Parlux Owners Will Get Discount On Perfumania Shares At Merger Conversion

Mar.27.12 | About: Parlux Fragrances, (PARL)

Perfumania's (NASDAQ:PERF) acquisition of Parlux (NASDAQ:PARL) has some interesting, and a little confusing, details. Upon the merger closing date, PARL shareholders have the option to trade each PARL share for either 0.5333 PERF shares, or receive $4 and 0.2 PERF shares. At the moment, PARL is trading for around $5.60. So if shareholders took the former deal, it would be the equivalent of buying PERF at: $5.6/0.5333 = $10.50/sh. If they took the latter, it would be like buying PERF at ($5.60-$4.00)/.2 = $8.00/sh.

Naturally, Perfumania's management expects that all Parlux shareholders will take the cash plus shares deal. As it says in the Letter of Transmittal, PARL shareholders that don't state their preference will by default get the cash/stock mix. As stated in the merger proposal, PARL shareholders that don't vote on the merger will be counted as voting against the merger. However, there are enough insiders and major holders that it won't make a difference if smaller shareholders vote or not.

The merger closing is on April 16th. That's the day when PARL shareholders will have said whether they want the cash and stock mix or the all-stock conversion.

Right now, PERF is trading for around $10.00 a share. Buying PARL shares now would give the equivalent of a 20% discount on PERF shares post-merger. If PERF shares are worth $10 apiece, the proper value of PARL shares is $6.00. If you are interested in owning PERF, I'd advise buying PARL instead. However, if you don't want to take the miniscule risk that the merger won't go through, then buying PERF is also a great deal as I'll explain in my next article.

I'd advise against buying PERF shares outright before the merger closing.

It's hard to predict exactly what will happen to PERF stock after the merger, but it might drop because of the risk-arbitrageurs. One of these signs is that there are millions of PARL shares available to short, however there aren't any PERF shares to short. Investors made arbitrage plays and bought PARL stock and shorted PERF stock once the acquisition details were known. If there were any PERF shares left to short, they would be immediately shorted because the arbitrage play is still there to be made.

There's a risk for current PERF shareholders that after the merger, the investors playing this arbitrage game will dump their converted PERF stock after attaining the small gain because they had no interest in holding PERF for the long term.

Small investment firms are playing this arbitrage game. MMCAP International recently submitted a Schedule 13G filing stating that they now own 5% of PARL. They never filed for Parlux holdings before. Centaurus Capital did the same thing. They recently filed a Schedule 13G for a 5% ownership of the company and had never filed before for Parlux.

What makes this arbitrage opportunity even better is, as reported by Perfumania, the Nussdorf Family and the Garcia Group, both large Parlux and Perfumania shareholders, are going to choose the all-PERF stock swap regardless of what the stock price is at the merger closing. The Nussdorf family owns 9.9% of PARL stock, and the Garcia Group owns 19.2% of PARL. By doing an all equity swap, at the current PARL price they are valuing PERF at $10.50.

The only reason one would buy PERF stock now is if they think the merger won't go through for some reason. My guess is there's a greater than 95% chance of the merger going through. The only shareholders that have been hurt by it are PERF shareholders. PERF was at $19 a share pre-merger announcement, and is now at $10 a share so it has lost 47% of its value because of it.

82% of PERF's shares are owned by the Nussdorf family, followed by 8.4% owned by the Garcia Group. The Garcia Group, run by Rene Garcia, is a managing member of Jacavi Holdings, a fragrance distributor that is one of Parlux' biggest customers. Both Garcia and the Nussdorfs pushed for the merger, so they will all vote for it. A company only needs a majority vote for a merger to go through, so it will surely be voted for by both companies. Furthermore, the independent committees for both companies voted unanimously for the merger.

Currently there's a lawsuit claiming that because Perfumania is Parlux' largest customer, Perfumania bullied Parlux into selling itself at an unfair price. The complaint mentioned that Perfumania's shares have since plunged, thus reducing what Parlux's investors will receive. However, the plaintiff in this lawsuit, purported Parlux shareholder Jose Diaz, doesn't seem to have a case. From speaking to the CFOs of both Parlux and Perfumania, they give the impression that the lawsuit is a joke. According to the Parlux CFO, the plantiff attorneys actually reached out to find a PARL shareholder to do the lawsuit in order to reimburse expenses. The attorneys found Diaz, not the other way around. Diaz didn't file a 13D so he isn't even a 5% shareholder of Parlux. PARL was at $3.40 before the merger announcement and is now at $5.60 for a 65% gain. Most PARL shareholders were very pleased with this merger.

The reason why PERF stock went down so much is because of the merger. This means the market thinks the company is paying too much the acquisition. On the other hand, if Perfumania is buying Parlux for too cheap, then PERF stock should rise back above the $19 that it was at before the merger announcement. It's a win-win either way for PARL shareholders.

Another reason why the Parlux/Perfumania price parity is off is because apparently Perfumania had tried another merger years ago that didn't pan out. That was an embarrassment for the company, and it still isn't fully trusted by the market. However this merger is very complete and thorough. It has every indication of going through.

Owning PERF shares isn't a whole lot different than owning PARL shares. They are both in the celebrity perfume business. Parlux shareholders can now enjoy the company's success through being a shareholder of Perfumania.

Trade recommendation: For PARL: Strong Buy, For PERF: Sell premerger, Buy postmerger

Disclosure: I am long PARL.

Additional disclosure: I am short PERF. However, my PARL position far outweighs my short PERF position. After the merger, I will be net long PERF and plan on holding for the long term.