The period of time between a merger announcement and the deal's consummation presents tricky issues for companies. While not formally merged, they frequently collaborate on integration issues, set joint strategic direction and decide on postmerger staffing and job cuts and other critical issues.
Certainly as an arbitrager, it is important to see that the merger partners put up a good public face. It gives you confidence that the merger is on track and that management continues to be happy with their boards' decision to do the deal.
This is apparently not so in the curious case of
. When the merger between these two drug companies was
announced back in June, the only impediment seemed to be some minor antitrust concerns. By early September, the companies had publicly laid out exactly what the government is requiring in order to approve the deal: the divestiture of Alza's prostate cancer treatment product
While the required asset sale increased the time it would take to close the merger (and thus lower the return to arbs like ourselves), it was not unusual or unexpected. Many deals require some sort of divestiture to appease the regulators.
Alza moved forward and held its shareholder meeting in September, and the deal was poised to close as soon as a buyer could be found for Viadur.
Abbott, meanwhile, has been embroiled in a dispute with the
Food and Drug Administration
over the manufacturing processes used to manufacture some in vitro diagnostic products at its Abbott Park, Ill., plant. The FDA alleges contamination by virus in several lots of the product and blames Abbott's process and controls. Abbott disputes this, claiming its product and processes are safe.
The battle has recently escalated, scaring some Alza shareholders who have filed suit against both Alza and Abbott to block the deal, claiming Alza shareholders were kept in the dark on the FDA issues when they voted on the deal in September. Since the deal is a stock merger with a fixed-exchange ratio, Alza holders will become Abbott holders when the deal closes.
Should the FDA shut down the Abbott plant or take even more drastic action, Abbott's share price could collapse, taking the valuation of Alza shares down with it.
Where things get strange is Alza's response to the lawsuit. The company has sided with the plaintiff and against Abbott and itself, at least on a narrow issue of discovery. Seems Abbott won't come clean to Alza over the details of the FDA investigation. Alza has used a shareholder lawsuit, of which it is a defendant, as the forum to protest Abbott's treatment of it. This is beyond unusual; it is unprecedented.
The implications of this gesture are clear: The participants aren't getting along, and therefore this merger is not as safe as it appeared. The spread between Alza's share price and the value of the merger consideration has moved out from $1 a few weeks ago to more than $5.36 on Friday.
Similarly, the spread has widened in Abbott's pending stock deal with
. Perclose, fearing the implications of a negative FDA action against Abbott, has postponed its shareholder meeting until the dispute is resolved, espousing the same concerns as in the Alza shareholder's lawsuit.
What were once considered two top-drawer, high-quality deals are now viewed as both speculative and dangerous. Abbott has chosen to remain close-mouthed not just to its shareholders, but to its intended merger partners as well. This makes evaluating the likelihood that the deal closes very difficult. Thankfully, the
Freedom of Information Act
compels public access to a portion of the correspondence between Abbott and the FDA. This provides some color and context to the allegations, but not the complete story. The arbitrage spread reflects this information vacuum -- perceived risk has increased, there is no information flow to evaluate this risk and hence the spread has widened.
Should Abbott resolve its FDA problem -- and I think it will since it has no choice but to capitulate -- the mergers will probably close without incident. If Abbott fails, and the FDA shuts down its plant, things may get ugly.
David Brail is the president and portfolio manager of Palestra Capital, a Manhattan-based hedge fund that focuses on risk arbitrage. Prior to founding Palestra, he was director of research at hedge fund Dickstein Partners for eight years. At the time of publication, Palestra Capital was long both Perclose and Alza shares, had a short position in Abbott Laboratories shares and a long position in Abbott Laboratories put options, although holdings can change at any time. Under no circumstances does the information in this column represent a recommendation to buy or sell stocks. Brail appreciates your feedback at