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Einhorn's Martin Marietta Short Exposes Vulcan M&A Bulls

David Einhorn, Martin Marietta story, corrected for reference to Einhorn's short of Saint Joe Company. An earlier version of the story incorrectly referred to St. Jude Medical.

NEW YORK ( TheStreet) -- Martin Marietta (MLM - Get Report) is David Einhorn's new favorite stock to short. While that's a bad development for Martin Marietta's shareholders, the market reaction to Einhorn's short may reflect positively on its $6.7 billion hostile bid for competitor construction aggregates giant Vulcan Materials (VMC - Get Report), which seemed all but dead earlier in May.

A recent Delaware court ruling and Vulcan Materials' insistence on staying independent made Martin Marietta's takeover attempt extremely challenged, but the near-identical late Wednesday share tumble of both companies after Einhorn revealed Martin Marietta as a short target signals that traders are still betting that the unsolicited stock offer will eventually succeed, even if terms and conditions change.
David Einhorn

Einhorn was widely expected to disclose a short position in Herbalife (HLF) at Wednesday's Ira Sohn Investor Conference in New York. Instead, the famed short seller -- who's tangled with Green Mountain Coffee Roasters (GMCR), real estate developer The Saint Joe Company (JOE) and gained his prominence for a bold call against Lehman Brothers ahead of its demise -- revealed the surprising move against Martin Marietta.

Martin Marietta shares fell over 8% to $68.60 in Wednesday trading, meanwhile Herbalife rallied over 16% to $49.51. During Herbalife's first quarter earnings call, Einhorn pressed the company on its accounting and raised questions about its growth prospects, but it is Martin Marietta's earnings that Einhorn called out as being richly valued.

"Recent earnings benefited from one time fiscal stimulus that is about to wind down," Einhorn said at the conference. Those comments aren't just a negative for Martin Marietta, they also reflect poorly on Vulcan's 2012 outlook. Both companies are the top two players in producing construction aggregates or crushed gravel and stone that's used to build roads and other infrastructure.

"We don't believe Mr. Einhorn's comments regarding valuation as measured by a P/E basis represent anything new," wrote Wells Fargo analyst Adam Rudiger in a note to clients reacting to Einhorn's short. While Einhorn focused on Martin Marietta's share valuation at a price of 35 times forward earnings as a key to his short position, Rudiger argues it may be the wrong valuation metric. "[Investors] more frequently look at EV/EBITDA multiples when valuing aggregates companies and on that metric, Martin Marietta shares are not as richly valued."

Still, it's Vulcan Materials, a bystander to Einhorn's short position, that may be the most interesting stock to watch.

In the moments after Einhorn disclosed his short, Sachin Shah, a special situations strategist with Tullett Prebon says that the spread on Martin Marietta's share exchange offer for Vulcan Materials rose from around $1 to $3.32. If traders were shorting that spread with the expectation that a deal will occur, Shah says Wednesday share gyrations could have yielded a quick $2 return as the spread quickly narrowed from $3.32 to below $1.

"People realized at the end of the day nothing changed about a possibility of a deal, it just changed what Martin Marietta would have to offer Vulcan Materials," says Shah. Martin Marietta's $6.7 billion share offer to acquire Vulcan Materials, a company with more than double its revenue, was contingent on a conversion that gave Vulcan shareholders 0.5 Martin Marietta shares for each share.

By Wednesday's close, an almost identical share drop of Martin Marietta and Vulcan -- and an end of the day merger spread of less than $1 -- signaled that traders expect the share conversion to remain in place, even as the hostile bid came against large difficulties in May.

"The market is saying that Martin Marietta is still pursuing the Vulcan Materials transaction," says Shah. He adds that Einhorn's short gives credence to Vulcan Materials resistance to the share offer launched in December.

If Martin Marietta's M&A fortunes were to change in courts, Shah says the company will need to address points made by Einhorn and help investors understand the company's worth, which has fallen from nearly $90 a share in mid-February to $66.75 in early Thursday trading. Only then can shareholders and both companies re-address a fair merger price.
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