Double Digit Premiums In U.S. Merger Arbitrage Plays: Part 2

by: Rajiv Tarigopula

For risk-seeking investors, there are some potentially high-return opportunities available in merger arbitrage these days. In Part 1, I took a look at three potentially high-return trade ideas with M&A deals at different stages of the game. Here's a closer look at two more with premiums greater than 10%:

Advocat Inc. (AVCA), a Nashville-based firm in the medical/nursing homes sector, has received a friendly company takeover offer from U.S. investment company Covington Investments LLC. This deal was announced on May 11, 2012, and the acquirer is seeking a 100% purchase of the target. The announced value of this deal is $74.07 million, which represents a whopping current premium of 28.59% (lower than the 71.98% premium at the time of announcement, but still tremendous for alpha-seeking market participants). The acquirer proposes to pay $8.50 cash for each share of Advocat, which is a gross spread of just under $2 per share.

Potential investors should realize that the target shareholders blocked this transaction, effective May 13, 2012. However, talks appear to still be in progress, with Covington sending a letter to shareholders of the desired target. In this letter, the CEO of Covington noted similarities in a parallel transaction involving Sun Healthcare Group, Inc. (SUNH) in an attempt to persuade shareholders to approve the deal. Keeping an eye on this one could be interesting. Competitors to the target include privately held GGNSC Holdings LLC, Life Care Centers of America, Inc., SavaSeniorCare, LLC, and other long-term care facilities; health care services companies that are publicly traded include Unitedhealth Group, Inc. (UNH), HCA Holdings, Inc. (HCA), WellPoint Inc. (WLP), Aetna Inc. (AET), and more.

Allos Therapeutics Inc. (ALTH), a U.S. firm operating in therapeutics, is being sought after by Spectrum Pharmaceuticals Inc. (SPPI), a player in the biomedical/pharmaceuticals field in a friendly 100% takeover. April 5, 2012 was the announcement date of this deal, and tender offer expiration is on July 23, 2012. Announced value in this all-cash transaction is at $75.45 million, with an announced premium of 22.62% and a surprisingly higher current premium of 27.27% (and increasing as the expiration date approaches). Spectrum has offered $1.82 per share of ALTH, resulting in a gross spread of $0.39/share. Financial advisers to the acquirer include RBS Capital Markets (with legal adviser White & Case LLP); the target's financial adviser is JP Morgan (JPM). Both the target and the acquirer's boards of directors have approved this transaction, effective April 5, 2012.

The drama surrounding the target firm in the mergers & acquisitions arena has played out over the past few years, but hopeful investors seek a close and a return on investment soon. They may well see that day come this year; with continued extensions of the tender offers from Spectrum, the July expiration may not be the last chapter in this story. Direct industry competitors to the target include BioCryst Pharmaceuticals, Inc. (BCRX), Bristol-Myers Squibb Company (BMY), privately held Cephalon, Inc., and others; in the biotechnology and generic drugmakers sectors, peer firms include Amgen Inc. (AMGN), privately held Genentech, Inc., Genzyme Corporation, etc., Biogen Idec Inc. (BIIB), Gilead Sciences Inc. (GILD), Life Technologies Corporation (LIFE), Teva Pharmaceutical Industries Limited (TEVA), Johnson & Johnson (JNJ), Pfizer Inc. (PFE), Mylan, Inc. (MYL), Watson Pharmaceuticals, Inc. (WPI), Sanofi (SNY), GlaxoSmithKline PLC (GSK), Novartis AG (NVS), and many more.

Of course, as stated in the first segment of this series, 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. 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: 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. However, in my experience, those holding a strongly justified contrarian view often achieve the best returns, especially when it comes to merger arbitrage plays. More to come.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in JPM, JNJ over the next 72 hours.

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