Fiat Chrysler Automobiles (FCAU) shares are surging and bringing nothing but treats on this Halloween day after the automaker confirmed its plans to merge with France's Peugeot PSA (PUGOY) in a $50 billion deal the pair said would create the world's fourth largest automaker. Upon final approval of the deal, this automaker will have a market capitalization of around $50 Billion. The all stock merger will save the combined groups more than $4 billion a year in cost synergies, the new group said, while creating a global automobile manufacturer capable of production 8.7 million vehicles a year while generating roughly €11 billion in annual profits. Shareholders of each automaker would own 50% of the combined operation, the companies said in a joint statement on Thursday. A binding agreement could be finalized within weeks, the statement said. The group's top brands will include Fiat, Dodge, Jeep, Alfa Romeo, Maserati, Opel and Vauxhall. With France's support of this deal, Minister Bruno LeMarie has offered supportive comments on the merger's scale and job protections. This is very good news for the potential new merger where FCAU could not get a blessing from the French government on a Renault-Nissan merger with FCAU.
What I would like the reader to take away from this article is how the market has not priced in the special dividends coming to FCAU shareholders. As part of this new stock merger deal, Fiat Chrysler could pay its shareholders a dividend of roughly $5.5 billion dollars. Last fall, FCAU announced the sale of Magneti Marelli to KKR that allowed a special dividend. Shareholders received that cash special dividend along with its annual dividend it paid out in May of .65cents/share. Fiat Chrysler continues to deliver to its shareholders in form of dividends and doesn't seem to be stopping anytime soon with its latest announcement. The biggest element to this article is what would the special cash dividend look like? Lets take a rough calculation below:
Shares Outstanding (1,567,378,478) divided by Approximate Special Dividend ($5.5 Billion) = $3.50/share
Now, its important to note that this is a very rough calculation. We need specific information today from FCAU during its earnings call that would confirm this detail, along with the board approval to pay this out. Again please note, these are rough calculations that could change in the next few weeks. These assumptions are based on a MarketWatch source who is providing these details.
Merger arbitrage is often considered an alternative hedge fund strategy, which involves simultaneously purchasing and selling the stocks of two merging companies to create smaller but more consistent profits. A merger arbitrageur reviews the probability of a merger not closing on time or at all. Here, the biggest risk to this potential merger is that of France's government not approving it. However, market rumors have been published that Minister Bruno LeMarie has offered high remarks for this deal.
In a stock-for-stock merger, which we see here with FCAU, a merger arbitrageur typically will buy shares of the target company stock (FCAU) while shorting shares of the acquiring company's stock (OTCPK:PUGOY). If the deal is actually completed and the target company’s stock is converted into the acquiring company’s stock, the merger-arb could use the converted stock to cover the short position. In this case, the arbitrageur can see that both companies have risen in value. This is creating a short-term opportunity for the merger-arb to see a discrepancy in who should be worth more and who should be worth less. Lets take a look below at the values of both companies since rumor of the merger has announced:
When you look at the recent price of PUGOY, the stock has increased in step since the deal speculation started. This could be due to speculators jumping into the name, not knowing details on the new structure of the common stock going forward. “Adjusted for differences in market cap and distribution, Jefferies estimates PSA is paying a 32% premium to take control of FCA and its shareholders assume more market risk,” said analysts at Jefferies.
From this above YChart, you can also see that PUGOY is outperforming FCAU by a wide margin. These two outperformances should narrow as more valuation details come out this week. Initially, PUGOY seems to be overvalued in this specific deal as FCAU is still undervalued, especially when you take into the account a massive $5.5 Billion cash dividend. One other key fact I would like to point out is the roughly $12/share cash holding the stock has, and a book value of at least $17.20/share. I would not be shocked to see an even bigger dividend announced in the future, or a regular cash annual dividend for the new conglomerate. What we need to find out is the exact spread in prices of these two companies in the next few weeks to be more certain in our valuations. I can tell you for full disclosure that clients I represent and myself are long shares of FCAU, as we believe prices are still undervalued even after the recent news.
What we need to find out specifically from both companies yet is the actual dividend payout to FCAU shareholders, and what the new share structure will look like for the new shares. As this deal continues to evolve, merger-arbs should watch closely to see if the market prices in what the companies actually agree too. This difference is actually called the spread, which is all of us merger-arbs want in this business.
With every merger, there is a potential risk of it not going though. However, for me, the risk is the actual execution of what these companies are aiming to do at the end of the merger. Both have struggled to break into countries like China, the world's largest market for new cars. Automakers across the board have sold 10% fewer cars there so far in 2019, but the joint ventures of Fiat Chrysler and PSA have been hit especially hard with the Presidents tariffs. Sales dropped by a third for Fiat Chrysler in the first half of the year, and more than 50% for PSA Group. PUGOY got out of the U.S. market in 1980 after years of trying to establish a market here. Time will tell if Charles Tavares will get it done, but I am in the camp that this time is different. The Peugeot line of sedans should fit nice with FCAU's Jeep and Ram Truck lines. As FCAU has not had a sedan model lately gaining any market share, Peugeot could help the Auburn Hills automaker turn that market segment around. Even with the potential risks, FCAU & PUGOY looks like a great risk-reward merger arbitrage opportunity in the making.
Going forward, FCAU remains the most attractive of the two companies right now. As PUGOY appears to trade at a high premium, investors should consider buying put options on PUGOY and purchasing FCAU as the spread narrows. Since we want to be prudent, investors should wait for the next couple weeks to see the actual details of the deal come out so we can make a more certain return. As far as it looks to me, it would make sense for FCAU to reward its current shareholders with a large dividend payment to reward its long-term shareholders for its lack-luster share performance as of recent. There is little doubt in my mind FCAU is still undervalued at 6.5x earnings, while having $12/share in cash on hand with less long-term debt than ever before. FCAU represents a unique opportunity for shareholders to participate in possibly the merger arbitrage deal of the year. Companies with good balance sheets like PUGOY and FCAU, helps investors like myself feel better for the long-term of these two companies coming together. Stay tuned for more details on the merger of FCAU & PUGOY to come in the next few weeks.
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Disclosure: I am/we are long FCAU. 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.
Additional disclosure: Ortner Capital consults clients who own FCAU common shares. These are opinions of Mr. Josh Ortner, CTFA, and should not be construed as personal financial advice.