Is Ariel Investments' Merger-Arb A Gamble?
Marshall is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Merger-arbitrage is usually a game individual investors don’t dabble in, given the higher risk and large sums of capital required to make it worthwhile, but if you were a merger-arb player, assuming the deal takes another twelve months to finalize, the annualized return would be near 5%, but not without inherent risks that the deal falls apart and the stock tumbles to pre-announcement levels.
It is unlikely another bidder will come in and make a play for WMS. This is exhibited by the fact that the stock still trades 5% below the actual buyout offer, where Scientific is the only likely suitor for the buyout, making some investors still uneasy as to whether the deal will go through.
It does appear that Scientific already has financing for the deal, planning to utilize a seven year loan to finance the buyout. On the flip side, the risk is inherent for Scientific shareholders, where the new company will have a debt to revenue of almost 2x, yet shares have been relatively flat since the announcement. The deal is likely a positive for both companies when considering their recent performance.
Both companies have been experiencing steady revenue declines, and so by combining the companies, hopefully synergies will allow the company to better weather the declining gaming industry demand, which has pressured revenues of late:
Although there is speculation that Scientific could pull out of the deal, Ariel is betting the deal will come to fruition. The multiple is 6.0 times WMS' trailing twelve month EBITDA, whereas, according to Bloomberg, similar deals have been done at a median EBITDA multiple of around 8.5x. The P/E ratio for WMS has also been in decline, and the recent buyout P/E of 24 is above recent multiples:
Although the combined companies should be better positioned for the long-haul, should you be an owner of WMS over the interim, playing the merger-arb opportunity presented? If so, use caution; other suitors, such as Bally and International Game, carry little cash (relative to their market cap) and likely will not make a play for the company, but Scientific already has the debt raised (see why you should sell Scientific Games).
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