|Shares Out. (in M):||171||P/E||NA||NA|
|Market Cap (in $M):||1,890||P/FCF||16||16|
|Net Debt (in $M):||900||EBIT||84||90|
***VIC took original post down due to a bug. This is the repost. Please vote again!
Unrightfully tainted by the ARCP accounting scandal, the HCT merger arb spread is an attractive opportunity to make 3.0% in the next 60 days, with a 95% probability to close. In the unlikely event of a deal break, I expect downside of 10 - 20%.
Merger arb spreads are fairly wide across the board due to recent significant losses at event-driven hedge funds, but this is one of my favorites.
HCT is a $2B REIT that owns medical offices buildings and senior living facilities. It is being acquired by VTR, a $20B goliath in the space, for mostly stock in a low-premium deal. An HCT shareholder may elect $11.33 in cash, or .1688 VTR shares. VTR has capped the cash availability to 10% of total consideration, with no cap on shares issued for stock elections. The value of the stock and cash elections are approximately equal, once factoring in that VTR will goes ex a 73c dividend in mid-Dec. Non-electors default to a stock election.
I currently recommend setting up the spread on a 100% VTR ratio, and electing stock:
Buy 1 share of HCT: $(11.06)
Short .1688 share of VTR: 11.455
1 monthly HCT div if close in '14: .057
Short .1688 of VTR's Q4 div (.122)
= .33 net spread, or 3.0% of $11.06 purchase price
The deal should close a few days after the HCT shareholder vote, which will be scheduled ~ 30 days after the proxy statement goes definitive. The proxy has been filed and is currently under review, with the last revision filed on 10/17. I expect it will go definitive within the next 2 weeks. The parties have guided a Q4 close, with VTR re-iterating that expectation on their 10/24 earnings call.
The main risk being mispriced by the market
HCT originated as a non-publicly traded REIT under the American Realty Capital umbrella and is chaired by Nick Schorsch. The largest American Realty Capital entity, ARCP, lost 30% of its market cap in the past couple weeks after being unable to issue Q3 figures. The ARCP CFO and CAO made non-GAAP accounting mistakes described as "intentional", triggering a wave of concern that other American Realty Capital entities might be hiding errors in their financials. Schorsch is also chairman of ARCP, and although there is no current management or industry overlap between HCT and ARCP, ARCP's bad CFO was CFO of HCT while it was non-public. He left HCT to take the position at ARCP in Q4 '13. Of note, HCT's latest 10-K was not prepared or signed by him.
What the market is missing is that HCT has in all likelihood already issued their Q3 figures. Although not yet filed with the SEC, the Q3 figures can be found filed on their website under "supplemental financials". HCT has not set an earnings date, but historically reported in the second week of Nov.
I also view the ineptitude of the ARCP CFO as a signal that major nefariousness is unlikely. The ARCP situation looks like it started with a novice mistake in the Q1 '14 non-GAAP adjustment table. American Realty has been greatly criticized as growing too quickly and expanding beyond its operational and financial competence. Had the ARCP disclosed the non-GAAP mistake, it would have justified the critics and been highly embarrassing to American Realty and the chairman. The ARCP CFO was one of the 5 founding partners with Nick a dozen years ago. I can imagine the CFO felt a temptation to find a way to sweep it under the rug. But this scenario would not indicate some kind of broad, orchestrated cover-up across multiple entites.
Furthermore, VTR conducted diligence for a week before signing the deal. The REIT business seems financially simple: collect rent (from real assets purchased from third parties), pay debt, pay overhead, pay shareholders.
The merger agreement does not allow VTR to walk from the deal because of anything happening at ARCP. If there were financial issues at HCT, VTR would likely have the ability to walk from the deal due to reps and covenants HCT made in the meger agreement. However, VTR sees the deal as accretive and has been public about looking forward to managing the assets.
Downside: HCT came from $10.00 in the spring, indicating a 6.8% yield. Comparable REITS have traded higher since then and trade at tighter yields. If the deal breaks for an unforeseen reason not related to the financials, 10-20% downside would capture a further discount from the American Realty Capital taint.
Happy to answer any questions in the comments to keep the write-up short.
If I may lobby for re-activation votes, I've posted a couple merger arbitrage ideas historically which have worked out well. Proscriptions of merger arbitrage in certain books we've all read aside, sometimes the market gets a little crazy and offers a nice source of expected absolute return. Why dedicate your own resources to this sporadically fertile area when you can wait for one of my future posts to get interested? Vote for my re-activation!
Deal closes in 60 days.
HCT Q3 earnings already on the website are released next week or filed with the SEC, removing fear of ARCP spillover (ARCP couldn't file earnings).