Western Resources, Inc. WR
March 04, 2001 - 10:55pm EST by
2001 2002
Price: 24.60 EPS 1.68
Shares Out. (in M): 70 P/E
Market Cap (in $M): 0 P/FCF
Net Debt (in $M): 3 EBIT 0 0

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Western Resources, Inc. (NYSE:WR) is cheap on a sum-of-the-parts basis. More importantly, catalysts are in place that will unlock the value during the coming year--including an announced merger, an IPO and a spin-off.

WR has two main divisions: (1) a regulated electric utility in KS and (2) a collection of non-utility assets (Westar Industries).

Regulated Electric Utility

In November 2000, WR agreed to merge its regulated electric utility with Public Service Co. of New Mexico (NYSE:PNM). The PNM shareholders initially had a violent reaction to the proposed merger but have since warmed up to it as PNM management has done a better job articulating the merits of the deal (e.g., EPS accretion, synergies and growth strategy).

In the merger, WR shareholders will get .6658 shares of PNM for each share of WR they own. This translates to $17.31 per WR share at today's price. In addition, PNM will assume ~$3B of WR's $3.3B of debt.

The merger is expected to close in early 2002 (the lengthy time frame is typical of mergers of companies in regulated industries).

Westar Industries

WR management has put into place a plan to IPO 10% of Westar Industries (the remaining, non-utility assets of WR) via a rights offering in the near future. WR will subsequently spin off Westar to its shareholders. An S-1 on Westar was filed on October 5, 2000.

The underlying assets of Westar are primarily (1) a 45% ownership of ONEOK, Inc. (NYSE:OKE), a natural gas gathering, processing, marketing, distribution and transmission company with a $1.3B market cap, (2) an 85% ownership of Protection One (NYSE:POI), a security alarm monitoring company with a $120mm market cap, (3) 100% ownership of Protection One Europe, and (4) an intercompany note from WR's utility which will be converted to PNM stock (the exchange ratio above already accounts for this).

WR management has conveniently laid out its view of the value of Westar in a SEC filing dated November 24, 2000 (as well as all of the details, valuation, etc. of the PNM merger--it's a must read). They believe Westar is worth $24 per WR share before any "holding company" or IPO discounts, or $12-15 per WR share assuming a discount range of 36-51%.

Arbitrage Opportunity

Here's an interesting arbitrage angle on playing this situation: you can buy one share of WR today for $24.60 and sell short .6658 shares of PNM for $17.31, thus eliminating the regulated electric utility from the equation.

In addition, you can sell short your pro-rata share of OKE (which is really the biggest part of Westar anyway)--.31 shares of OKE per WR share--for $13.88. Thus, you receive $6.59 net today (buy WR for $24.60, sell PNM for $17.31 and sell OKE for $13.88). Assuming that all the events unfold as planned, you keep the $6.59 plus any additional value in Westar from the alarm monitoring companies and other miscellaneous assets which could be up to an additional $5-$8.

There isn't much of a cost to the arbitrage assuming that you get short rebates because the short proceeds exceed the WR purchase price and there is a positive carry on the dividends. The borrow on PNM and OKE seems good.

The obvious question is what happens if the PNM deal doesn't close. Given that both WR and PNM are trading close to their pre-announcement values, I don't see this as a huge risk. In addition, it's likely that there are other interested buyers for WR's electric utility and WR's management is committed to breaking up WR.

IPO and Spin-Off Opportunity

One final footnote: The best benefit from this idea may well come from gaining a familiarity with Westar. After the IPO of 10% via the rights offering (and who is to say that management won't give away Westar in the rights offering--afterall, it is being placed with existing shareholders), the remaining 90% will be spun off to WR shareholders when the PNM merger closes. Selling pressure on Westar may create a favorable buying opportunity at that time. In addition, it seems likely that management will break up Westar at some point in the future given the diverse nature of its assets.


See discussion above. Merger, IPO via a rights offering and spin-off.
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