​WWII 041: 29% Annualized Return Arbitrage of RBN Stock, What Securities I Use For Arbitrages, Four Percent Rule May Be A Problem for Retirees

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In this episode, I shine the light on merger arbitrage by telling you the story of the purchase of Robbin & Myers by National Oilwell Varco.

Main Topic: Merger Arbitrage and the Story of National Oilwell Varco's ($NOV) Acquisition of Robbin & Myers ($RBN)

One key to success in investing is to be flexible and always looking for undervalued securities. You never know what Mr. Market will offer up to you on any given day or for any given strategy. The story of NOV buys RBN is one of simple deal arbitrage combined with a conservative estimate of probabilities of certain events happening resulting in a large profit in a mere twenty-five days with very low, easily understandable risk.

First, some basics about the transaction. On August 8, 2012, RBN (Robbins & Myers) and NOV (National Oilwell Varco, Inc.), entered into a merger agreement and filed a form DEFA14A with the SEC.

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The Purchase Price Was Paid in All Cash

By preferring all-cash payments, I know exactly what I’m going to get. No taking chances trading my cash for stock that will do who knows what.

The DEFA14A form laid out the consideration as $60 per share in cash paid to RBN shareholders

The Deal Was Done At A Fair Price

I believed the price represented the fair market value of RBN and provided shareholders with a reasonable premium from the pre-announcement price. Before the transaction was announced, the share price was $46.80 and the purchase price was a 28% premium to the price before the announcement.

About The Target

Robbins & Myers is a leading supplier of engineered, application-critical equipment and systems for global energy, chemical and other industrial markets. The company provides products and services for upstream oil and gas markets, along with a portfolio of industrial process and flow control products. Robbins & Myers has 3,400 employees and operates in 15 countries.

About The Buyer

National Oilwell Varco, headquartered in Houston, Texas, is a worldwide leader in the design, manufacture and sale of equipment and components used in oil and gas drilling and production operations, the provision of oilfield services, and supply chain integration services to the upstream oil and gas industry.

A Big Fish Was Swallowing A Little Fish

NOV had a market cap of around $28B, with cash of about $3B. RBN would be acquired at a price equivalent to an enterprise value of $2.5B. Clearly this was a case of a big fish, with cash on hand, swallowing a little fish

The Little Fish Profitable and/or Valuable (In case we are stuck owning it)

RBN over the 10 years before the transaction had grown book value per share by 10% per annum, and earnings per share by 21%. Earnings per share in the most recent year were 14% of sales per share. Return on invested capital was averaging 32% over the ten year period. On a stand-alone basis, RBN had generated incredible value for investors as indicated by stock price rising from $11 per share to $48 per share before the $60 merger.

There Were Other Bidders Involved

Although there were several interested parties, there ultimately were no other bidders in this case. The value of the underlying company was enough to maintain it’s value and share price to some extent if the deal was not consummated.

The Transaction Was Not a Hostile Takeover

“At a special meeting held on August 8, 2012, our Board of Directors unanimously determined that the merger and the other transactions contemplated by the Merger Agreement are advisable and in the best interests of Robbins & Myers and its shareholders. Accordingly, our Board of Directors unanimously recommends that the holders of Common Shares vote “FOR” the proposal to adopt the Merger Agreement. Our Board of Directors also unanimously recommends that the holders of Common Shares vote “FOR” approval of the say-on-merger-pay proposal and the proposal to adjourn the special meeting, if necessary or appropriate, to solicit additional votes if there are insufficient votes to adopt the Merger Agreement.”

The agreement was pre-negotiated and announced in coordination and was clearly not a hostile takeover. We don’t like to get involved in hostiles, as they could fall apart easily for any number of reasons. For more, see a fair number of takeovers Carl Icahn has attempted.

There Were No or Modest Financing or Abnormal Contingencies

Merger terms were traditional, with no financing contingencies or weird requirements.

Major Shareholders Were Supportive of the Transaction

In the announcement, RBN’s largest shareholder (10% of stock) had agreed to vote for the transaction. We prefer larger positions to have already committed, but this point was not a pertinent in this transaction.

Both Boards Had Approved The Transaction

Both Boards had already approved the transaction before we got involved.

Regulatory Approval Was Required But Did Not Appear To Be At Risk

Under the Hart-Scott-Rodino Antitrust Improvements Act and related rules (which we refer to as the HSR Act), certain transactions, including the merger, may not be completed until notifications have been given and information furnished to the Antitrust Division of the Department of Justice and the Federal Trade Commission and all statutory waiting period requirements have been satisfied.

The remaining hurdles for closing of the transaction were shareholder votes, clearance from the DOJ under the Hart-Scott-Rodino Anti-Trust Act, and clearance from the Canadian Competition Bureau under the Competition Act of Canada.

This was clearly not a case of a merger creating a monopoly of any kind. Both companies provide equipment and components for oil and gas drilling and production, but NOV’s major competitors are Halliburton with a market cap of $37B, Baker Hughes with a market cap of $19B, and Schlumberger Limited, with a market cap of $100B. NOV has a market cap of $28B, and the combined company would have a market cap at the lower end of major oil field services companies. Plenty of competition.

The Economics of the Investment Were Worth The Risk Involved

We waited until January 2013 to get involved with this story, after the shareholders had approved the transaction and after the company announced an intention, coordinated with the DoJ, to close on February 19, 2013. At that point, the DoJ would have had to intervene to further extend the transaction. Given that NOV and RBN had already responded to two requests and indicated no further requests were made, and our understanding of the transaction as describe above, we determined the probability of an intervention at that point was slim. The DoJ and the Canadian regulatory authority had been given nine months to lodge a complaint, more than enough time, and not a peep.

Our first purchases were on January 25, and we continued to purchase shares until the transaction closed. Our shares were acquired for between $57.71 and $59.37 with a weighted average cost of $58.93. Given that our holding period was a mere 25 days, this represented a return of 2% in 25 days, or 29% annualized.

However, given the short duration of the investment, the value of the Little Fish, and all the other facts that were known or could be easily estimated, we felt comfortable using modest leverage to increase the return on this position. Using borrowed money at 2% per annum, we leveraged the investment such that our actual realized returns on invested cash, assuming a full position and 25% total portfolio leverage, net of interest cost, approaches a 50% annualized return.

KEY DOCUMENTS:

Initial announcement and merger documents.

https://www.sec.gov/Archives/edgar/data/84290/000119312512348001/0001193125-12-348001-index.htm

The announcement of closing of the transaction on February 20, 2013

https://www.sec.gov/Archives/edgar/data/84290/000119312513066867/d489401d8k.htm

Get The Spreadsheet

Click the button to receive the spreadsheet I used to track my positions in this arbitrage and calculate my returns.


Ask JB: What Securities Do I Use for Merger Arbitrage?

What securities do you use? Just the equities or do you also use options? Why?

JB Says:

Most arbitrages I do use equity longs only. It is possible to use options and shorts to arbitrage, but I choose to ignore those types of transactions and seem to find plenty of equity long-only type arbitrages.

How much leverage? Why?

JB Says:

I don’t recommend leverage to others because most will over-use it in an attempt to maximize their profits. What they have done instead is to maximize their risk of things going wrong. Personally, I use modest leverage if any.

What has been your biggest mistake? And what did you learn from it?

JB Says:

Being shaken off an arbitrage by a friend who shook my confidence. There were many aspects to that mistake from a psychological perspective, but the primary one was not having enough confidence in my position to shake off someone else’s opinion.

Do you have a burning question on investing you would like answered? Click the button below to send it to me and I will answer it on the podcast!

News: The Four Percent Rule Could Spell Trouble for Retirees

http://www.cnbc.com/2017/02/09/that-4-percent-rule-could-spell-trouble-for-early-retirees.html

JB Says: The four percent rule refers to the maximum you should disburse from your retirement account each year. This assumes investment returns of more than four percent and was established in the 1990's as a rule to keep you from blowing through your retirement income.

The reality is that most fixed income investments will not return four percent these days, and any long term bonds that you could be invested in, will decline in price over time as interest rates rise.

The best thing you can do is spend the decades prior to your retirement adding cash flow to your life so you won't have to rely on your retirement accounts as much.

Thoughts on this podcast? Disagree with me on some point? Something I missed? Leave a comment!

About the Author

Jeremy Scott Bailey is an investor, author, entrepreneur and host of the "What Works In Investing?" podcast now available on iTunes. He is founder and Chief Investment Officer of Burgeón Group, Inc. an investment advisory firm that provides portfolio management services to families and individuals.

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