ORCHID CELLMARK INC ORCH
September 16, 2011 - 3:06pm EST by
jgalt
2011 2012
Price: 2.68 EPS $0.00 $0.00
Shares Out. (in M): 30 P/E 0.0x 0.0x
Market Cap (in $M): 81 P/FCF 0.0x 0.0x
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT 0.0x 0.0x

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Description

Since this is a simple arbitrage situation, I will keep this write-up short.

 

This is not an incredibly liquid situation (~$100,000 traded / day on average volume) so may be suitable for small funds and PAs, but I believe that if this deal closes on Oct 7, an investor can earn a spread of 4.5% in only 3 weeks (given the current offer at 2.68).

 

I don't believe this deal has much risk of not closing, but if it doesn't close, you're left with a growing DNA diagnostics business that should be a good target for another industry player down the road.

 

On April 6, 2011, Laboratory Corporation of America (LabCorp or LH) and Orchid Cellmark (ORCH) announced a definitive agreement for LH to acquire all shares of Orchid Cellmark at 2.80 per share in cash. The closing price of ORCH's stock the previous day was $2.01 so this was a nice 39% premium for ORCH shareholders.

 

Some shareholders filed lawsuits for breach of fiduciary duty given that one analyst had a $6 price target for the shares and the company's results had been positive. LH is also paying only 1.0x sales net of net cash. The courts however are not looking favorably on these lawsuits and according to the latest 10-Q it appears they have slim chance of going anywhere.

 

The aggregate purchase price is $85.4 million ($65.6 after deducting ORCH's cash and equivalents). LH has a market cap of $8.5 billion and as of 6/30/11  had cash and equivalents of $118.9 million, about $2 billion in debt, and had generated free cash flow for the previous six months of around $325 million. As such, financing is not an issue for LH (and indeed the tender offer documents confirmed that the offer is not subject to any financing condition). The expiration of the offer was May 17, 2011 (it was extended, as we'll see below).

 

The original press release in case you're interested:

http://www.sec.gov/Archives/edgar/data/920148/000119312511090236/dex99a5a.htm

 

The original agreement and plan of merger:

http://www.sec.gov/Archives/edgar/data/1107216/000119312511090300/dex21.htm

 

 

The tender offer document was filed on April 19, 2011:

http://www.sec.gov/Archives/edgar/data/920148/000119312511101695/dex99a1a.htm

 

The important conditions to the offer are:

o   Minimum condition - means that LH isn't obligated to purchase shares unless it is tendered a majority of fully diluted shares. This condition has been satisfied as LH has been tendered (and this has been stable during each tender extension) around 80% of ORCH's shares.

o   HSR condition - any applicable waiting period under Hart-Scott-Rodino Antitrust Improvements Act of 1976 has not expired or terminated (this is the one we're waiting on right now)

 

On April 18, both LH and ORCH filed a Notification and Report Form for M&A under HSR with the DOJ and FTC. This triggered a 15-day initial waiting period. The DOJ and FTC then requested extensions to the waiting period, requesting additional documents from LH and/or ORCH.

 

After LH and/or ORCH comply with the DOJ/FTC's request, the waiting period expires automatically at 11:59 pm NYC time on the 10th day of any such request. By law, the regulators can only request one extension, and any subsequent extension must be agreed to by LH (or ordered by a court). LH has thus been cooperating with the regulators to make sure everything is cleared.

 

Extensions

 

Since the original offer, LabCorp has extended the tender offer several times to allow for the Federal Trade Commission to review the merger pursuant to Hart Scott Rodino. Here's the first extension:

 

On May 18, 2011, LabCorp issued a press release announcing that it has extended for ten (10) business days its Offer to purchase all outstanding Shares in order to provide the DOJ and the FTC additional time to review the transactions contemplated by the Merger Agreement pursuant to the HSR Act. The Offer will now expire at 6:00 p.m., New York City time, on Wednesday, June 1, 2011, subject to extension in certain circumstances as required or permitted by the Merger Agreement and applicable law. LabCorp also announced that, based on preliminary information from its information agent, approximately 25,526,141 Shares have been tendered to date, which represents approximately 85.1% of the outstanding shares of the Company's common stock. A copy of the press release has been filed as Exhibit (a)(25) to the Schedule 14D-9 and is incorporated herein by reference."

 

Top-Up Provision

 

Per the merger agreement,  LH has the option to buy from ORCH a number of shares at $2.80 which constitutes 1 share more than 90% ownership. Thus if only 80% of the shares are tendered, LH can still obtain 90% ownership by buying shares directly from ORCH.

 

Why does this matter? Because if LH has 90% of the shares, it is required to effect the merger without convening a meeting of ORCH shareholders. 

 

And according to the agreement, if more than 80% of the shares have been tendered at the expiration, then LH must provide a 10-day extended period for tenders unless it exercises its top-up option.

 

If you do not tender your shares and the merger goes through, you still get the $2.80 per share.

 

As of the last extension announced on Sep 12, 87.2% of ORCH shares had been tendered (80.0% fully diluted).

 

Will it close?

 

I have zero insight into whether this will be blocked by regulators, but here's how I'm thinking about it:

 

  • This deal has been extended no less than SIX times (on May 18 until Jun 1; on Jun 2 until Jun 15; on Jun 16 until Jul 15; on Jul 18 until Aug 12; on Aug 15 until Sep 9; and on Sep 12 until Oct 7) running over five months since the original offer;
  • This deal appears to be a perfect fit for LH;
  • ORCH reported revenues of $58 million, $59 million and $64 million for the years ended 2008, 2009 and 2010. LH, on the other hand, reported sales of ~$5 billion in each of those years;
  • The other big player in the industry, Qwest Diagnostics, had sales of ~$6 billion
  • In its latest presentation (BOA Global Healthcare Conference, Sep 14), LH notes that the market size is around $55 billion (another slide shows LH with 9% market share and Qwest with 12%);
  • This doesn't look to me to be an onerous hurdle, given that ORCH will add 1.3% to LH's sales.

 

 

 

Catalyst

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    Description

    Since this is a simple arbitrage situation, I will keep this write-up short.

     

    This is not an incredibly liquid situation (~$100,000 traded / day on average volume) so may be suitable for small funds and PAs, but I believe that if this deal closes on Oct 7, an investor can earn a spread of 4.5% in only 3 weeks (given the current offer at 2.68).

     

    I don't believe this deal has much risk of not closing, but if it doesn't close, you're left with a growing DNA diagnostics business that should be a good target for another industry player down the road.

     

    On April 6, 2011, Laboratory Corporation of America (LabCorp or LH) and Orchid Cellmark (ORCH) announced a definitive agreement for LH to acquire all shares of Orchid Cellmark at 2.80 per share in cash. The closing price of ORCH's stock the previous day was $2.01 so this was a nice 39% premium for ORCH shareholders.

     

    Some shareholders filed lawsuits for breach of fiduciary duty given that one analyst had a $6 price target for the shares and the company's results had been positive. LH is also paying only 1.0x sales net of net cash. The courts however are not looking favorably on these lawsuits and according to the latest 10-Q it appears they have slim chance of going anywhere.

     

    The aggregate purchase price is $85.4 million ($65.6 after deducting ORCH's cash and equivalents). LH has a market cap of $8.5 billion and as of 6/30/11  had cash and equivalents of $118.9 million, about $2 billion in debt, and had generated free cash flow for the previous six months of around $325 million. As such, financing is not an issue for LH (and indeed the tender offer documents confirmed that the offer is not subject to any financing condition). The expiration of the offer was May 17, 2011 (it was extended, as we'll see below).

     

    The original press release in case you're interested:

    http://www.sec.gov/Archives/edgar/data/920148/000119312511090236/dex99a5a.htm

     

    The original agreement and plan of merger:

    http://www.sec.gov/Archives/edgar/data/1107216/000119312511090300/dex21.htm

     

     

    The tender offer document was filed on April 19, 2011:

    http://www.sec.gov/Archives/edgar/data/920148/000119312511101695/dex99a1a.htm

     

    The important conditions to the offer are:

    o   Minimum condition - means that LH isn't obligated to purchase shares unless it is tendered a majority of fully diluted shares. This condition has been satisfied as LH has been tendered (and this has been stable during each tender extension) around 80% of ORCH's shares.

    o   HSR condition - any applicable waiting period under Hart-Scott-Rodino Antitrust Improvements Act of 1976 has not expired or terminated (this is the one we're waiting on right now)

     

    On April 18, both LH and ORCH filed a Notification and Report Form for M&A under HSR with the DOJ and FTC. This triggered a 15-day initial waiting period. The DOJ and FTC then requested extensions to the waiting period, requesting additional documents from LH and/or ORCH.

     

    After LH and/or ORCH comply with the DOJ/FTC's request, the waiting period expires automatically at 11:59 pm NYC time on the 10th day of any such request. By law, the regulators can only request one extension, and any subsequent extension must be agreed to by LH (or ordered by a court). LH has thus been cooperating with the regulators to make sure everything is cleared.

     

    Extensions

     

    Since the original offer, LabCorp has extended the tender offer several times to allow for the Federal Trade Commission to review the merger pursuant to Hart Scott Rodino. Here's the first extension:

     

    On May 18, 2011, LabCorp issued a press release announcing that it has extended for ten (10) business days its Offer to purchase all outstanding Shares in order to provide the DOJ and the FTC additional time to review the transactions contemplated by the Merger Agreement pursuant to the HSR Act. The Offer will now expire at 6:00 p.m., New York City time, on Wednesday, June 1, 2011, subject to extension in certain circumstances as required or permitted by the Merger Agreement and applicable law. LabCorp also announced that, based on preliminary information from its information agent, approximately 25,526,141 Shares have been tendered to date, which represents approximately 85.1% of the outstanding shares of the Company's common stock. A copy of the press release has been filed as Exhibit (a)(25) to the Schedule 14D-9 and is incorporated herein by reference."

     

    Top-Up Provision

     

    Per the merger agreement,  LH has the option to buy from ORCH a number of shares at $2.80 which constitutes 1 share more than 90% ownership. Thus if only 80% of the shares are tendered, LH can still obtain 90% ownership by buying shares directly from ORCH.

     

    Why does this matter? Because if LH has 90% of the shares, it is required to effect the merger without convening a meeting of ORCH shareholders. 

     

    And according to the agreement, if more than 80% of the shares have been tendered at the expiration, then LH must provide a 10-day extended period for tenders unless it exercises its top-up option.

     

    If you do not tender your shares and the merger goes through, you still get the $2.80 per share.

     

    As of the last extension announced on Sep 12, 87.2% of ORCH shares had been tendered (80.0% fully diluted).

     

    Will it close?

     

    I have zero insight into whether this will be blocked by regulators, but here's how I'm thinking about it:

     

     

     

     

    Catalyst

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