Double-Digit Premiums In U.S. Merger Arbitrage Plays, Part 1

Includes: BAC, FFBT, JAKK, OSK, PB, VQ
by: Rajiv Tarigopula

For risk-seeking investors, there are some potentially high-return opportunities available in merger arbitrage this week. In this first article of a series in which I will examine several such trading opportunities, here's a closer look at three deals with premiums greater than 10%.

1. Venoco (NYSE:VQ), a player in the oil exploration and production industry, is in the middle of a going-private offer by an American management group. This deal was announced in late August 2011, and the acquirer is seeking to close out the takeover of this target with a purchase of an additional 49.7% stake in VQ, of which they already own the remaining 50.3%. The announced value of this deal is $382.8 million, which represents a huge current premium of 31.23% (higher than the 27% premium at the time of announcement). The acquirer proposes to pay $12.50 cash for each share of Venoco, which is a gross spread of just under $3 per share.

VQ's financial adviser is Bank of America Merrill Lynch (NYSE:BAC), which is receiving a fee of $5.3 million for its work. Important to note is that this deal has been approved by both the target board of directors (on Jan. 16, 2012) and the target shareholders (on June 5, 2012). Things are looking good for those optimistic about this merger being completed, but the possibility of share price manipulation should not be discounted. Direct competitors to the target oil and gas operator include Berry Petroleum (BRY), Occidental Petroleum (NYSE:OXY), Plains Exploration and Production (NYSE:PXP), and others.

2. East Texas Financial Services (OTC:FFBT), in the savings and loan/thrifts sector, is being sought by acquirer Prosperity Bancshares (NYSE:PB). This friendly deal was announced on Dec. 9, 2011, and is pending completion (which was expected at the end of June 2012). The announced value of this deal was $20.11 million, which was a 44.38% premium at the time it was announced. Current value of the deal due to share price movements is $21.81 million, which still represents a robust current premium of 28.3% for brave investors. In this all-stock deal, the acquirer proposes to pay 0.406 of its own shares for each target share owned by shareholders.

This deal has been approved by both the acquirer's and the target's boards of directors (on Dec. 9, 2011, when announced), and the target shareholders approved the deal effective April 26, 2012. However, the deal is still pending approval by the Federal Reserve Board, the Federal Deposit Insurance Corporation, and the Texas Department of Banking and Finance, creating a dramatic environment for potential traders and investors. Options plays in this arena are certainly not a bad idea, in my view. Consolidation in the financial services sector recently has been frequent, and those following such transactions may want to keep an eye on industry peers Flagstar Bancorp (NYSE:FBC), New York Community Bancorp (NYB), People's United Financial (NASDAQ:PBCT), Hudson City Bancorp (NASDAQ:HCBK), Washington Federal (NASDAQ:WAFD), Capitol Federal Financial (NASDAQ:CFFN), and Astoria Financial (NYSE:AF), among others.

3. Oaktree Capital Group LLC (NYSE:OAK), an investment company, is seeking to acquire JAKKS Pacific (NASDAQ:JAKK), a U.S. toymaker, in an unsolicited bid announced on Sept. 14, 2011. Oaktree Capital Group currently owns 4.9% of this firm, and is looking to takeover the company with an additional equity closeout purchase of 95.1%. At the time of announcement, the announced value of the deal was $360.5 million, representing a premium of 24.17%. Share movements since then have made the current premium rise to 26.58%. OAK has offered $20 cash per share to JAKK shareholders, resulting in a gross spread of $4.20 per share in this all-cash transaction. The target company is being advised by Bank of America Merrill Lynch as well, and investors should note that the target board of directors blocked this deal effective Sept. 13, 2011.

Though the talks on this deal seem to have broken down recently, Barron's recently affirmed its outlook on shares of JAKK to reach the offer price of $20/share, and bullish investors may take a look at this as a value investment rather than a merger arbitrage speculative play. Recently quarterly earnings reports offer a great deal of material for due diligence. Competitors to JAKK include brand-name toymakers Hasbro (NASDAQ:HAS), privately held Marvel Entertainment, and Mattel (NASDAQ:MAT), among others.

Of course, any investors seeking such lucrative plays in merger arbitrage should realize that there is good reason the market hasn't fully priced in the offer per share into the price of targets' equity shares. You must take into account the probability of the deal not gaining regulatory or government approval, management and company boards not approving the deal, or a whole host of other factors as these can all contribute to downside risk on these equities. In short, do your own due diligence before diving into one of these with hard-earned capital.

Disclosure: I am long BAC.

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