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One of the most unusual special situation investments: contingent value rights

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May 08, 2012 – Comments (5) | RELATED TICKERS: CVI

As someone who is always looking for interesting investments that are often off the radar of the mainstream media, I am particularly fascinated with something called contingent value rights.  These rights are usually used in conjunction with a buy-out of a company, providing the former shareholder with milestone payments if certain future events happen.

For example, here's an interesting one. It appears as though Carl Ichan has funally succeeded in his effort to take over CVR Energy (CVI) for $30 per share. As part of this deal, current CVI shareholvers will receive a contingent value right (which interestingly is often referred to by its acronym CVR) that entitles them to an upside if Ichan is able to re-sell the company within nine months.

CVI is currently trading at $30.27/share. So essentially one can pay $0.27 each for these rights. That intrigues me, but I think that I am going to pass for now for a couple of reasons. One, if another company was really that interested in CVI why wouldn't they just come out with a competing bid right now rather than waiting for Ichan to close on his deal and then negotiate with him.

Also, as the following article mentions, refiners are likely experiencing peak earnings right now. this makes them look cheap on the basis of many metrics, like P/E, but if earnings begin to fall what once was cheap may not be so. Not to mention the fact that nine months is not a very long time. Let's say that Ichan is able to flip CVI in a year...I assume that means that rights holders would miss out on any upside.

Here's a link to an interesting article on the deal. I'm not sure why the formatting is so funky, but the link works and the content is good:

Icahn Gets Creative on CVR Energy Bid

Contingent value rights are often used in conjunction with pharma and biotech mergers, providing payments to former shareholders if certain approval or revenue milestones are hit on specific drugs.  Here's a link to an interesting article on their use in that industry:

As Investors Eschew Risk, More M&A Deals Combine Cash with Milestone-Based Fees

I have not yet found a CVR situation that is attractive enough for me to personally invest in in real-life, but I'm definitely looking.  Has anyone out there ever invested in one or is anyone aware of an attractive one that's available right now?  I'd love to hear about it.

Thanks for reading everyone.  Have a fantastic day!

Deej

5 Comments – Post Your Own

#1) On May 08, 2012 at 2:44 PM, Valyooo (99.60) wrote:

One, if another company was really that interested in CVI why wouldn't they just come out with a competing bid right now rather than waiting for Ichan to close on his deal and then negotiate with him.

Meh...can't you say that about any investment?  If it is so cheap, why doesn't everybody else bid the price up.  If a special situation worked so well why doesn't everybody else do it making it not work anymore, etc.

Thanks for bringing my attention to this, it's pretty cool.

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#2) On May 08, 2012 at 3:21 PM, RallyCry (< 20) wrote:

At $30.27 you are paying a 1% premium above $30.00 for contingent value rights spanning nine months. I guess it just depends on the number of potential suitors and the economies of scale that can be created for the buyer that would fetch a higher acquisition premium. I think my required rate of return for 1% carrying cost of the contingent value right would have to be atleast 20% or a buyout price of $36.34. While I think the likelihood of an accepted competing bid coming in 9 months is probably less than 1 in 5, I think its reasonable to be compensated 20% to make it worth my while for what will with at least 80% certainty end up being a loss of 1%

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#3) On May 09, 2012 at 12:02 PM, steinwaycapital (< 20) wrote:

There have been a couple such contingent value rights or contingent cash payment situations in the past that provided interesting optionality.

 By far the best deal in this category was the contingent value rights coming out of the Comdisco (CDCO.PK, CDCOR.PK) bankruptcy estate some 10 years ago. The CVRs in this case are very funky inasmuch CDCOR's have a time value of money protection embedded in them, meaning the longer the liquidation plan of Comdisco goes on the more value CDCOR sucks away from CDCO. many CDCO long common holders dont even understand this mechanism.

 There is a strong reluctance to read the documentation that goes with CVRs.

Litigation related CVRs are tough to handycap. 

From a analytical perspective it pays to distinguish between transferrable and non-transferrable CVRs. 

CVI deal will offer a non-transferrable rigtht. This will not be exchange listed. The option gurus arent even going to adjust the option prices in response to this. Its a non-event.

 Transferable CVRs are more interesting inasmuch there will be a traded market place for these papers that can help in the temporary expression of future value.

 Transferable/Tradable CVRs have more of the characteristics of spinoffs which is what interests me mostly about such CVR situations. 

 on CVI, I will read your link to the other analysis on the situation as I havent see any discussion so far of how the rights actually work. There is always a mechanism and this gives sometimes rise to confusion. The option guys state that this is going to be shopped for 15 months. your article says 9 months. Since I havent read the prime document, there is that question whether it is 15 months following gaining control or 9 months. I dont have the answers but there is that question. 

 GFI published a good piece about CVI, but they were postulating that CVI management should do series of MLP spinoffs. They never dissected what would happen if Icahn gained control. Their research though is recommendable as far as understanding their recent capex deployment.

 CVI managers do not look like the dumbest guys out based on strategy and I would think that Icahn would want to have them around. I am not sure if Contingent CAsh payment holders will get anything if refineries will be sold independent from fertilizer.

How attractive is this bundle of assets to a prospective buyer.

One alternative strategy here would be to go with IEP. the holdco of Icahn. If you can't beat him, join him.

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#4) On May 09, 2012 at 4:53 PM, TMFBlacknGold (98.97) wrote:

Great post. I actually own $UAN, which is majority owned by CVI. The thing I am worried about is that UAN benefits from having the CVI refinery co-located to its urea-ammonium-nitrate facility, thus bringing costs down. I imagine UAN adds value to any potential CVI deal, but then again it may throw some suitors off. 

Given the tremendous growth in fertilizer prices do you think UAN will suffer or remain relatively sheltered from the takeover news or future bids?

I'm having some trouble finding out how this affects my position with the LP. Does anyone have any ideas or plausible scenarios? Maybe UAN offers better value than CVI, but I don't really know how to evaluate it.

BlacknGold 

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#5) On May 14, 2012 at 10:41 AM, steinwaycapital (< 20) wrote:

As an update to my previous comment I clarify the question I raised that comes as a correction to above article.

 The Contingent Cash payment have a 15 month duration ( vs the incorrect stated 9 months). 

 There is a mechanism in place whereby the company can be sold in parts, as opposed to in one big chunk.

 Given how integrated the operations are, I dont think it is realistic to see a shopping of the company in parts. 

 As I have advocated in a different comment, I believe Mr. Icahn may not be interested in a genuine shopping around but could be interested in folding such interest over time into a bigger stake in Chesapeake, which could make very well use of all the assets that CVI holds. The CCPs allow for a stock based transaction to happen. I would not rule out that a deal has been pre-arranged with CHK that would give Icah ultimately a very big stake in something he hasl already been circling around for a while. 

 Coincidentally, Icahn increased his stake in CHK on Friday. This doesnt resolve the debt maturities and capex unbalance on  CHK but it sure gets Icahn further entrenched in the capital structure.

 Geographically I vew CVI and CHK as contiguous. Philosophically well aligned. Especially under increased Icahn control. 

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