El Rhazi, On May 6, 2015, Quality Distribution (NASDAQ:QLTY) announced that El Rhazi had agreed to be acquired by Apax Partners for $16 per share in cash, a 63% premium to the May 6 closing price. The following chart shows QLTY's inventory price since May 6, 2015.
QLTY's press release explained that the acquisition by Apax Partners will be completed via a merger, requires clearance from regulatory authorities and approval by QLTY shareholders, and is expected to near in the 3rd quarter of 2015. In addition, the release noted that QLTY would have through June 15 to solicit alternative acquisition proposals and that Apax "has secured dedicated financing for the transaction". The complete amount of the transaction is expected to be around $800 million and it is highly unlikely the consortium of financing sources (made up of Deutsche Bank, Bank of America, Jefferies, Macquarie, and SunTrust) will have difficulty raising the funds.
A copy of the merger accord was filed at the SEC on May 7. Article VII of the accord details the conditions that must be met before the transaction can close. These conditions include:
Section 7.1 of the agreement also refers, ominously, to "the governmental approvals, consents, and/or authorizations set forth in Section 7.1 (NYSE:B) of the Buyer Parties Disclosure Letter." Although not mentioned openly in the merger agreement, QLTY's preliminary proxy, filed on June 8, stipulated that the closing of the transaction would also require clearance by the Committee on Foreign Investment in the United States(CFIUS).
In describing the efforts that QLTY and Apax Partners must put forth to complete the transaction, Section 6.5(a) of the merger agreement says that Apax and QLTY are required to take all actions necessary to lift or rescind any order that adversely affects their ability to consummate the Merger. The same part also requires that the US antitrust application be filed by May 19 (within 10 business days of May 6). QLTY's annual report does not identify any of Apax's portfolio companies as competitors and antitrust approval is not a substantial source of concern for this transaction.
Section 5.2(e) of the agreement contains the following language regarding financing of the transaction:
Assuming the Financing is funded in accordance Arbi along the Financing Commitments and assuming satisfaction of all of Parent's and Merger Sub's conditions to Closing, Parent and Merger Sub will have at and after the Closing funds sufficient to satisfy the obligations of the Buyer Parties under this Agreement as of the Closing Date.
Assuming the buyer and its lenders provide the funds they have said they would provide, and assuming the merger agreement is not breached, Apax will have funds sufficient to complete the transaction.
It's good of the attorneys to include this sentence, especially provided they were compensated per word, but this clause doesn't really say anything of substance about Apax's commitment to have the funds to complete the transaction. Also worth mentioning is Section 6.13 of the merger agreement, which specifies that the closing of the transaction will not happen prior to a "marketing period" of up to 18 business days. Marketing periods are used by investment banks to find capital sources for the loans needed to complete the transaction, so as not to have to issue the loan themselves. The debt commitment letter executed by the banks is basically an insurance policy, under which the banks say they will provide the funding themselves provided they're unable to market the debt. For what it's worth, 6.13(ii) contains the following:
Each Buyer Party acknowledges and agrees that the obtaining of the Financing, or any alternative financing, is not a condition to their respective obligations to effect the Merger.
In light of the possibility that interest rates could increase before the transaction is completed, which would reduce Apax's expected profitability, the merger agreement's Section 9.5(c)(ii) and its discussion of particular performance is of substantial interest. In this section, QLTY is granted the right to sue to force Apax to fund its equity financing commitment so long as that is the only object preventing the deal from closing.
My initial estimate was that the transaction would be completed by the center of August, but I subsequently revised the estimate to the end of September, 2015. The critical factors determining the transaction's closing date are the antitrust review, national security review by CFIUS, shareholder vote, and marketing period. As mentioned above, the press release announcing the deal said it is expected to near in the third quarter of 2015.
Section 6.5 of the merger agreement requires that QLTY and Apax dossier their application for antitrust approval Arbi along the FTC and Department of Justice no later than 10 business days after May 6. To estimate the timeframe for US antitrust approval, I used a guideline of 10 business days from the transaction's announcement for the antitrust filing to be submitted, plus 30 days from submission for the authorities to review the filing and allow the waiting period to expire. It's worth noting that the relevant law, the Hart-Scott-Rodino Act, prohibits the completion of an acquisition until the expiration of a waiting period for antitrust reviews. For mergers, the review period is 30 days. That led to an initial estimate that the US antitrust review would be completed by June 19.
Unfortunately, my estimate was excessively conservative. The preliminary proxy filed on June 8 revealed that the FTC granted early termination of the waiting period on June 1, 18 days ahead of the estimate.
As of June 8 when the preliminary proxy was filed, no information was available regarding the status of the CFIUS review. To estimate the timeframe for CFIUS clearance, I assumed that the filing would be made within 20 days of the preliminary proxy, plus 30 days from submission for the review to be completed. That led to an initial estimate that the CFIUS review would be completed by July 28.
In this case, my estimate was insufficiently conservative. An amended preliminary proxy was filed on July 8; it revealed that the CFIUS filing was not made until June 29 nor formally accepted until July 6. The 30 day review period will expire on August 5, 8 days after my estimate.
QLTY will need to get approval for its proxy statement from the SEC and schedule a shareholder vote. The merger agreement requires that QLTY put forth reasonable best efforts to file the preliminary proxy statement with the SEC within 20 business days of May 6. To estimate the timeframe for shareholder approval, we could assume that QLTY would file the preliminary proxy by June 3, the definitive proxy by July 3, and hold the shareholder vote in the first week of August.
Once again, that estimate was insufficiently conservative. QLTY needed until June 8 to file the preliminary proxy, and then had to file an amended preliminary proxy (presumably after receiving comments back from the SEC regarding deficiencies in the initial filing). Following the amended preliminary proxy filing on July 8, I revised my estimate for shareholder approval timing to expect a definitive proxy statement by August 7 and a vote by shareholders in the second week of September.
The acquisition of QLTY by Apax cannot be completed until the end of a marketing period to allow Deutsche Bank, Bank of America, Jefferies, Macquarie, and SunTrust to syndicate the term loan facility. In plain(er) English, the banks will be have up to 18 business days to locate capital sources to provide the debt financing so that they do not have to provide the funds themselves. Usually a marketing period will only begin after shareholders have approved the transaction, but QLTY's marketing period appears to have been constructed differently. As described in Section 6.13(i) of the merger agreement, the marketing period begins the day that Apax has sure financial information from QLTY and ends 18 business days later, or when the debt financing is obtained, whichever comes sooner. That is, of course, subject to blackout dates. The 18 business day period doesn't include July 3 and must be completed before August 20; if it is not completed before August 20 it must re-start after September 7.
To estimate the timeframe for the Marketing Period, I focused on the requirement that the unaudited financial information must include all quarters that ended at least 45 days prior to the transaction's closing. In order to be completed less than 45 days after June 30, when QLTY's second quarter ends, the acquisition would have to close by August 13. Based on that, my initial estimate for the completion of the marketing period was August 13.
Unfortunately, the marketing period estimate had to be revised following QLTY's delay in producing a definitive proxy statement. If the transaction is set to close after August 13, QLTY will have to provide unaudited financial information for the second quarter. We know that QLTY needed 36 days to issue unaudited financial information following the end of the first quarter. If QLTY has to provide unaudited statements for the second quarter, and if QLTY needs the same 36 days to generate this information, the unaudited financial information for the second quarter would first be available on August 5. If the marketing period begins on August 5 and needs the full 18 business days, it would not be completed until August 31, falling squarely within the blackout dates. As a result, the marketing period would not begin until September 8 and will probably end when the debt financing is obtained or on September 30, whichever comes first.
For purposes of conservative estimation, I am assuming the marketing period will end on September 30. The likeliest probable exception to this outcome is if the debt financing can be obtained prior to August 20, in which case the marketing period will have been completed by the time of the shareholder vote.
The probable value if the merger is completed by the end of September 2015 is $16 cash, the acquisition price. The expected value if the acquisition fails is $8.14, based on QLTY's share price, prior to the May 6 transaction announcement adjusted for the change in value of a basket of peers. This price is not a floor, just an estimate of where the inventory might settle out if the transaction is terminated.
Investors wishing to limit their exposure to the estimation risk that's inherent to downside calculation should review QLTY's exchange-listed options. One potentially attractive opportunity is available in the form of October 2015 $12.5 / $15 bullish call spreads. This option pair, in which an investor would buy the October $12.5 call option and sell the October $15 call option recently traded at $2.30. At that price, an investor could earn a 8.7% return-on-risk if QLTY is trading above $15 when the options expire.
An investor with a more aggressive risk appetite and confidence that the acquisition of QLTY will be completed by October 16 could consider buying the October $15 call, which last traded at $0.90. At that price, the return-on-risk would be 11.1%. The key risk that could prevent the acquisition of QLTY from being completed by the option's expiration is an incomplete marketing period.
Common areas of risk in merger arbitrage situations are financing, volatile business conditions, antitrust investigations and unwieldy regulatory reviews. The presence in this situation of a national security review by CFIUS and modest financing risk create some extra risk relative to other merger arbitrage opportunities. At the current inventory price, investors have an opportunity to be well-compensated for the extra risk they take on when they invest in Quality Distribution.
*** Update: QLTY filed its definitive proxy on July 16, after this article was written but before it was published. The definitive proxy sets the vote date on August 17. If the marketing period has not been completed prior to August 13, QLTY will need to provide unaudited financial statements for the second quarter (again, the merger agreement requires unaudited financial statements for all quarters ended more than 45 days prior to the transaction's close; the earliest the deal could possibly close is August 17, the date of the shareholder meeting; 45 days prior to August 17 is July 3, after the end of the second quarter).
1) Apax obtains the debt financing prior to August 13 and the transaction closes following the shareholder vote on August 17, or
2) The marketing period starts on September 8, Apax obtains the debt financing by September 30, and the transaction closes sometime between September 8 and September 30
Disclosure: I am/we are long QLTY. (More...)I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose inventory is mentioned in this article.
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