Cash tender offer - Want to make money in an uncertain market?

Cash Tender Offer

   Want to make money in an uncertain market?  Consider buying stock of a company that's the subject of a cash tender offer. In a cash tender offer, cash is offered to company stockholders in exchange for their shares.  These deals can offer investors attractive returns.

   Investing in cash tender offers can be rewarding indeed.  According to a published article, investors would have turned $10,000 into $70,600 from 1981 to 1995 by buying the target company's shares a day after the announcement and holding until the deal closed. The same amount invested in the stock market would have grown to $31,400.  While these results are impressive, there could be periods when you'd lose money. And, there's no guarantee this strategy will work in the future.

   Acquirers include hedge funds, private equity, management led investor groups, and other corporations.  The day after the announcement, the target company's shares often trade below or at a "discount" to the offer price.  The size of the discount reflects the uncertainty and time to completion of the deal.  As the closing date nears and concerns about the deal are resolved, this spread usually narrows.  In part, it's the increase in share price between the day after the announcement until the closing date that offers the potential for gains. If the discount widens, then perhaps there's trouble afoot. The deal price could be lowered or worse, the deal could fall apart altogether.

    Occasionally, the target company's shares will trade above or at a "premium" to the offer price. This is generally an indication that arbitrageurs expect the offer to be increased.  Perhaps shareholders intend to resist the bid because the price is too low. The acquirer may have to offer a higher price to get their approval. Or a competing offer is anticipated by the market. The emergence of another suitor could result in a bidding contest, pushing the stock higher and higher.

    Midwest Air Group was the subject of a protracted bidding war. Air Tran first bid $4.50 a share for Midwest in late-2006 but met resistance from Midwest's board.  In an effort to consummate the deal, Air Tran upped its bid several times. Then, in a surprise development, private equity firm TPG Capital made a $16.00 cash bid in August 2007. Air Tran responded with a $16.25 cash and stock offer. Just days later, Midwest's board announced that it had unanimously approved a sweetened TPG's all cash offer of $17.00 a share.  News of Northwest's proposed sale to Delta Airlines clouded expectations for a timely close but TPG completed the transaction in late January 2008, ending a nearly two year bidding war.

   There have been losses.  The leveraged buyout of SLM Corporation (SLM) by JC Flowers, a private equity fund, fell apart soon after Congress passed legislation in late 2007 lowering the rates lenders could charge on student loans. JC cited the legislation as constituting a material adverse event or "MAE" and withdrew its $60 offer. The stock price unraveled along with the deal and recently traded near $10 a share.

    With many deals wrapping up in less than a year, most gains or losses will be short-term.  This makes tax-deferred retirement accounts, like IRAs, better suited for participating in cash tender offers than taxable accounts.

    In spite of some spectacular failures, most tender offers have been successful. Intrepid investors may want to consider participating in a handful of cash tender offer situations. After a promising start, we unwound our positions after experiencing substantial losses during the recent market crisis. We recently decided to wade back into this strategy. The table below highlights some deals we're following.

    We recently took a position in Burlington Northern Santa Fe Corporation (BNI). Burlington is the subject of a tender offer by Berkshire Hathaway (BRKB), Warren Buffett's investment vehicle. It's not a pure cash offer however. Rather, Berkshire is offering cash or Berkshire stock. We won't be averse to accepting stock, provided we can get it, since we view Berkshire as undervalued. (Though we could just as easily buy Berkshire shares on the open market.) Potential investors can go to the SEC website for the latest and most complete information regarding the offer.

	Target company	Ticker	Sector	Offer	Recent	Disc/Prem	Close	Concerns	Acquirer	Return**
*	Varian, Inc.	VARI	Med Equip	$52.00	$51.59	-0.8%	Jan-10	Customary	Corporate
*	Burlington N S Fe	BNI	Railways	$100.00	$98.73	-1.3%	Mar-10	Customary	Corporate
*	Merrimac Indus.	MRM	Comm Equ	$16.00	$15.89	-0.7%	Mar-10	Customary	Corporate
*	STARLIMS Tech.	LIMS	Data Sftwr	$14.00	$13.89	-0.8%	Mar-10	Customary	Corporate
	Starent Networks	STAR	Comm Dev	$35.00	Closed		Dec-09	Customary	Corporate	15.5%
	Avocent Corp.	AVCT	Comp Peri	$25.00	Closed		Dec-09	Customary	Corporate	2.9%
	SPSS, Inc.	SPSS	Data Sftwr	$50.00	Closed		Oct-09	Customary	Corporate	5.5%

We try our best to present valid data although we cannot guarantee its accuracy. Close date is an estimate. Concerns noted above are not meant to be comprehensive. Deals may not be closed under the original terms or may fail to be consummated altogether which could result in substantial losses.

* Indicates we hold a position in this security as of December 30, 2009.
** Our unaudited, annualized return from this position.