Endo Pharmaceuticals (ENDP) recently announced a cash tender offer for all outstanding shares of Healthtronic (HTRN). The offer is $4.85 per share. You can read the full tender offer with key parts highlighted here. Currently, Healthtronic is trading at $4.74 per share. This creates a potential gross return of 2.32% with a deal that is expected to close no later than July 1, 2010. A potential annualized gross return of 36.36% (all gross return figures do not factor in commissions). This is a great spread and annualized return for a merger/risk arbitrage trade but when things sound too good to be true it just might be.
On June 1, 2010 after the tender offer was announced the U.S. Food and Drug Administration sent Healthtronic (HTRN) a warning letter in regards to its wholly owned subsidiary Endocare Inc. The news caused the tight deal spread to widen with Healthtronic (HTRN) dropping down to about $4.00 per share. Healthtronic (HTRN) has responded to the letter and stated that the letter will have no affect on the completion of the merger. Endo Pharmaceuticals (ENDP) has not yet released a statement.
Will the FDA letter be material enough to cause Endo Pharmaceuticals (ENDP) to abandon its buyout of Healthtronic (HTRN)? I don’t know. All I can do is change my estimated probabilities that the deal will close.
According to Ben Branch and Taewon Yang in their paper “Predicting Successful Takeovers and Risk Arbitrage” for the Quarterly Journal of Business and Economics regular cash tender offers have about an 87% chance of being completed. Any change I make to this average probability would be completely subjective. I have a hard time lowering the probability further than 80% because of the following points.
- Endo Pharmaceuticals (ENDP) is much larger than Healthtronics (HTRN). Endo Pharmaceuticals (ENDP) has a market capitalization of $2.35 billion and Healthtronic (HTRN) has a market capitalization of $214.6 million.
- Financing is not a problem. According to Endo Pharmaceuticals’ (ENDP) latest 10-Q, they have $848.72 million in cash and short-term investments, more than enough to buy Healthtronic. The tender offer also mentioned that the buyout will be funded with cash on hand.
- It is a friendly buyout with Healthtronics’ (HTRN) board of directors recommending shareholders tender their shares.
The overhang of the FDA warning letter causing the deal to terminate makes this trade a tough one to load up on. Is the spread and potential return large enough to become a position in a diversified risk arbitrage portfolio? I would say yes but each arbitrageur needs to assess their own comfort level with the risks and rewards of this trade.
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