Merger arbitrage had a tough week, with the Treasury aggressively blocking Allergan's (NYSE:AGN) merger with Pfizer (NYSE:PFE) and the Department of Justice suing to block the Baker Hughes (NYSE:BHI) merger with Halliburton (NYSE:HAL). One merger that I don't expect to be derailed by the government is Western Refining's (NYSE:WNR) acquisition of Northern Tier Energy (NYSE:NTI). Though we've seen many wide spreads in recent months, the current deal structure offers no upside for Northern Tier shareholders. I recommend exiting any position unless you are confident in the fundamental value of WNR stock.
Total Considerations Received all Lower than NTI share price
Per the merger agreement, investors have 3 options - all stock, all cash, and a mix of the two. The initial announcement notes that investors can receive 0.7036 shares of WNR, $26.06 in cash, or $15.00 in cash + 0.2986 shares, or 0.7036 shares. However, the agreement stipulates that options 1 and 3 will be adjusted to reflect the economics of option #2. Thus, there is no arbitrage between the different arrangements.
Given that shareholders are poised to receive $23.53 in total considerations and shares of NTI trade at $23.58, the market is pricing in some share price appreciation in WNR that would raise the overall ante. Perhaps due to NTI's size, unique unit structure, and incredibly tight spread, there could actually be an opportunity to make money on the short side if conditions persist - the opposite of conventional merger arb. You could actually hedge out the risk by shorting NTI and going long WNR; however, I think this would be the textbook definition of picking up pennies in front of steamrollers.
Bottom Line: Stay away from this situation
In contrast to the high profile mergers that have recently broken, I do not believe this deal will receive much regulatory scrutiny. WNR already effectively exerts control over NTI, and I do not see any reason to anticipate anticompetitive concerns. There's absolutely no arbitrage available at this time with the market pricing deal odds at 100%.
That said, I do not think investors should be involved in the situation at this time. If you are bullish on WNR, I think an outright position in WNR makes much more sense. If the deal somehow breaks, which I think has a probability of occurring of less than 5%, NTI units would decline at least 10-15% to reset NTI's valuation to reflect valuations in the refining space. Being long NTI at its current price offers little reward with substantial risk.
Disclosure: I am/we are long AGN.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.