Wednesday, April 25, 2012
Sunday, December 11, 2011
Gilead has recently announced a tender offer to acquire Pharmasset's outstanding shares (click here for details). The tender offer is slated to run through January 12th, with Pharmasset investors receiving cash shortly thereafter (usually takes 1-3 business days). As such, investors can set themselves up to receive an approximate 75% annualized gain by buying Pharmassset's shares today.
While financing risk often explains a sharp discount to the offer price, Gilead's offer is not contigent on financing. Further, the company recently raised $3.7 billion by tapping the bond market, which when combined with more than $2 billion of cash on its balance sheet, will provide Gilead with ample capital to effect the tender.
So why is Pharmasset trading well-below the offer price given the high likelihood of the deal closing within the next month? Firstly, I think investors are spooked by the massive premium that Gilead offered for the company. At approximately 90%, the downside risk is very signficant should the deal not go through. While I think this is a very low probability, particularly since Gilead raised its offer multiple times before winning over Pharmasset's board, merger arb specialists are undoubtedly taking into account the pre-deal price when assessing their downside exposure.
Secondly, at ~$10 billion, Pharmasset's sizable market cap likely explains some of the gap. There is simply not enough merger arb capital out there to absorb the supply of paper being sold from long-term Pharmasset holders (who rightfully sold out of their position when the deal was announced). This is particularly the case as we head into the end of the year when investors naturally become more risk-averse. Last thing a trader wants is for a merger arb position to blow up in his face as he is wrapping up the year, particularly since the transaction won't close until after the new year.
Finally, the last reason (and perhaps the most pressing concern for risk arb) traders is an unusual provision in the agreement, called a "Key Product Event". To avoid me misinterpreting the provision, here it is in its entirety:
A “Key Product Event” is any serious adverse event that (i) is determined by an independent safety review committee overseeing the safety of the relevant clinical study to be directly related to PSI-7977 (not predominantly related to any compound with which PSI-7977 is coadministered) and to have: (a) resulted in death; (b) been life-threatening; (c) required inpatient hospitalization or prolongation of existing hospitalization; (d) resulted in persistent or significant disability or incapacity; (e) resulted in a congenital anomaly or birth defect; or (f) required significant intervention to prevent permanent impairment or damage and (ii) (x) results in the FDA’s placing a clinical hold on the development program of PSI-7977 or (y) is likely to result in a significant delay in the development timeline of PSI-7977 as of the date of the Merger Agreement.
The key point to note is that efficacy is not enough for Gilead to pull out of the deal - the drug must have resulted in death or be life-treatening. While I am not a scientist and certainly not in a position to render any opinion on Pharmasset's drug, one has to have faith that Gilead has done substantial diligence on this issue before committing to buy the company (and raising its offer 3 times before finally winning the prize).
My own personal view is that short sellers are grasping on this issue to try and push the stock down. After rising to as high as $135 after the deal was announced, Pharmasset's shares have steadily declined to $129, providing a huge windfall for put buyers that bought near-term puts following the deal's announcement. With that said, I think the fears surrounding the Key Product Event are creating a very compelling risk/reward for those investors willing to look past the noise created by short sellers.
If anybody has anything intelligent to add to the discussion please feel free to drop me a line. Hopefully, I am not missing the steamroller as I reach for a couple of nickels:)
Friday, November 4, 2011
As I indicated in my previous post, the biggest concern I had was that the tender would attract so much interest that there would be an oversubscription by odd-lot holders (i.e. those holding less than 1,000 ADRs). However, the proration factor turned out to be nearly 11% vs. the Company’s intention to purchase 7.7% of its shares outstanding. As such, there was never really any threat of odd-lot holders not getting paid out in full.
Based on the handful of comments I received on the post, it sounds like there are some fortunate individual investors who decided to hold their nose and take the plunge on an attractive risk reward. Congrats to all and let’s hope we can get in the middle of another fight between a pair of Russian oligarchs in the near future!
For all those interested, here is a great article ("Bread Line or Stock Sale") from the wall street journal that shows the difficulty most Russians faced in tendering their shares. Unlike us fortunate Americans who simply had to place a 3 minute call to instruct our broker to tender our shares, most Russians had to tender their shares in person. The article talks about the massive "bread" lines of people that formed to take advantage of the "once in a lifetime" offer. Unfortunately, many they didn't make the October 28th cutoff.
Thursday, October 27, 2011
However, I learned about an investment opportunity two weeks ago that only a small fry investor like me could fully take advantage of. It all started when my brother-in-law, who works for one of the premier option market makers, received a firm-wide email alerting him to an opportunity in Norilsk Nickel. Norilsk is a $40 billion market cap Russian-based metals and mining Company.
The email indicated that Norilsk (ticker NILSY on the pink sheets) was conducting a tender offer for approximately 7.7% of its shares at a substantial premium to its then current trading price of approximately $20 share. More specifically, the tender offer price is $30.60/share, representing a 50+% premium. While not unusual in its own right, the fascinating part of the tender offer is that individual shareholders who own less than 1,000 shares will not be prorated in the tender. As such, assuming the Company follows through on the tender, an investor could pocket approximately $10,000 in less than two weeks time just buy tendering their shares!
For a large institution holding several hundred thousand shares, this offer hardly seems that appealing. While they will likely be able to tender a small portion of their shares (perhaps ~5%), the vast majority of their position will not be accepted and as such they have to be primarily focused on the fair value of the Company (which presumably is around $20/share). Given that most of Norilsk shares are held by very large shareholders, the Company’s share price has hardly moved since the tender was announced, despite the fact that the offer contemplates a 50% premium to the pre-tender price!
Ever the opportunist, and recognizing a compelling risk/reward when I see it, I purchased approximately 1,000 shares in three separate trading accounts. Tomorrow is the day of reckoning as the Company will officially close the tender and presumably announce the results thereafter. As I see it, the key risks are the following:
- The Company decides at the last minute to pull or delay the tender
- The Company lowers the offer price, since they see no reason to reward mostly individual shareholders with a 50% premium
- So many small shareholders pile into the trade that even the non-prorated class ends up getting prorated (i.e. not all of my 3,000 shares are accepted for tender)
- The government challenges the tender (this is a separate issue that is not worth going into in this email – safe to say, this issue has likely been taken off the table given recent comments from the Russian government)
While there is a distinct possibility the tender offer fails to go through, I still think this is an incredibly attractive risk reward that frankly I have not seen available in a very long time. In a worst case scenario, the tender offer is pulled and I end up owning stock in a $40 billion Russian metals Company.
While not my intention to be long NILSY, most of the more bearish analysts think the stock is worth $18. In a worst case scenario, assuming it trades down to this more pessimistic view of fair value, my maximum short-term paper loss would be $7,500 [(my purchase price of $20.50 - $18.00) * 3000 shares]. My upside, assuming the tender is accepted is $30,300 [ ($30.60 - $20.50) * 3000 shares]. If you assume there is an 80% chance of the tender going through, that provides an expected value payoff of $22,740 (.8* $30,300 + .2 * -7,500). Certainly not fool proof, but a compelling risk-reward in my play book.
I look forward to reporting back on the results of the tender! Knowing my luck, something bad will happen between now and tomorrow, but given the massive run in the market today, I feel even better about my downside.
For those interested in reading more about the tender offer, please follow this link: http://nnbuyback.com/home.html
Tuesday, August 9, 2011
The video, which was put together by SBS Dateline (Australian TV) in March 2011, is about 14 minutes long so it requires some investment of your time, but definitely worth listening to. There are at least 3 major cities profiled in the documentary that are virtually unoccupied, but have the capacity to support millions of people. It’s kind of eerie to see the camera pan across these cities and show high rise building after high rise building with virtually no tenants.
Perhaps the most telling statistic in the video is that there are approximately 64 million empty apartments in China. Despite this overcapacity, the government recently mandated that 36 million affordable homes be built over the next five years, including 10 million in 2011 and another 10 million in 2012.
I also found the story on The South China Mall in Dongguan, China to be particularly fascinating. The mall, which was completed five years ago, is nearly three times the size of the Mall of America in Minnesota. As detailed in this May 2005 New York Times article ("China, New Land of Shoppers, Builds Malls on Gigantic Scale"), the mall has 150 acres of palm-tree-lined shopping plazas, theme parks, hotels, water fountains, pyramids, bridges and giant windmills. The mall also has a 1.3-mile artificial river circling the complex, which includes districts modeled on the world's seven "famous water cities," and an 85-foot replica of the Arc de Triomphe. Despite the mall’s world class architecture and its relatively close location to Shenzhen and Guangzhou (two major Chinese metropolises), the video vividly details how the mall is a virtual ghost town, with a large chunk of the mall unleased and seemingly no customers to be found on its premises.
While I will readily concede that I have never been to China and my thesis rests squarely on third party research and information, the multitude of articles written and videos produced over the last few years, provides compelling evidence that the growth in China’s real estate market remains unsustainable and enormously damaging to the global economy when it inevitably corrects.
Over the last few weeks, investors have faced unsettling news from all corners of the world. Whether it is the debate over the debt ceiling in the US, the potential contagion fears from a sovereign default in Europe, the dangerous consumer bubbles forming in Brazil and India, or the overall slowing economic growth throughout most of the developed world, investors have a lot to be concerned about. However, in my opinion, nothing is as dangerous or potentially destabilizing as the real estate bubble forming in China. So many companies, from equipment manufacturers to commodity producers to Chinese state-owned banks will be severely impacted by a slowdown in Chinese fixed investment.
While it is difficult to predict when the correction will occur, and history suggests that the Chinese government will do everything in its power to keep the charade going, the fissures seem to be developing by the day.
Already, we have learned that traditional banks have severely curtailed their lending to the real estate sector ("Chinese Property Firms Getting Squeezed"). As such, lending has moved to the “shadow banking system” in the form of trust companies, which have more than doubled their lending to real estate developers over the last quarter vs. traditional banks, which reduced their loans for property development by 75% in 2Q (see chart below).
As we saw in the US during our own housing bubble, the migration of lending from traditional banks to an unregulated and unaccountable shadow market, represents the last leg in what we all know will end badly for these unsuspecting trust company investors.
Sunday, July 31, 2011
Wednesday, July 13, 2011
As highlighted in this recent Financial Times article, "Credit To Redeem", the consumer credit bubble occurring in the Brazilian economy is on par with the real estate and credit bubble that led to the US's undoing in the summer of 2007. This paragraph from the article says it all:
"Part of this inflation has come from rapid credit growth, particularly consumer borrowing. Observers such as Paul Marshall and Amit Rajpal at Marshall Wace, a London-based hedge fund, argue that Brazil is at risk of a full-fledged consumer credit crisis. Retail borrowers are on average spending one-quarter of their disposable income on debt servicing, compared with only about 16 per cent in the US. Defaults are rising. Serasa Experian, a credit monitoring agency, this week said its index of consumer delinquencies rose 22 per cent between January and June, the biggest increase in nine years."
While the central bank is forecasting credit growth of 15 per cent this year, no one agrees on how much debt households can bear. “What’s the limit that people can pay in terms of interest charges plus amortisation? When it’s getting to a third of their income, it’s pretty high,” says Mr Volpon.
In another FT artice, "Brazil Risks Tumbling From Boom to Bust," we learn of the remarkable borrowing rates faced by consumers.
The average rate of interest on consumer lending has jumped from 41 per cent in 2010 to 47 per cent most recently in May 2011. This rise from an already elevated level reflects the cumulative effect of tightening by the Brazilian central bank in order to contain inflation.
The consumer debt service burden, which stood at 24 per cent of disposable income in 2010, is now slated to rise to 28 per cent in 2011.
While the Brazilian central bank has aggressively tightened monetary policy, including raising interest rates to a global high of 12.25%, the bank's actions to date have had minimal impact on the growth in credit. Further, the raising of interest rates has resulted in a 40% increase in the Brazilian real and attracted significant foreign investment flows, which have only exacerbated the country's challenges.
While always difficult to predict the top of a bubble, its very clear that the credit binge occurring in Brazil is unsustainable and will end in tears. Add this to the list of risks facing investors as we enter the second half of 2011.