GM General Motors Company

By Stephen Wilmot 

On paper, it is a sensational time to invest in companies about to be bought out. In practice, even the best-laid merger plans are up in the air.

A popular investment strategy, risk arbitrage, involves betting on the gap or "spread" between a takeover offer and the stock market value of the company being taken over. Following last month's market meltdown, spreads on the auto industry's biggest deals are mouth-wateringly wide.

The value of Fiat Chrysler, for example, is less than half that of its merger partner Peugeot once dividends and other distributions agreed by the auto makers are factored in. If the companies complete their 50-50 merger on the terms agreed last December, Fiat Chrysler's shareholders will get half the combined company by providing just 31% of the equity. It should be a no-brainer to buy Fiat Chrysler's stock and cover the position by selling Peugeot's short. This apparent pricing anomaly didn't exist even a month ago.

But there is a problem: Investors can't short Peugeot right now. The stock trades on the Paris exchange, and the French market regulator banned short selling for 30 days in the heat of the selloff last month. Given that the merger isn't due to complete until early next year, following a lengthy antitrust review, buying Fiat Chrysler stock without cover is a very risky play given consumer lockdowns.

Then there is the thorny question of whether the deal math will have to be revisited. Both companies agreed to pay their shareholders a EUR1.1 billion dividend for 2019. In the economic shutdown, with companies burning through cash they can't replace through sales, such payouts seem like a very bad idea. On Friday, both companies postponed their annual general meetings, and thus their dividend decisions, until June.

A bigger question concerns the EUR5.5 billion special dividend due to Fiat Chrysler shareholders before completion. Depending on just how badly this year pans out, this also might seem unwise -- in which case the way the transaction's benefits are split could look very different. Fortunately, the companies won't need to address this question until the end of the year, by which time the scale of the current economic crisis should be clearer. However, all this uncertainty means that enticing deal spread is at this point little more than a spreadsheet fiction.

In other cases, the very question of whether a merger will happen is open. In January, car parts supplier BorgWarner made an all-stock offer for Delphi Technologies, the rump of the old General Motors components business. Then, last week, BorgWarner publicly accused Delphi of breaching the terms of their agreement by drawing down a $500 million credit facility in full -- as many companies are doing to maximize their cash balances in the shutdown. If Delphi doesn't correct the situation, its suitor claimed the right to call off the engagement. Delphi stock plunged, opening a gap for arbitragers, but jumping in hardly seems a sure bet.

Most extreme is Navistar International, the U.S. truck manufacturer that sells the International brand. In January, minority shareholder Volkswagen, through its listed truck unit Traton, offered $35 a share for the stock it doesn't already own. Having traded at a premium to the offer for all of February, the stock closed at $16.69 on Monday. If the deal goes ahead on existing terms, investors will more than double their money.

Navistar may be worth a gamble: Volkswagen will eventually want control, and the spread may have been blown out of proportion by hedge-fund deleveraging. But this is a game that needs to be played with extreme caution. The old arbitragers' world of small, fairly certain gains has given way to one of potentially huge but highly uncertain ones.

Write to Stephen Wilmot at stephen.wilmot@wsj.com

(END) Dow Jones Newswires

April 07, 2020 05:12 ET (09:12 GMT)

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