Over The Wire: When Being Ineligible Is A Good Thing

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If there’s one thing I’ve learned over the years in doing merger arbitrage in Australian companies, it is to always check the fine print. In quite a few small quirky Australian M&A deals, the ones I like best, investors who are not from either Australia or New Zealand get a different treatment than those that do. Some Australian M&A advisors apparently tend to think, for reasons unclear to me, there are countless legislations around the world that forbid Australian companies to pay out anything else than cash to their foreign shareholders. As a result, payment in scrip in either the acquiring company or, for example, in an unlisted spin-off, is on many occasions not an option for a non-Aussie investor.

Fast forward to Over The Wire (ASX:OTW), an Australian IT Telecommunications provider. It is being acquired by Australian Broadband (ASX:ABB) in what appears to be quite a straightforward deal. There’s no regulatory risk, OTW’s board controls 41,5% of the vote and will vote in favor: 75% of the votes cast at a shareholders meeting is required for the deal to go through.

That likely shouldn’t be a problem. The deal is being done at what’s close to an all-time high for OTW stock. An independent expert has determined the offer is within the fair value range, and I have not been able to find any shareholder opposition. The deal does contain a Material Adverse Clause (for both the acquirer and the acquired party), but that’s about it in terms of deal risk.

Merger consideration

OTW shareholders by default get paid AUD 4.60 plus 0.23 ABB shares. However, they are allowed to elect either the full consideration in cash (AUD 5.75) or in stock (1.15 ABB shares).

OTW stock closed at AUD 5.30 today. At current market prices, the default merger consideration is worth AUD 5.52, the stock option is worth AUD 4.61 and the cash option is worth (obviously) AUD 5.75. Any rational investor, ignoring any personal tax preferences, would therefore elect to be paid fully in cash. However, as always, there’s a catch: ABB has limited the total amount of cash it will pay out to 80% of the total merger consideration, and any cash elections that violate this set maximum will be scaled back.

At current market prices, almost everybody will choose cash and almost everybody will pretty much end up with the default option anyway: the election isn’t much of an election at all. Still, the default option is trading at a 4% spread to OTW’s current share price. Actually not that bad for a deal with little apparent risk and a short timeline, but nothing to blog about. Also, I could not find any borrow for ABB shares (although, admittedly, I haven’t looked at any of the Australian brokers), which would make it difficult to hedge the scrip part of this trade and the ABB share price has been quite volatile lately.

So why am I blogging about this deal? “Ineligible Foreign Shareholders”, and that’s everybody who is not from either Australia or New Zealand, are not given an election at all. Instead, they are “forced” (I make it sound like that’s a bad thing) to accept the cash option, and will, unlike Aussie investors, not be subject to any scale-back mechanism whatsoever. In other words, while Australian merger-arb investors are sweating a 4% spread with price risk, the rest of the world is looking at a nice 8.5% spread all-cash.

There’s still a chance ABB will suddenly wake up to the fact most other countries outside of Australia do actually allow for scrip deals and will change their definition of “Ineligible”. ABB says in the Scheme document they might add “other jurisdictions that the board [..] may decide can be offered Aussie Broadband shares under that country’s relevant securities legislation, without undue compliance burdens for ABB”. It’s hard to handicap the chance of this happening, but I don’t think it’s that likely: no further mention is made of this phrase to any of the many other references to what an “Ineligible Foreign Shareholder constitutes elsewhere in the document. Also, in all the Australian M&A deals I did, the definition was never changed. However, worst case your jurisdiction does get added as being “eligible”, and you’ll be stuck with the default merger consideration.

The Scheme meeting is scheduled for the 24th of February. If the deal completes as planned, payment to OTW shareholders is expected on the 15th of March. If you’re still “ineligible” by that time, this adds up to a nice, clean 87% annualized return.