2 Merger Opportunities: Keurig Green Mountain And RealD

| About: Keurig Green (GMCR)

Summary

High annualized return arbitrage opportunities for all-cash buyouts of Keurig Green Mountain and RealD.

Very low deal break risk; established purchasers and the deals are not contingent on financing.

Deal closures are expected by the end of March, but returns are also attractive for later closure dates.

Comparatively, RealD offers a better return and less potential downside.

In market conditions like the present, long investors reviewing their portfolios often find a disheartening sea of red. M&A arbitrage can provide a counterbalance to market volatility and very attractive positive returns when undertaken in a prudent manner. My goal is to choose deals which have low transaction hurdles and a relatively clear time horizon while still offering reasonable returns. While the basic 2% to 6% returns do not appear that attractive, they are likely to occur in less than two months, resulting in very attractive annualized returns.

The all-cash takeovers of Keurig Green Mountain (NASDAQ:GMCR) and RealD (NYSE:RLD) are two such opportunities. The following tables illustrate annualized returns with a range of starting prices and closure dates to account for market movements and timing of deal closures.

Highlighted is what I believe to be the range of most likely outcomes (as of 3 February close prices).

Of the two, it's clear that RLD offers the better unweighted return profile, but before making a decision to purchase one or both, let's review the status and conditions/risks of each deal.

Keurig Green Mountain

  • Announcement date: 7 December 2015
  • Pre-announcement share price: $54
  • Deal price/premium: $92 per share in cash/70%
  • Acquirer: JAB Holding Co. (via subsidiary)
  • Deal value: $13.9B (equity value)
  • Acquirer break fee/% of deal value: Zero
  • Potential downside price/break probability: $45 or below/very low
  • Shareholder vote date: 24 February 2016

Key Terms and Status:

  1. Shareholder approval - Pending; Coca-Cola (NYSE:KO) holds 17% of voting shares and is in favor; no significant shareholder opposes the deal, and given the large delta in deal price to pre-announcement price, expect an overwhelming FOR vote
  1. Financing - The consummation of the merger is not subject to financing conditions. A debt commitment letter is in place with an underwriter syndicate, and acquisition bonds have been rated lowest investment grade for the standalone subsidiary.
  1. Regulatory approval/expiration of waiting periods:
    1. Hart-Scott-Rodino Act filing submitted 19 Dec., withdrawn and refiled 19 Jan.; and waiting period expires 18 Feb. The need to refile indicates some level of FTC concern, but there is no indication of a real deal breaker as significant competition will remain in the coffee market post-acquisition.
    2. Canadian Competition Act - Status not reported, but review period assumed to be expired.
  1. No court orders/injunctions - Typical law firm mill lawsuits filed, none expected to disrupt acquisition.
  1. No GMCR undisclosed material adverse effects, covenant breaches - None expected
  • Earliest closure date: 25 February 2016
  • Author's expected closure date: 31 March 2016
  • Dividends prior to expected closure: None

Notes: The lack of an acquirer termination fee is somewhat unusual, but the acquirer has no contractual escape clauses other than a GMCR violation of one of the key terms. This means that inability to obtain financing is not a valid termination reason, and if JAB attempted to back out for lack of financing, GMCR could sue for specific performance or equivalent damages. Regardless, the financing appears to be on track despite recent bond market jitters.

RealD

  • Announcement date: 9 November 2015
  • Pre-sale process share price: $9.27 (1 October 2014); Pre-deal announcement $10.57 (6 November 2015)
  • Deal price/premium: $11 per share in cash/19%
  • Acquirer: Rizvi Traverse (via subsidiary)
  • Deal value: $551M (enterprise value)
  • Acquirer break fee: $29M/5% of deal value
  • Potential downside price/break probability: $9 or below/very low
  • Shareholder vote date: 24 February 2016

Key Terms and Status:

  1. Shareholder approval - Pending; rollover investors, including Founder Michael Lewis who holds 12.5% of voting shares, will vote FOR, and will remain as equity holders post deal. No significant shareholder opposes the deal.
  1. Financing - The consummation of the merger is not subject to financing conditions. A debt commitment letter is in place with Highbridge Principal Strategies.
  1. Marketing period - Pending.
  1. Regulatory approval/expiration of waiting periods:
    1. Hart-Scott-Rodino Act filing submitted 22 Nov., and the waiting period expired 21 Dec.
  1. No court orders/injunctions - Typical law firm mill lawsuits filed, none expected to disrupt acquisition.
  • Earliest closure date: 26 February 2016
  • Author's expected closure date: 26 February 2016

Notes: RealD has struggled with cash flow and income, and this appears to be the best outcome for shareholders after a lengthy one year-plus sale process. It is worth noting that activist fund Starboard pushed the sale process with its own offer and was a 10% holder but has significantly reduced its holdings post announcement.

Other Thoughts

The break risk of each deal appears to be very low, so why is RealD trading at a larger spread than GMCR? Large arb desks may not be able to get enough of RLD to make it worthwhile. GMCR typically trades more than 10x RLD dollar volumes. Another factor may be market favoritism of JAB over Rizvi. JAB has been buying up coffee-related and other FMCG companies over many years, is now the #2 coffee company in the world by sales, and is seen as a strong buyer. Rizvi is a lesser-known entity, but is a significant player in the private equity scene, and there is no reason to believe it will not follow through.

Is there risk of the deals breaking due to poor equity and bond market conditions? Possibly, but the underlying financial conditions of GMCR and RealD have not changed significantly since the deals were announced, which negates a "market-conditions" excuse to break or renegotiate.

Some readers may be wondering why a weighted return/assumed deal break probability was not presented. In my estimation, the break probability for these deals is well under 5% and is not meaningful to the calculations of return. What is meaningful is the binary outcomes, and on that score, RealD is likely to inflict less pain in the event of a broken deal.

Conclusion

Although both deals are good opportunities, the choice for my own portfolio is RealD. It has less downside in the event of a broken deal, and significantly better real and time-weighted returns. GMCR also has the added hurdle of FTC approval, although that ultimately should not be a problem. Investors wanting some portfolio diversity could utilize both.

Those wanting even more diversity and future picks should consider following contributor Andrew Walker and his Investing with an Edge series and Chris DeMuth's M&A Daily for other arbitrage opportunities. Also, please use the comments section to let me and the other readers know whether you're playing one or both of GMCR/RLD, and to highlight other opportunities.

Author's note: Comments, suggestions, and criticisms are welcome. Feel free to send a personal message if you prefer not to comment publicly. If you liked this article, please click Follow beside my name at the top of the article.

Disclosure: I am/we are long RLD.

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.

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