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ChemChina Syngenta May Not Go Syngently Into The Night

|Includes: Syngenta AG (SYT)

Summary

Potential chance there are no more Offer Extensions and tendered shares don't reach 98%.

Swiss Withholding Tax of 35% is a major doozy. (YMMV).

Option Contracts Have a Nightmare Scenario.

Thank you for enduring the pun headline.

To get this right out front, I'm SHORT Syngenta (NYSE:SYT) via long put options, and could sell them at any time or flip positions (I flipped once already, see below.)

The ChemChina - Syngenta merger is effectively a done deal. The special dividend was paid, the First Settlement occurred May 18, and per Swiss law the company is actually formally under ChemChina's control with 82.2% of shares tendered for the First Settlement (above the 67% required). We're now in the Second Settlement phase, and the options contracts are trading at levels that seem unusually high...until you understand the risks. To the contrary, I think they are trading WAY too low. Short put sellers are attracted to the option premiums, trying to squeeze a little more lemonade from the fruit. What they don't realize is that their lemonade stand is sitting in the middle of an interstate.

Here we go:

First, Thresholds: Special Situations and Arb's post on the Avast purchase of Netherlands-based AVG is the genesis of this post. The key points discussed:

% Tendered Result
Dutch Tender Offers
>95% No Dutch Withholding Tax
<95% 15% Dutch Withholding Tax

Second, Tax Rate: The Dutch Withholding Tax is 15%.

Third, Extensions: Avast extended the offer a bunch of times in efforts to get to 95%. First offer ended August 31, 2016 and they got 89% of the vote. Extended the offer twice to September 29th...and got 92.8%. They announced the deal was successful, and per the Prospectus kicked off the Subsequent Offer Period to October 14th, got 96.5%, extended AGAIN to October 28th (nice acquirers) and ended up not getting all of the shares, de-listing to the Over-The-Counter, sued for an appraisal, which the courts opined on 4 months later in February 17 and the squeeze out ACTUALLY happened in March 2017.

VERY IMPORTANT differences with the Syngenta situation:

First and Second, Thesholds and Tax Rate: The threshold is higher and the Withholding Tax is much higher.

Swiss Tender Offers
% Tendered Result
>98% No Swiss Withholding Tax
<98% "May" have 35%* Swiss Withholding Tax

Here's the prospectus on the sub 98% situation, emphasis mine:

The consideration paid to remaining Syngenta minority shareholders (irrespective of their tax residence) in the squeeze-out merger may, depending on the structuring of the squeeze-out merger, be subject to Swiss withholding tax of 35% on the difference between (NYSE:I) the amount of the consideration and (ii) the sum of the nominal value of the shares concerned and of the proportionate part of Syngenta's reserves from capital contributions (Reserven aus Kapitaleinlagen) attributable to the respective shares.

The * above references that 35% Swiss Withholding Tax could be adjusted by treaty depending on your country. Currently the US and Switzerland negotiated 15%, but to get that you have to jump through some hoops proactively, or file paperwork retroactively.

Third, Extensions: In the entire prospectus, I found plenty of references about extending the Main Offer Period but nothing about Subsequent Offering Period Extensions. Given this deal is coming together over a year after announcements, AND some rumors about China's intention to merge ChemChina and SinoChem next year, AND ChemChina being a company that wants to get the show on the road to feed its people (vs. Avast's PE owners that think more about financial implications), it doesn't seem like ChemChina is interested in Forever Extensions. (Remember that Avast closed the deal short of the 95% needed and that only came in during the final 2 week extension.)

Avast started with 89% tendered and worked their way up to 92.8% over 2 months, closed, and got +3.7% in the 2-week extension (and then extended again). Syngenta received 82.2% before its 2-week extension...will it get 15.8% more in that time?

The Big Difference: Consequences

1. Swiss Business Holders: A Small-Consequence Constituency

While the AVG deal was eager and constant in beating the drum about tendering to receive better tax treatment:

From Tender Offer:

The applicable withholding taxes (including Dutch dividend withholding tax) and other taxes, if any, imposed on AVG shareholders in respect of the Liquidation Distribution are likely to be different from, and greater than, the taxes imposed upon such AVG shareholders had they tendered their Shares pursuant to the Offer (or during the Subsequent Offering Period, which includes the Minority Exit Offering Period, if applicable).

The Syngenta deal has a constituency of Swiss shareholders who may only suffer minor setbacks if they don't tender:

  • Shareholders holding their Common Shares or ADSs as business assets (Geschäftsvermögen) or classifying as professional securities dealer (gewerbsmässiger Wertschriftenhändler) have the same tax consequences as if they tender their Common Shares or ADSs in the U.S. Offer (see above).

Of course, who knows what percentage of shareholders are Swiss, but here's the breakout of ADSs vs. Swiss shares:

As of the close of business on March 4, 2016, the last practicable date before publication of the Swiss Offer Prospectus, Syngenta had 92,945,649 registered Common Shares issued, of which 5,491,196 were represented by 27,455,980 issued and outstanding ADSs and (ii) 1,035,653 were held by Syngenta or its subsidiaries.

Assuming all Syngenta subsidiaries and all ADSs tender...that would mean 86,418,800 shares are leftover. 2% of the total shares are 2.15% of this 93% subset of non-ADS shares.

2. The Magnitude of Swiss Withholding Tax

Here I'll admit I'm shakey, as I'm not exactly clear on the calculations of the amount. Again the prospectus (emphasis mine):

The consideration paid to remaining Syngenta minority shareholders (irrespective of their tax residence) in the squeeze-out merger may, depending on the structuring of the squeeze-out merger, be subject to Swiss withholding tax of 35% on the difference between the amount of the consideration and (ii) the sum of the nominal value of the shares concerned and of the proportionate part of Syngenta's reserves from capital contributions (Reserven aus Kapitaleinlagen) attributable to the respective shares.

My best guess is either that the sum of the nominal value and proportionate reserves from capital contributions are either 1) Book Value, or 2) something far less than Book Value, as in Par Value plus initial Additional Paid in Capital.

For Prosensa (NASDAQ:RNA) (see the Avast/AVG post linked earlier), the $17.75 consideration was adjustment downward by $2.25, which is 15% of $15, meaning they calculated $2.75 of "average Paid-in-Capital" for those shares. The deliverable on those puts was unilaterally adjusted downwards by the $2.25/share.

Let's just WILDY guess: Best case scenario Book Value is the metric. YCharts tells me it's $17.24. So:

  • $93 consideration - $17.25 = $75.76 * 35% = $26.52 potential haircut. The new deliverable would be, in this scenario, $66.48, meaning More or less if Reserven aus Kapitaleinlagen is more or less than $17.24.

What's the Big Deal??

To have the option deliverable not undergo a giant repricing ChemChina, any of these could occur:

  1. Get 98% of shares tendered (more difficult than AVG deal); or
  2. NOT get 98% but "may, depending on the structure of the squeeze-out merger" avoid Swiss Withholding Tax (I don't know they'll be ambitious in getting this done); or
  3. Keep extending the offer to get over 98% (it's not clear the Prospectus allows this); or
  4. The OCC adjusts this contract (or fails to adjust it) in a way that capriciously picks winners and losers.

The OCC part is tricky, because AVG got the 95% but everything was tied up in the courts...and the OCC didn't adjust until the end of the trial, while Prosensa got 96.76%, structured it as an asset sale anyways, and the options were adjusted 3 weeks later.

If you put a $26.52 unilateral adjustment on the Put deliverable, you are talking serious pain for short put holders. Right now I can buy a Dec $90 strike put for $2.60. (I force you to pay me $90 and give you 1 SYT share.) With a normal contract, if you're down some money, maybe SYT comes back, or your dividends make you whole (eventually). If the deal fell apart...you still own Syngenta.

BUT, if the deliverable adjusts to $66.48 in cash, overnight, I'm making $20.92 on my $2.60 investment... 8x my investment, and that is it, finito. The book is closed. Syngenta is delisted.

Which all begs the question:

Are you willing to risk a $21 loss to make $2.60?

I'm not. But I'm ready to go the other way on that.

FULL DISCLOSURE: I USED to be short the puts, as I expected the deal to get approved and close, and my thesis was right. I overlooked the nuances of cross border M&A, Swiss Withholding Tax, and the magnitude of the consequences. Given the massively asymmetric payoff, I flipped sides. I reserve the right to close my position at any time, for a profit or loss, at my choosing.

Disclosure: I am/we are short SYT.

Additional disclosure: Caveat: I'm long SYT in that the deal will close, but I'm short SYT via put options that I think could reprice lower.