I spend a lot of time looking at merger and acquisition deals and special situations, like liquidations, because I feel cautious given market valuations. Merger and acquisition deals are not as correlated to the strength of the economy or the market. There are three large deals that I really like and that are widely owned by gurus:
Altaba Inc. (NASDAQ:AABA), previously known as Yahoo, is a holding company in liquidation mode. Currently, it trades at nearly $70 and has mostly cash on the asset side of the balance sheet. A few Alibaba (NYSE:BABA) shares are still left. The fully-taxed liquidation estimate is just over $74. I used to short Alibaba to balance out the Altaba holdings. Even though the company still holds a few shares, I've stopped doing so. On the company's website, it updates the net asset value frequently. Here is a screenshot:
I've recently added shares as I expect a substantial distribution (more than $50) on a short-term basis based on the June 27 plan of liquidation:
"The Fund currently expects to make a pre-dissolution liquidating distribution late in the third quarter, although this timing is subject to Board discretion and could change. Prior to making such a distribution, the Fund will announce the record date and the amount of cash and/or the number of Alibaba Shares to be distributed. Such announcements and further information regarding the liquidation and dissolution of the Fund will be provided in subsequent press releases or filings with the U.S. Securities and Exchange Commission (the 'SEC') as such information becomes available."
What makes it so attractive is that through the distribution, I get back most of my investment. Subsequent distributions are effective returns on a limited amount of capital and, therefore, equal a higher rate of return. In the schedule 14A, the company says the "pre-dissolution liquidating distribution will be between $52.12 and $59.63 per share".
It is important to realize how the company arrives at its net asset value. As shown above if the company merely returns around NAV, there is already 5% upside from this cash box. Annualized, this could exceed 20%.
But here is how the company arrived at its estimate:
"In addition, in light of the fact that the Board has adopted the Plan of Liquidation and Dissolution and anticipates entering into a dissolution and winding-up process, in determining the amount of the Fund's assets that would be available for a pre-dissolution liquidating distribution, the Fund intends to retain sufficient assets to ensure the Fund's ability to satisfy or make adequate provision for all of its liabilities, including the expansive array of potential, contingent and future liabilities the Fund would be required to provide for in the context of a dissolution and winding up..."
It is very important the company reserves conservatively to protect its directors and executives from liabilities in case of a shortfall. Tax authorities from both the U.S. and China may be involved and they would not be pleased with any shortfall.
The rational thing to do is to reserve very conservatively to ensure there is enough to deal with the highest possible tax bill. But this whole corporate situation has always been about minimizing taxes. Ultimately, that did not entirely go according to plan, but I'd be surprised if the liabilities are not at least 20% overstated. I would give myself a margin of safety here as a director or executive.
Because the majority of the capital is returned in the short term, the effect of overstated liabilities becomes magnified. Let's say I put in $70 and get $52 returned before the end of the year. By that time, I have 25% of my original capital invested and no positive return yet. But if over the next three-quarters of the year the company returns $2.5 billion extra (if liabilities are 20% overstated), it easily returns 25% on the initial capital invested. I perceive the main risk to be in unexpected delays, which decrease the annualized returns.
Gurus that hold Altaba include First Pacific Advisors (Trades, Portfolio), Primecap Management, Steven Romick (Trades, Portfolio), Paul Singer (Trades, Portfolio), George Soros (Trades, Portfolio), John Paulson (Trades, Portfolio), Jeremy Grantham (Trades, Portfolio), David Tepper (Trades, Portfolio), Howard Marks (Trades, Portfolio), Paul Tudor Jones (Trades, Portfolio), Mario Gabelli (Trades, Portfolio) and Ruane Cunniff (Trades, Portfolio).
Allergan PLC (NYSE:AGN) is very attractive at $162. This pharmaceutical company is well known for its failed tax inversion attempt with Pfizer (NYSE:PFE) and its cash cow therapy Botox. I liked the company even before AbbVie (NYSE:ABBV) came out with a bid because of its modest cash flow multiple (8 times pre-deal and 10 times now) and its growth therapies like Vraylar.
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I don't know why, but there is a large spread. The raw spread is about 9.14% for a deal that should close by the first quarter of 2020. Please realize this is based on my assumptions, but I think this deal has a more than 30% annualized expected return profile.
My assumptions include the deal will close end of fourth-quarter 2019, the break price is to be $129 and there is an 8% chance the deal falls through.
AbbVie's share price dropped hard on the deal. That's a potential risk (an activist can come in to try and kill the deal), but I don't hear the shareholder slate protesting too much. It is also a very big company, making it difficult to come in and ruin all the fun. To further complicate such a plan, AbbVie likely deliberately structured the deal so it doesn't require shareholder approval (technically that would be to issue shares).
Both companies trade at unchallenging valuations, especially for pharmaceutical companies. AbbVie is getting a good deal here in my opinion. It is paying around 10 times free cash flow for Celgene (NASDAQ:CELG). AbbVie pays part of the deal in shares and I even like those. I've added additional Allergan shares to my existing position on the day of the deal and didn't hedge out all of the AbbVie risks because its shares seem very attractive as well at 7.32 times free cash flow.
Allergan is super popular with gurus, but those that hold it in size include Seth Klarman (Trades, Portfolio), Jim Simons (Trades, Portfolio), Paulson, Tepper, Mason Hawkins (Trades, Portfolio) and Diamond Hill Capital (Trades, Portfolio).
Celgene is also a large and attractive merger and acquisition target to buy into. Bristol-Myers Squibb (NYSE:BMY) did a deal with Amgen (AMG), contingent upon the Celgene merger closing, for the global rights to a therapy called Otezla for $13.4 billion. That's cash.
Bristol-Myers Squibb at an earlier stage said it would divest Otezla, but now there is confirmation and this makes the deal much more palatable from a balance sheet perspective. It may prevent issues with regulators and it looks like the asset fetched a decent price.
Bristol-Myers Squibb guided for the merger with Celgene to close by end of 2019. I think it will close by the end of November. I also think there is a very high likelihood this deal will successfully close given how far in we are and the developments so far.
The spread is about 1.07%, but I think this is a great opportunity. It is my most important merger and acquisition position. I estimate the expected annualized return to be in excess of 4%. That's before taking into account a contingent value right that Celgene shareholders also receive.
This contingent value right will pay out either $0 or $9 in a few years. For the right to be in the money, there are three separate events that need to have positive results. I believe it is more likely this ultimately expires worthlessly. Many analysts ascribe a dollar or two of value to this CVR. One to three dollars of additional value makes all the difference.
I don't take the time value of money into account. You get all of your invested capital in this deal back when it closes and then some. To simplify the situation, if you ascribe two bucks of value to the CVR, it increases the annualized expected return of the transaction to 11%. If you go up to $3 of value, the deal is boosted to an expected annualized return of 16%.
Gurus owning Celgene include Simons, David Abrams (Trades, Portfolio), Paulson, Jones, Soros, Grantham, Joel Greenblatt (Trades, Portfolio), Pioneer Investments (Trades, Portfolio), David Rolfe (Trades, Portfolio), Gabelli, Murray Stahl (Trades, Portfolio) and Michael Price (Trades, Portfolio), among others.
Disclosure: Long Altaba, Celgene and Allergan.
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