RealMoney Silver - Insider Arbitrage: HUN

Insider Arbitrage: HUN
By Jonathan Moreland
RealMoney.com Contributor
12/19/2007 11:36 AM EST

It's pleasurable enough to be in a stock when a buyout is announced -- it's ecstasy when a bidding war breaks out.

That's the feeling shareholders of chemical maker Huntsman (HUN) must have had this summer. HUN spiked from $18.83 to $24.10 on June 26 after Dutch manufacturer Basell solidified a $25.25-per-share takeover deal for Huntsman. Just a week later, however, the stock added an extra layer of loveliness when Apollo Management bid $28 a share in cash for the company in order to combine it with its Hexion Specialty Chemicals unit.

A nearly 45% jump in seven trading sessions isn't bad at all for a boring old chemicals stock.

Whenever I've been fortunate enough to be in a takeover target, I've always advocated selling into the offer shortly after it's made -- especially when no bidding war is expected. The risk of losing the sudden sizeable gain if the merger isn't consummated is rarely worth the small reward that's usually left when the target stock finally levels off just below the takeout price.

So I was surprised when Huntsman made it onto my insider buying screens recently. But there it was. Both Peter and Jon Huntsman, CEO and a director (respectively) at their eponymous firm, purchased more than $1 million of HUN stock last month as it traded down near $24. The pair also ponied up more than $15 million back in August when HUN also dipped down to the same post-announcement lows.

These buys represented large dollar amounts, and an averaging up in price for the insiders -- two aspects of trades that tend to score them well in my insider system. The purchases were also of a stock that was showing good overall technical momentum -- another plus. They weren't, however, large increases in holdings for the duo, who also benefit from a boatload of family-owned shares. That's a mitigating factor to bullishness, but it wasn't enough to knock it out of my screen given the other factors.

Especially when Huntsman's insider history does show a large, recent increase in holdings from another buyer -- U.K.-Based Cheyne Capital Management. This firm, which specializes in "event-driven" investing among other strategies, picked up a 5% stake in HUN after the merger announcement.

The Huntsmans and Cheyne obviously expect this merger to close, and to get $28 a share for their shares when it does. If so, they'll be pocketing a more-than-12% capital gain. That may not excite individual investors looking for the next home-run stock priced under $5, but that's a nice payday for an arbitrage play. And in this cruddy market, a relatively safe 12% gain for a U.S. equity may just have its place.

Always a Risk

Of course, the big question is just how "safe" this bet is. The pending Huntsman-Hexion combination is a large transaction, so it will take several more months to close. So you first have to factor in the time-value of the money on the line. In this case, the gain is expected in less than a year.

In Huntsman's latest earnings conference call, CFO Kimo Esplin relayed that "Hexion has until July next year, subject to a possible 90-day extension under certain circumstances, to close the transaction." So if all goes well, that more-than-12% gain would be bankable in seven to 10 months. You'll likely get a bit more than 1% from the continued small dividend the company pays out as well.

Adding to that, the deal structure further states that the cash price per share to be paid by Hexion will increase at the rate of 8% a year inclusive of any dividends paid, if the transaction is not consummated by April 5th, 2008. So Hexion has incentive to close the deal even sooner.

That brings the potential annualized gain of a bet on HUN now up to an impressive 33% if done by April 5, fading to a still respectable 20% if it takes till the end of October.

That assuming that no fly gets in the ointment. And while there is no financing condition needed on this transaction given Hexion's commitments from Deutsche Bank and Credit Suisse, there is a buzzing risk in the deal from none other than good ol' Uncle Sam.

Specifically, Esplin also explained in the last conference call that "U.S. and foreign competition law approvals" are required for consummation, and that on "Oct. 4, 2007, Hexion and Huntsman received a second request for additional information from [the U.S. Federal Trade Commission] in connection with the merger."

When a government approval is involved, anything can happen, and I am certainly not qualified to offer any odds here. But the Huntmans and Cheyne are better qualified to chime in on the matter, and they have done so with their money.

In fact, Peter Huntsman was so keen to arbitrage this deal that he started buying back shares at $24 in August after selling shares for around $19 less than five months before. That quick reversal of sentiment shows the extent of his seller's remorse. (The purchases would also seem to be afoul of the short-swing rule that bars insiders from both selling and buying their shares in the open market within a six-month time frame. But Peter Huntsman can claim no pecuniary interest in the shares he sold in March since they originated in a family trust.)

Adding to insiders' bullish conclusion on HUN is an assessment of downside risk to the stock if the merger does fall through. Remember that Huntsman already had another bid for $25 per share on the table before Hexion came along. That old bidder has since gobbled up another firm and may not be around to offer the same price again. A massive global slowdown could also put a crimp in the value of Huntsman if it is forced from this marriage. But that last risk is hovering over all stocks now. All in all, I can see why insiders are trying their hand at arbitraging Huntsman.