Adding Up the Tyco-TyCom Transaction

About two weeks ago, I penned a column looking at Tyco's (TYC) $14-a-share proposal to repurchase the public's 11% minority share in TyCom (TCM), the undersea cable subsidiary that Tyco took public 18 months ago at $32.

Events moved considerably more quickly than the time frame I had envisioned. TyCom's special committee of independent directors gave its blessing Friday to a deal that improves the buyout's terms: Holders will now get 0.3133 a Tyco share for each TyCom share, compared with the originally proposed 0.2997 a Tyco share. Based on Tyco's closing price from Friday of $48.75, each share of TyCom will receive approximately $15.27 worth of Tyco shares when the merger is closed, likely in early January.

Other than the unusually quick two-week negotiation period, this outcome is typical in minority squeeze-out mergers like this. TyCom's special committee of directors successfully executed the task before them: extracting a bump in the merger terms in exchange for approving the transaction. While I'm not impressed with the relatively stingy 5% sweetening, the short duration of the wait makes up for it.

I had postulated that a sweetening to 0.306 or better would prove profitable if you had shorted the original ratio of Tyco shares for each share of TyCom purchased, paying a 30-cent premium to the original implied deal value on the day the proposal was unveiled. As the final 0.3133 ratio exceeds the hypothetical hurdle of 0.306, let's see how the math of the trade worked out.

Using Friday's closing prices of $15.10 for TyCom and $48.75 for Tyco, based on the original ratio of .2997, the spread that you had paid 30 cents for is now running approximately 55 cents, a 20-cent profit. To compare this with other arbitrage spreads, you'll need to annualize this two-week return, which works out to about a 37% return. They should all be this good.

You can also compare that outcome to the implied return of what is left: the difference between Tyco's share price multiplied by the new ratio, minus TyCom's current price. This merger spread (.3133 times 48.75 minus 15.1) equals 17 cents, which will be earned over the four months it'll take to publish a proxy statement, get it through the Securities and Exchange Commission review process, schedule a shareholder vote and close the merger.

Annualizing the 17 cents implies a 4.5% return. Better than passbook savings, I guess, but hardly the sort of return I would be willing to seek with my capital, given any merger's risks of nonconsummation.

The stage of the deal now under way -- from the signing of a merger agreement to consummation -- is clearly less risky than the stage that involves waiting for the initial proposal to ripen into a merger agreement. But eight times as risky? No way, but that's what the two investment returns imply. This is why I prefer to invest in the early stages of these types of transactions. Slightly riskier, certainly, but the rewards are more than commensurate with the risks.

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