Merger Arb...Before the Merger
One type of investing technique is to purchase the stock of companies that are in the process of being taken over, often while simultaneously shorting the stock of the company that is the buyer in order to capture the spread between the two prices, which will theoretically disappear once the deal closes. This type of situation is called merger arb. Many famous investors have made a lot of money by doing this. That's how John Paulson started his funds. The problem with merger arb in today's investment world with both so much information out there and so much money floating around is that the spreads on deals are super narrow. Many merger arb opportinities nowadays equate to picking up the proverbial pennies in front of a steamroller.
One way to get into a merger arb opportunity before the spread narrows and make the returns attractive enough to warrant investment would be to buy the stock of the company that is being acquired before an official deal is announced. That's just the type of situation that I am going to talk about. The company that I find interesting is called Loral Space & Communications (LORL). LORL is a satellite communications company that is in the process of being wound down. It has been one heck of a special situation investment over the past several years, literally returning over 1,000% to investors since emerging from bankruptcy.
I think that LORL may have one trick left up its sleeve. The company's lone remaining worthwhile asset (ignoring its weak XSTAR business) is a 62.8% stake in Telesat, a private provider of "satellite-delivered communications solutions to broadcast, telecom, corporate and government customers on a global basis."
Before I get any further into this discussion and attempt to value this stake I need to mention a recent legal development with LORL. In November of 2012 Loral sold its other valuable asset, a satellite manufacturing business called Space Systems to MacDonald, Dettwiler and Associates Ltd. (TSX: MDA). Why is this relevant? It is because Space Systems was sued for patent infringement by a company called ViaSat for patent infringement. Last week, the verdict was announced and Space Systems lost to the tune of $285 million (link). Ouch. Fortunately for LORL the terms of its sale of the business capped its liability to $200 million. LORL is in the process of appealing the ruling. Any reduction in this penalty would add upside to the valuation that I'm about to do.
Some people turn up their noses at simplified valuations of businesses and investments, but I'm a big fan of simplicity in investing. As an event-driven investor, I would rather do aback-of-the-envelope type of valuation for a stock than dig deeply into all sorts of numbers. As the saying goes, it's better to be generally right than exactly wrong. So here's my back-of-the-envelope valuation of LORL. I am basing it on the sale of the entire company rather than just its stake in Telesat because the majority investors in LORL have expressed an interest in selling the whole thing rather than the asset for tax purposes. Here we go:
LORL's current market cap is $2.2 billion.
The company owns 62.8% of Telesat.
In 2011 LORL rejected a $6 billion offer for Telesat. The rumor mill has any purchase of it today at $7 billion and I've seen bull cases written up by investors that value it at $7.5 to $8 billion. From that the $3 billion in net debt that Telesat has must be backed out.
($7 billion selling price - $3 billion in net debt) x 62.8% = $2.5 billion...the value of LORL's Telsat stake.
SCENARIO 1 (minimum value reported in press): A sale of LORL for $7 billion = 14% return
SCENARIO 2 (conservative case of the bulls): A sale of LORL for $7.5 billion = 29% return
SCENARIO 3 (more aggressive estimate of bulls): A sale of LORL for $8 billion = 43% return
SCENARIO 4 (original offer from when the company was up for sale in 2011, which at the time was rejected for being too low): A sale of LORL for $6 billion = -14% return
SCENARIO 5: No Sale: ???????????
So there you have it. I think that an investment in LORL today stands a good chance at providing investors with a solid double digit return in a reasonably short period of time. An announcement of an acquisition is possible as soon as Telesat's earnings announcement on May 1st.
Much of my knowledge about this situation has been provided by the great reseatch on LORL by Chris DeMuth Jr. and Mkie Arnold.
I'd love to hear others' thoughts on this situation and of course any other interesting ones that you've come across.
Have a great day!
Loral Loses ViaSat Patent Matter, But Could Be A Win For Shareholders
One Last Bite At The Apple With Loral
Jury Verdict For ViaSat Should Ease Problems For Potential Loral Acquirer