company's stock price and should not contribute to a larger than average discount from deal price.
3. Shareholder Dissent: This appears to be a fair price for Motorola Mobility shareholders. While there will always be shareholders who hold out for better prices, in this instance, there should not be the type of widespread anger needed to threaten the deal. Carl Icahn has been the company's most vocal shareholder, dating back to before the Motorola breakup. He recently called for a monetization of the Motorola mobile device IP and we can only imagine that he is happy with the price and swiftness of the deal.
4. Time Value of Money Concerns: This is a real consideration. Not only do investors need to calculate the raw discount to deal price, they also need to consider the expected time needed to complete the transaction. But this is not a likely problem in this deal because Google estimates that the transaction will be completed by the end of 2011 or early 2012. This could drive the annualized return to above 20% in the best case scenario.
5. Regulatory Concerns: This is the last major concern and considering our dismissal of the other typical concerns in our above list, this could very well be the reason for MMI's larger than expected discount to deal price. The U.S. Federal Trade Commission is already investigating GOOG so regulatory issues are a reasonable vague concern but upon closer examination, we do not see the real threat to the competitive marketplace. As they explicitly state in the merger press release, "Google remains firmly committed to Android as an open platform and a vibrant open source community."
We think Motorola Mobility represents one of the best merger arbitrage plays of the year. Not only is the acquirer well funded, shareholders have pushed for strategic alternatives, the acquirer is committed, the acquisition price is reasonable, the transaction should close soon and the regulatory concerns are likely overblown.
In addition, we think there is a possibility that other potential buyers could step into the mix. Just last month, a consortium led by Apple Inc (AAPL) acquired Nortel Networks' patents for $4.5 billion. In that auction, Google bid a relatively modest $900 million. If they are this cautious about valuing industry IP assets, maybe this means that there are other strategic players like Apple Inc, Hewlett-Packard (HPQ), Nokia Corp (NOK) and Microsoft (MSFT) who would consider making a higher bid for MMI. In addition, AAPL, HPQ, NOK and MSFT are also flush with excess cash and as such, they could easily finance a superior bid. For example, MSFT had more than $60 billion of cash and investments, or closer to $45 billion of excess liquidity during the last quarter. AAPL's excess liquidity was closer to nearly $70 billion.
In summary, MMI's discount to the deal price is alone worth the price of admission, but potential interest from other parties really puts this risk arbitrage opportunity over the top.
Disclosure: I may initiate a long position in GOOG, HPQ, MSFT over the next 72 hours. I own AAPL and MMI shares. I intend to purchase more MMI shares if the stock price drops.