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) 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), 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.

Earlier in May, a Delaware court delayed Martin Marietta's bid for Vulcan Materials by four months and beyond the company's June annual shareholder meeting where a slate of hostile Martin Marietta directors had been nominated to Vulcan's board.

Findings by Delaware Chancery court judge Leo E. Strine on May 4 that Martin Marietta breached confidentiality agreements in its bidding process halted the merger by four months and past Vulcan's shareholder meeting, blocking a critical proxy contest that may have moved the merger forward. However, on Wednesday, Bloomberg reported that Martin Marietta will get an expedited appeal to the decision, which is expected by May 25.

Prior to Einhorn-fueled Wednesday trading, Vulcan Materials shares only declined moderately and remained above levels prior to Martin Marietta's hostile takeover, even in the face of setbacks.

"This is a setback for MLM, but in our view the coming decision of the DOJ on the assets that need to be divested remains the key decision," wrote Jefferies analyst Mike Betts in note to clients reacting to the initial Delaware courts decision. A key to any deal, combining the two top players in their niche market, might hinge on regulatory approvals from the antitrust division of the Department of Justice and Martin Marietta's previously announced divestiture plans.

If Einhorn's premise that makers of inputs for roads are facing a poor outlook for forward earnings, now could be a logical time to consider a merger, which Martin Marietta had noted would create significant synergies.

Those who already wrote off Martin Marietta's initial exchange offer or have a conviction of Vulcan Materials' share value as a standalone may see an opportunity, especially if Einhorn's analysis provides little new information to longtime investors.

In an early May note to clients, Rudiger of Wells Fargo noted that shares of Vulcan were unlikely to fall back to a share price in the mid $30s before a hostile bid emerged because of the company's progress in cutting costs, and improving margins in its construction aggregates business to go with generally improving earnings.

In early Thursday trading Vulcan Materials shares added to an over 8% Wednesday decline, falling nearly 2% to $34.56 -- its 2012 low.

"If Vulcan Materials shares trade down significantly below $35, we believe they would be attractive to long-term investors, all else being equal," wrote Rudiger, noting that nearly $500 million in planned asset sales can pare Vulcan's debt to more sustainable levels.

If traders are right on their expectation that Martin Marietta will move forward with its bid, its also possible that an M&A war could reheat. Since Vulcan shares remain tied to the exchange conversion, a recovery in Martin Marietta shares would also be a benefit, were it to successfully refute Einhorn's short call.

"Vulcan Materials dramatically cut costs and put in restructuring efforts," says Shah of Tullett Prebon. With Einhorn's statements and a diminished value of the share exchange, he adds, "if you are Vulcan Materials board or a shareholder do you really want to have Martin Marietta stock at 0.5?"

For more on hostile M&A, see why 2012 deals hinge on Goldman Sach's idea of fairness. Also see why a kinder, gentler activist emerged in recent Nook and AOL deals with Microsoft for more on shareholder activism.

-- Written by Antoine Gara in New York

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