Taking Advantage of a New Merger Trend

Corporate stock buybacks in the wake of share declines since Sept. 11 have been prominently covered in the media. These opportunistic share retirements by issuers with sufficient liquidity to take advantage of lower prices have been aided by a loosening of the SEC regulations that govern the timing and methods of these repurchases.

There is a similar trend emerging in this new investing world -- squeeze-out merger proposals by parent companies seeking to acquire the minority stakes of subsidiaries they already control. These transactions have a similar opportunistic agenda -- to buy back shares at prices that reflect a post-Sept. 11 environment.

Thursday saw the unveiling of two such deals -- Tyco's (TYC) $14-a-share proposal to repurchase the public's 11% stake in undersea cable company TyCom (TCM), and Global Crossing's (GX) attempt to merge its Asia Global Crossing (AX) back into the parent for an as-yet-undetermined price to the minority shareholders.

These deals join recently commenced processes by SBC (SBC) to buy the minority stake in Prodigy and the Levy family's attempt to buy back the public minority in NCH (NCH).

Transactions such as these all are driven by unique circumstances. Sometimes, as I suspect is the case with NCH, it is a desire to continue operating an essentially family-owned company without the inconvenience of public shareholders and the disclosure obligations that go along with it. In the case of Prodigy, SBC appears to have determined it can best accomplish its ISP goals by owning Prodigy in its entirety.

And Now for Something Totally Different

But TyCom and Asia Global Crossing are much more interesting situations, providing very different investment opportunities.

In the case of TyCom, Tyco now proposes to buy back for $14 -- or, more precisely, .2997 shares of Tyco -- the same shares it sold to the public for $32 in a July 2000 IPO underwritten by Goldman Sachs. From the perspective of Tyco on a consolidated basis, they will be closing out a short sale of 61 million shares for a $1.1 billion profit.

Whatever reasons Tyco had for creating a separate trading subsidiary 15 months ago apparently are no longer valid. What was supposed to be a richly valued, high-multiple acquisition currency has imploded into an embarrassment that might otherwise be hidden in the vast conglomerate.

Removing TyCom from the ranks of the public follows the same logic that led to the repurchase of NBCI and Go.com by their parents last year. Those deals were neat and clean as the parents -- General Electric (GE) and Disney (DIS) -- had contractual rights embedded in the documents that created the tracking stocks to close out the public holders. TyCom is, however, a real company. A buyout here will not be as clean. And that is where the opportunity to profit arises.

Typically, when a company like Tyco takes public a subsidiary, it recruits a couple of independent directors to join a board dominated by designees of the parent. They are called upon as a special committee to review and advise the public shareholders on the bid. In most cases, the special committee is successful in extracting an improved price from the parent. I am betting that something along those lines will happen in TyCom, if for no other reason than Tyco digging in its heels and refusing to bump a bid that is $18 lower than where it bagged the IPO buyers would be so unseemly, but also because I believe a credible case can be made for higher values based on TyCom's cash flows and likely future earnings.

Given Tyco's long and unassailable record of closing its many deals, I am confident this process will end in agreement with the special committee, not in an impasse. By putting on the spread by selling short .2779 shares of Tyco for each share of TyCom purchased, you can create the proposal for 30 cents more than Tyco is proposing. As long as the deal ends with a ratio of .306 or better, the trade will be profitable. I am optimistic we see a deal at a ratio greater than that by year end.

Asia Global Crossing is another story altogether. In the context of announcing that the parent company's business has radically deteriorated, Global Crossing -- or, as one of my bond brokers has begun calling it, "Global Crushing" -- disclosed merger talks are under way between it and the independent directors of Asia Global Crossing. There is no public proposal; apparently an announcement will be made in the future of an agreed-upon ratio to merge the two stocks.

Asia Global Crossing, which went public less than a year ago, trades for $1.27, off 82% from its $7 IPO price in a deal brought by Goldman Sachs and Salomon Smith Barney. Based on Global Crossing's $1.13 share price, the market seems to be guessing the proposed merger ratio will be around 1.2 to 1.3 for the 41% stake owned by Microsoft (MSFT), Softbank and the public, but there is nothing substantive on which to base an analysis.

Asia Global Crossing shareholders will face a serious dilemma. They own shares of a company with $1.2 billion of debt, $800 million of cash and a $300 million-revenue, EBITDA positive business of operating a Pan-Asia telecom and data network. In other words, a possibly solvent company.

Those holders are going to be faced with taking common stock in Global Crossing, a company with approximately $7 billion of debt that earned something less than $100 million of EBITDA in the most recent quarter. Solvent? Well, you can buy Global Crossing's bank loans for 55 cents on the dollar and its junk bonds for 22 cents on the dollar. The debt markets have clearly rendered their verdict, even if the stock market still accords $1 billion of equity value to Global Crossing.

Of course, Global Crossing may argue that Asia Global Crossing is independent in name only, and that its network is worthless divorced from the greater resources of the parent. In other words, its common might be equally doomed should Global Crossing fold. Not exactly a compelling investment argument.

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