Surely John Paulson’s discussion of merger arb with Melissa Lee counts as one of the highlights of this year’s Delivering Alpha conference.
In part, it became a highlight through the luck of timing, that is, breaking news on the subject: 21st Century Fox had just offered to take over Time Warner, bidding $80 billion. Time Warner has also immediately rejected the offer, but in the view of the market, the fact of such an offer puts the company in play.
A common pattern in such cases is that the offerer’s equity falls in value in the wake of the offer, and the target’s equity rises. That isn’t what happened in this instance, exactly. Yes, on the side of the target matters played according to Hoyle. TWX spent the day Wednesday (the 15th) climbing from $90.06 to $90.60, then it leaped above $91 overnight.
Meanwhile, though, FOX opened Wednesday at $33.12, and (after a day of wild hour-by-hour swings) settled down at the same place at end of day. Thursday, though, was when it discovered what the market thought of the idea of its acquisition of Time Warner –it spent most of the day above $33.40.
At the conference, Melissa Lee began the interview by congratulating Paulson on the 20th anniversary of Paulson & Co. She observed that it “started off as an arb shop” though it has since expanded its scope.
Drivers of Activity
Paulson accepted the congratulations, and launched into a discussion of the three factors driving mergers and acquisitions activity today: low interest rates; record equity valuations (these two factors together mean that companies can use either stock swaps or borrowed cash or a combination of the two, in acquiring one another); and, finally, the degree to which acquisitions have become necessary for executives in their own self-defense: the executives of a company that isn’t business making deals will find that “they themselves have become a takeover target.” Paulson called this the “accretive” nature of takeovers.
As to the Fox deal, Paulson didn’t want to predict how matters will play out. He spoke in general terms, though, about how he and his associates analyze such a deal, especially when the initial bid is rebuffed and the prospect of a hostile takeover fight has arisen.
There are of course risks. Any piker can say “aha! This will cause a rise in the value of the target” and rush in to try to ride that. But the pikers might get in only after most of the spike has happened already, ad just in time to take the other side of the roller coaster ride, the one that gets scary when the initial bidder backs away.
Paulson alluded to the Pfizer bid for AstraZeneca a little more than a year ago. Speculators who bought in before Pfizer backed away lost money. On Friday, May 16, 2014, AZN stock closed at $80.28 (after an intraday high of $81.19): the next business day’s close? $70.64. That’s a one-day loss of 12%.
In the hope of avoiding such a loss, Paulson assured Lee, he will look closely at the 21st Century/Time Warner deal.
One consideration is that this bid doesn’t lend itself to the prospect of a rapid fire auction, such as one can get where two very larger bidders emerge for a single company that is of strategic value to both of them but has a low capitalization before put in play. The this case, the bidder and the target are roughly the same size, so on the one hand “there’s a limit to how much cash you can pay” and on the other “there’s also a limit to how much stock you [21st Century] can provide before it becomes diluted….”
On the Valeant/Allergan matter, Paulson & Co. has a stake in Allergan which is almost inevitably identified as “the maker of Botox.” It should be noted: Allergan has other products as well, some well-known, such as Restasis (a treatment for dry eye syndrome) and Juvéderm (an injectable anti-wrinkle gel). Still, Botox is the blockbuster. Heck, the late Joan Rivers, comedy legend, titled a chapter in her memoir, “Botox, Baby!”
Paulson & Co. has a stake in Allergan so it has obviously not escaped John Paulson’s attention that Valeant wants to buy it.
Ms. Lee observed that a traditional merger arb play aims at making the spread, then exiting the position once is deal is completed. Paulson suggested that that wasn’t what he was aiming at here, “In many situations today you can make far more than the spread by holding on to the acquirer’s stock after the transaction is completed.” Valeant/Allergan is a case in point, because Valeant “is a very serious acquirer…Mike Pearson is very cost conscious.”
What Paulson expects is that Valeant will acquire Allergan and reduce costs to such a point that it will be 25% accretive to Valeant’s EPS. If one presumes that Valeant’s stock will rise by the same amount, then Allergan, prior to an acquisition by a stock and cash offer is worth “as much as $2.20 a share.”
If Paulson were aiming for the spread in this situation, he’d be aiming for a gain of $1.72 a share. But since his best is on Valeant’s ability to attain cost synergies, his goal is as much as $2.22 per share.