Ensco (ESV) and Atwood Oceanics (ATW) have recently filed definitive proxy materials in connection with the upcoming merger. This filing is highly interesting due to the speculative nature of the merger (from Ensco’s side, of course) and the relatively high valuation that Atwood Oceanics received. I have initially stated that this merger is good for Atwood and bad for Ensco and maintained this stance up until now (I’m not alone in this evaluation of the merger). The filing sheds light on the negotiation process and provides great insight on why Atwood was highly valued. Both stocks have experienced significant downside after the merger announcement with short interest increasing, so any news on the merger front are important for stock price action as it might take just one major upside catalyst to send shares on a short-squeeze rally.
Here's a quick summary of main points of the merger:
- Atwood shareholders get 1.60 shares of Ensco for each Atwood share they own.
- Ensco shareholders will own 69% of the combined company, while Atwood shareholders will own 31% of the combined company.
- Both Ensco and Atwood shareholders will vote on October 5, 2017.
- Atwood needs 2/3 of its common shareholders to approve the merger.
- Ensco needs a majority of shares to approve the merger.
- If merger fails because of Atwood, the company will pay $30 million to Ensco.
- If merger fails because of Ensco, the company will pay $50 million to Atwood.
Now let’s see how the exchange ratio was defined and why Ensco agreed to a breakup fee of $50 million.
It turns out that Atwood Oceanics was long thinking about selling/merging itself to a competitor. Back at a meeting on February 27, 2015, Atwood’s CEO indicated to a CEO of a Company A (names of real companies are of course not disclosed in the filing) that combining Atwood and Company A could possibly make strategic sense. Atwood’s CEO reiterated his desire to study the potential of combination with Company A at a breakfast meeting on September 9, 2016. Further that day, Atwood’s CEO also approached CEO of a Company B.
It is not surprising to learn that Atwood was trying to find a solution a year ago because it was approaching a backlog cliff and already facing serious problems. The filing also mentions that Atwood’s CEO also approached the CEO of a Company C at an industry event on November 1, 2016.
However, the real action started when Atwood’s CFO met for lunch with CEO of a Company D on January 26, 2017. This company will be the only real Ensco competitor in the bidding process that followed. On April 18, 2017, the CEO of company D stated that company D will be ready to make an all-stock proposal representing approximately 30% premium to Atwood’s then current share price, or $10.40. On April 25, 2017, Company D sent a non-binding indication of interest to Atwood, implying an equity value of $11.00 for Atwood shares. On May 10, Atwood asked Company D to value Atwood at 66.5% premium to Atwood’s May 10 closing share price, a valuation that was out of Company D target range.
Meanwhile, Ensco was also negotiating with Atwood. Interestingly, Ensco’s initial offer was an exchange ratio of 1.278 Ensco shares for one Atwood share. On May 19, Atwood informed Ensco that its bid was lower than the competing bid, which ultimately led to Ensco’s proposal of 1.60 Ensco shares per Atwood share which was accepted.
As we see here, Atwood’s management did a terrific job selling the company at the highest possible price. As some commentators here on SA suggested, the resulting high price of the merger was due to Ensco’s decision to outbid a competitor. I maintain my view that owning Atwood assets is not a key determinant in future success for any potential acquirer, so I do not understand the rush of acquiring Atwood at any price, especially given Atwood’s financial situation.
Atwood’s management was well aware of the difficult situation they were facing, so they were asking Ensco to pay with both stock and cash for transaction in order to avoid the vote on merger by Ensco shareholders. I find this very important, so I’ll provide a direct quote from the filing here: “Mr. Saltiel [Atwood CEO] also indicated that Atwood would prefer to engage in a transaction with increased closing certainty which did not require a shareholder vote from Ensco and therefore Mr. Saltiel suggested that any revised proposal from Ensco include both stock and cash, with the stock portion below the threshold requiring an Ensco shareholder vote”.
In my view, the main reason for this wish is that Atwood understood that it was searching for a high valuation that may not be beneficial for Ensco shareholders who, in theory, can vote “no” on the merger. Also, should the merger fail, Atwood shares will get decimated and the company will have no chance to arrange a similar deal with another company, like Company D from the filing. Once again, I must say that I’m surprised that both Ensco and Company D approached Atwood in the first half of this year, while they could have easily waited until the end of the year, when backlog problems would have likely had a significant negative effect on Atwood’s share price.
Speaking about the valuation of the deal, Ensco’s advisor was Morgan Stanley and Atwood’s advisor was Goldman Sachs. Both advisors decided that the deal was fair. I must admit that I’m quite skeptical about the practical usefulness of advisors’ work for investors. The valuation ranges are typically so wide that you can “forecast” the share price with the same “certainty” by a quick look at a company’s stock price chart. For example, Morgan Stanley arrived to a conclusion that the implied exchange ratio resulting from the discounted equity value analysis was 0.67x – 2.93x while the merger ratio was 1.60x. There is work and knowledge behind those numbers, but how can they help an investor or trader? Essentially, I suggest that investors and traders should always do their own due diligence and think for themselves. The “fair” label on the deal by both Morgan Stanley and Goldman Sachs only means that the deal is not completely outrageous.
In conclusion, I want to say that the materials of the filing highlight the attractiveness of the deal for Atwood shareholders. At the same time, the deal looks dubious for Ensco. I’m not surprised that Ensco’s shares have been under much pressure in recent weeks. Nevertheless, I’d expect a rebound if oil prices help a bit and a significant rebound if the merger fails. Should oil prices stay below $50, even more downside is possible, although the majority of risk scenarios (except bankruptcy, of course) have already been priced in Ensco shares.
