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Contrarian M&A: A Deal That Falls Apart For The Right Reasons Is A Good Deal To Buy

Last time I participated in a deal that fell apart was Primero Mining.

A small synopsis for the motives of engaging in contrarian M&A investment was provided here:

As it turned out, Primero Mining survived the arbitrage related carnage unscathed. Participation in arbitrage sell-off to levels of $3.25 and even lower in the following months allowed a decent entry point to participate in the solid operations of Primero which would propel the stock later to levels of $7 and beyond. There was an added twist with Primero inasmuch you could invest in warrants that post deal carnage were traded at 40 cents. Luckily we were able to dispose the Warrants about 1 year later at $1.60 for 3 fold gains. This was a lucky opportunity as the existence of warrants in such contrarian M&A situation is not always a given. In this case though it was a nice low cost turbo charger.

A very different contrarian M&A opportunity is now provided with MISC Berhad in Malaysia. This security trades in Kuala Lumpur under MISC MK or 3816.KL (on yahoo finance). It is a 63% controlled entity of Petronas, the state oil and gas company of Malaysia. Historically, MISC Bhd and Petronas have evolved as separate organizations, MISC Bhd was founded 4 years before Petronas. Petronas on January 31 of 2013 announced a takeover bid to take over the rest of MISC Bhd at a price that the market didn`t like. They didn`t like it to such a degree that not even a deal sweetener of 4% made a difference. Accordingly the deal got voted down by minorities for what appears the right reasons, namely valuation. In the ordinary course of business, this would be a reason to jubilate as shareholder democracy has prevailed and a bad deal was thwarted.

In the context of arbitrage investments the opposite is true. Even a bad deal ought to pass shareholder approval, if the purpose is to make some short term gain of a few basis points, or so the thinking goes. Certainly you would not expect arbitrageurs to contribute to the worthy cause of investing in the democratization of societies in the way that George Soros does.

I would thus not be surprised if an investor such as George Soros might be a contrarian arbitrage investor. It could very much suit his style, while for 90% of arbitrage investors it clearly would not fit their style.

Brief arbitrage comments on the MISC Berhad deal now falling apart are provided below. All things look very scary since Friday. Another deal is falling apart and woe thee if you are holding the short end of the stick.. I already like the usage of the word "plunging" by Reuters or the word "revolt" used by Bloomberg in below articles. In reality, shareholder groups revolting and looking at a plunging stock now wanted higher value and they will have to be patient for a little while to get it.

Investors reading this are encouraged to be likewise patient on this name and on this evolving story. Before continuing with the story, here are the enclosed journalistic sound-bites, irrelevant as they are for the further elaboration of the thesis underlying an investment in MISC Berhad.;rpc=43

The prima facie reason why MISC Berhad shareholders have been revolting against a deal engineered by an omnipotent controller is that it wasn't enough and they didn't like the scaring tactics employed by Petronas who painted a bleak picture on MISC Bhd suggesting that the stock could plunge to MYR 2 without a Petronas deal. At the time of this writing, the MISC Bhd stock only plunged to 4.75.. Thus, the fear-mongering rethoric of Petronas has been proven wrong and this in and of itself could be reason to treat this story very serious as it promises to be a strong source of lucre, just as the last such deal that I had a chance to witness which was Primero through its warrants.

The superficial reasons for looking for higher value were among others that shareholders in MISC Bhd are generally a very patient pension fund oriented crowd. In fact the impatient folks are only believed to account for 10% of outstanding shares, or less. The shareholders in MISC Bhd have been strong believers in their company for well over 25 years. The business exists for 43 years. In fact they were so loyal to their company that they willingly participated in a capital raising exercise in early 2010 at MYR 7. This capital raising exercise raised in excess of 5 billion ringit and was broadly subscribed by all shareholders with no meaningful exception. As a result of the rights offering, Petronas did not increase its ownership position further but it remained at 63%. Thus for very legitimate reasons, loyal shareholders of MISC did not feel like they should be parting with their shares at levels of 5.30 or 5.50 if they just recently paid MYR 7, when the stock was trading at 8.50. This is a very logical argument and we do not wish to argue with long term shareholders who know the company better than we do. They have their good and valid reasons for rejecting a bad deal and its safe that we just want to sense this and acknowledge it rather than swimming against the shareholder sentiment. As contrarian arbitrageurs we can never be unhappy with a democratic shareholder vote. It would be a lot worse if the deal fell apart as a result of an earthquake, tsunami, breaching of a MAC or something similar. A shareholder votum is the last thing we want to worry about. Acknowledging that it can happen is the first step towards lucre realization. Fighting it and having a hissy fit over it would lead to almost certain realization of loss.

The story of MISC as contrarian arbitrage gets even better as the independent financial advisor opinion on the deal has declared not just one time but two times that the deal is "not fair" to shareholders, from a financial perspective, but nevertheless they declared it as reasonable, given that it apparently is not advisable to fight Petronas as dominant shareholders. However, since Petronas was not the founder of the company to begin with, lets just say, that shareholder logic prevailed.

I like in that context the opinion of DBS Vickers who advised shareholders not to tender, two times. That is a lot of backbone to show for a regional brokerage firm and investment bank. Their price target for MISC Berhad is much higher. IN fact, most of the 14 international and regional brokerage firms covering the name had much higher price targets on this name going back all the way to 2008.. IN the time period 2003 to 2008, the stock traded at a multiple reaching as much as 2.3x book value.. Prior to the deal being announced the stock had fallen to 0.8x book value, despite it being a company with USD 8 billion in equity..

To the best of my knowledge, the company has grown book value since 2008.. There is a rights offering the clouds the picture a little bit but not very much.. The rights offer raised around $1.7 billion. In the not too distant future, MISC will potentially sell one of its assets on its balance sheet, or a 50% portion of it for $1.7 billion. We expect this event to further surface book value and at a minimum reduce the gearing ratio from a net debt to equity of around 30% to about 10%. This upcoming transaction or divestiture is to be approved by shareholders of MISC in upcoming June 2013 AGM. It is definitely what you could call a catalyst embedded into the investment thesis.

Apart from the deal with Petronas having fallen apart because of democratic shareholder vote through a tender, the same shareholders get now to vote, whether they want to sell a 50% interest in a nice and very modern floating oil and gas processing asset to the same Petronas who wanted to stiff them out of their ownership interest..

And what would happen if MISC Bhd shareholders came back to Petronas and told them in June to forget about it? How would that feel to Petronas. After all, this floating oil and gas processing platform can be deployed profitably in any number of geographies at any number of dayrates. Its completely ludicrous for Petronas to assume that MISC can have no other customers than Petronas, But I am pretty sure that it wont get to this level of shareholder acrimony. I think one slap in the face of Petronas CEO is enough. For all we know and after many strategic blunders he may be on his way out of the door by the time the next parliamentary elections are over in Malaysia. There is a very high likelihood that his days will be counted and as a result, MISC shareholders can get to enjoy once again their company without having to fear that someone will steal it from them at the wrong price with a coercive offer.

Companies like MISC Bhd who ship LNG globally generally are valued by the market at a premium. IN fact, Golar LNG backed by John Fredrickson trades at 3x book value, versus a current valuation for MISC Bhd of less than 1x book value. MISC Bhd incidentally is the second largest LNG shipper with 27 vessels owned or leased and since Fukushima the dayrates have tripled. From a strict sum of the parts valuation perspective, parts of MISC`s business ought to be valued at a very strong premium to book value and not at a doggish value as the Petronas CEO seems to be suggesting in his scare tactics.

There are of course the assets that are no longer part of MISC such as the passenger liner business and container shipping business. All that was recently known about these businesses was that they contributed to cumulative USD losses of 789 in the years 2009 to 2011 and that is quite some amount that would readily be believed to mask operating profitability of the remaining businesses. All these businesses have now been fully divested with the last 400 million Ringit writedown occurring in 1H 2012. As of June 30, 2012, all divestitures and vessel scrappings have been completed.

In fact the operational profitability and after tax profitability have been nicely progressing in year to year comparisons over the past 3-4 quarters and even more impressively over the past 2 quarters.

The sad thing of the ill-motivated Petronas bid is that when it was published in January 31, 2013, it was published before the very impressive Q4 2012 results were presented. These were presented in February 2013 and reported a tripling of operational results. However with a bid in for the company, this put a lid on potential price appreciation. Which consequently didn't happen. One can only wonder how MISC stock would have reacted with no bid being in the market and with a tripling of earnings being reported. We have to wait now to see how the market will react to stellar Q1 2013 earnings, soon to be announced.

The typical reaction of most brokers is to stop covering a name adequately, once a valid and or irresistible bid has been tabled. Most brokers indeed recommended to their customers to accept the offer, even though it was widely acknowledged to be a low-ball offer that Petronas had tabled.

Now that shareholders have voted with their feet, I guess the brokerage community will be back to covering this name and before long may even raise the price target on this name.

There are a number of catalyst here and I am right now at a loss to even describe all the different categories.

There will be a deleveraging catalyst once gearing goes from 30% to 10% and Moody`s has already pre-announced that this would be a positive development on the credit.

There will be earnings fireworks ahead.

There will not be further blood on the streets.. other than today and the next couple of weeks till earnings are to be reported..

There should be a resumption of dividends in due course pressurized by the pension fund holders owning this name.

The last dividend declared dates back to calendar 2009 in the annual amount of 35 sen. At the time this represented a 4% yield relative to the 9 plus ringit stock price.

Mean reversion in the price to book value multiple is a legit catalyst since not even during the asian crisis of 1998 did this name trade at below 1.5x book value and we see no reason that this name should be trading now at such levels, when financial turnaround of the business is well under way. IN fact, MISC management which is separate from Petronas, has stated that 2013 fiscal year should be better than adjusted 2012 fiscal year. Adjusted for the significant charges still taken in the earlier part of 2012 on the exit of business. Generally speaking even the doggish oil tanker business is expected to recover by late 2014, in a view that is also mirrored by Wilbur Ross who has heavily invested in that turnaround through his controlled entity Navigator Holdings..

Nuff said about catalysts. The risks are worth pondering. I think they are those of a cyclical business. Or various different cyclical businesses. Fortunately, we have a diversified business with different overlapping cycles that are not in sync. The bad part of this is that MISC will never be valued at 3x book value, but it also should not be valued at 0.45x book value as the Petronas CEO has been suggesting in his scare tactics.

There is the risk that Petronas will shun doing business with them which would be self defeating given their 63% interest. The most likely circumstance is that dividends will start flowing again and that there will be a peace and love fest at the next annual meeting or at the latest by 2014 annual meeting in June 2014.

Could Petronas come back with another offer? Possible but given the slap in the face it may be unlikely in near term. This just shows the risk of operating a business with an emotionally insecure leadership. The best thing for Petronas would indeed be to offer 50 sen more and get it over with before the stock reverts to its historic mean of 1.5x book value. Something is telling me though that this is not likely to happen, even though it would be a good deal for Petronas and they probably would secure shareholders holdouts. Petronas wanted to get 90% acceptance rate, and they got 86%, aside from the 63% that they own, which are included in that number. Petronas was simply too greedy and this opens an opportunity for more opportunistic investors. Petronas essentially is telling us that this is money-good.

The reason petronas could not accept the 23% of shares tendered to them is that this would have left only 14% shares out there and there is a legal requirement in Malaysia to leave a free float of 25% in a listed security at all times. Petronas could have accepted up to 12% of shares, but they didn't stipulate any pro-ration to that effect in the deal document and thus were not able to proceed with a partial uptake or shares. IN the end they got stiffed with all the costs of undertaking the tender offer. No doubt, the CEO will be hearing not so nice things at the next upcoming board meeting.. After all, Petronas is the biggest company in Malaysia at its most prominent figure just got a slap in the face from an irrelevant retail shareholder base..

Imagine that this happened to the Exxon CEO.. priceless..