An investment idea that I haven't heard anywhere else yet...A new "Merger Security"
June 19, 2011
– Comments (12) |
RELATED TICKERS: ETE
, SUG
Hi everyone. I was dying to write about this strange special situation last week, but I had to wait two days to abide by TMF's trading guidelines. I found a new "Merger Security" that is being issued by Energy Transfer Equity (ETE) to finance its recently announced purchase of Southern Union Company (SUG). This one isn't going to turn into a ten-bagger like some of the awesome Rule Breaker selections, but it does look like an excellent low risk, solid return place to park one cash in today's low interest rate environment. Here's my rough notes on the situation for anyone who's interested.
"I just purchased a position in Southern Union Co. (SUG). As you may have heard, the company agreed to be bought out by ETE today. So why purchase a stake in a company that's already up over 17% today you ask? Well, I'll tell you (even if you didn't ask). The unique structure of the buyout makes this an interesting investment.
When the deal closes, ETE will issue SUG shareholders $33 face value "B" shares. These B shares will pay investors a minimum dividend payment of 8.25% over the next year. At that point they can be traded in for either $33/share in cash or 0.77 shares of ETE.
One could look at this situation as the best available bond out there with a free upside call on ETE. I have been looking at corporate bond interest rates fairly closely over the past several weeks and the very best thing that I have seen out there is some 20-year MeadWestvaco Corp. (MWV) paper that yields 6.9%. This is a company with a crappy credit rating (not that that means anything, but still) and you have to lock your money up for two decades to get this rate. By the time that twenty years passes interest rates will probably be double digits again ;). At the current SUG share price of $33.25, we're looking at essentially a one year bond that pays 7.4% interest which may even be taxable at the dividend rate rather than as regular income. If that's the case then this 7.4% is even more valuable. Wait, there's more. This 7.4% yield assumes that you are trading in the "B"shares for $33 in cash at the end of one year and losing a quarter per share. If you end up taking the 0.77 ETE shares (which as if the current quote are trading at $45.62 for a conversion price of around $35.13) then the interest rate on the bond-like payment jumps to around 8.2% plus you get any of the free upside in ETE. ETE's acquisition of SUG is supposed to be immediately accretive to ETE's earnings and I think that barring a change in tax laws (which I find unlikely) its stock should do fairly well over the next year.
So there you have it, the best bond-like return out there right now plus an absolutely free upside call on ETE. The only danger that I see here is if the deal falls apart, which I suspect is unlikely. Oh and of course, the closing of the deal could drag on delaying the start clock on the dividend payment and lowering its annualized yield."
"OK, here's some additional information on SUG (in case you're still interested). ETE is issuing a whopping $4.2 billion in "B" shares to finance the SUG acquisition. Yes, technically it has the right to call the B shares at any point during the first year, but I highly doubt that it will have the money to do so. In addition to the new B shares that it is issuing, it's assuming $3.7 billion in debt with this deal. ETE's credit rating isn't the best, though one of the major credit rating agencies recently said that they viewed the SUG acquisition positively. Earlier this year, ETE attempted to float a bond issue of a little over a billion dollars at 7% and the market basically rejected it and they had to pull it back. I read that a smaller issuance at 7.75% might have worked. That leads me to believe that if ETE wanted to call in all of the B shares immediately, which it would probably be in its best interest to do, it probably would not be able to.
In the event that the shares are not called, they will pay an 8.25% dividend quarterly for the first three years and then 8.25% or LIBOR + 750 basis points...whichever is higher after that. Also, if the shares are not called at $33 during year one, the option to redeem them for 0.77 ETE shares and capture much of the upside in the stock kicks in.
As I mentioned, the million dollar question here is whether ETE would be financially able to pay off all of the B shares during year one. It looks to me as though it would be difficult for them to do so. If they don't, then this is an amazing place to park one's cash. The downside is less than 1% and the potential upside is a cumulative 8.25% dividend with a possible option to capture any gain in ETE's stock.
Here's a link to the presentation that describes this deal:
http://phx.corporate-ir.net/External.File?item=UGFyZW50SUQ9NDEzODMzN3xDaGlsZElEPTQzMDY2OHxUeXBlPTI=&t=1 "
SUG's stock has rallied slightly to $33.56 since my purchase at around $33.21, so anyone who buys in now risks losing out on $0.56/share if the "B" shares are called immediately rather than the $0.21 that I am risking. As I mentioned earlier though I personally believe that the risk of losing capital here is low. It doesn't hurt to have some, low-risk trades like this in one's portfolio especially in an economy that seems to be foundering. I am trying to be more positive nowadays so I am generally bullish on where the market and my stocks are headed, but I'm a sucker for high yield bonds and that's essentially what this trade works like so I'm in.
Deej
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