Back on April 27 of this year through a definitive agreement, CoStar Group (CSGP) and LoopNet (LOOP) announced their intention to merge. It is a cash + stock transaction with a deal spread that offers good absolute and annualized returns.
Terms of the Deal
The initial terms of the deal valued the transaction at $860 million with CoStar Group buying LoopNet. The shareholders of LoopNet will receive per share $16.50 in cash and 0.03702 shares of CoStar Group.
Business Descriptions
CoStar Group via S-4 filing.
CoStar Group, Inc. provides information and analytic services to the commercial real estate industry in the United States (U.S.) and United Kingdom (U.K.). CoStar offers the most comprehensive commercial real estate database available, has the largest research department in the industry, and provides information and analytic services. CoStar’s integrated suite of services offers customers online access to the most comprehensive database of commercial real estate information, which has been researched and verified by its team of researchers, currently covering the U.S., as well as London and other parts of the U.K. and parts of France. Since its founding in 1987, CoStar’s strategy has been to provide commercial real estate professionals with critical knowledge to explore and complete transactions by offering the most comprehensive, timely and standardized information on U.S. commercial real estate.
LoopNet via S-4 filing.
LoopNet owns and operates an online marketplace for commercial real estate in the United States. The online marketplace, available at www.loopnet.com, enables commercial real estate agents, working on behalf of property owners and landlords, to list properties for sale or for lease and submit detailed information on property listings in order to find a buyer or tenant. By connecting the sources of commercial real estate supply and demand in an efficient manner, LoopNet’s online marketplace enables commercial real estate participants to initiate and complete more transactions more cost-effectively than through other means.
Key Reasons for Merger
The S-4 filing lists many reasons as to why the merger was agreed upon but the most significant reason for LoopNet’s acceptance of the merger was the large portion of cash being paid. In management’s view the large premium and cash being paid fairly compensates shareholders if LoopNet was able to execute their strategic 4 year plan effectively.
The market and execution risks associated with LoopNet’s recently adopted four-year strategic plan and the Board’s judgment that the premium reflected in the merger consideration reflected fair compensation for the loss of the potential stockholder benefits that could be realized if that plan were successfully executed.
The fact that a large portion of the merger consideration will be paid in cash, giving LoopNet stockholders an opportunity to immediately realize certain value for a significant portion of their investment;
Probability of Closing
Let’s run through some of the usual suspects that could prevent the merger from being completed.
Financing
The merger is dependent on CoStar Group securing a term loan and issuing equity. J.P. Morgan entered into an agreement with CoStar to provide the term loan portion of the financing.
On April 27, 2011, CoStar entered into a debt commitment letter with J.P. Morgan Securities LLC and JPMorgan Chase Bank, N.A., which provides for a fully committed term loan of $415.0 million and a $50.0 million revolving credit facility, of which $37.5 million is committed, which will be available, subject to customary conditions, to fund the cash consideration for the merger and related fees and costs and the ongoing working capital needs of CoStar and its subsidiaries following the merger.
The equity offering occurred back in May.
Real estate information and analytics provider CoStar Group said today it has commenced an offering of 3.75 million shares of common stock to fund a portion of its acquisition of LoopNet. Any remaining proceeds will be used for general corporate purposes, and the offering is not contingent on the close of the acquisition, CoStar said.
In its announcement, CoStar noted that it will grant its underwriters a 30-day option to purchase up to an additional 562,500 shares of common stock.
The financing is complete with the term loan commitment and the equity offering.
Market Risk
Usually the least risky factor but if a financial panic were to occur in the next several months like we saw in 2008 then this deal could be in jeopardy. Many deals fell apart during this period because financing dried up. With everything that is currently happening in Greece and the European banking system it is highly possible we see another credit event. However, financing has already been arranged for this merger and CoStar Group will have to pay a termination fee of $51.6 million if it decides to walk away from the deal for other reasons not granted in the merger agreement.
Size of the Buyer
Costar Group (CSGP) currently trades at a market capitalization of $1.3 billion and LoopNet (LOOP) trades at $707 million. Before the merger announcement LoopNet had a market capitalization around $586 million. We do not have a smaller company trying to buy a much larger company through aggressive leveraging or debt issuance.
Business Conditions
Commercial real estate is not where it was pre-2008 but it has rebounded. Both LoopNet and CoStar Group took hits to their revenue and income during the financial crisis but both have regained lost ground. CoStar Group has even surpassed its 2008 revenue peak.
Before the merger announcement neither company had any debt and the interest payments on the $415 million term loan is well covered solely by CoStar Group’s EBITDA and/or Free Cash Flow.
Management or Shareholder Opposition
This is a friendly merger with both boards agreeing to the merger. We know there will not be any shareholder opposition because LoopNet’s shareholders overwhelmingly approved the merger.
Stockholders of LoopNet Inc. overwhelmingly approved a previously announced merger with CoStar Group Inc.
The number of votes cast represented approximately 75 percent of LoopNet’s aggregate voting power, and 99.6 percent of the votes were in favor of adoption.
LoopNet stockholders approve CoStar merger (Houston Business Journal)
Regulators and the Public
This is the most likely cause for this deal failing. It won’t be from the public. Objections from everyday people usually involve services that affect their daily lives like a telecom or utility merger. The more likely culprit will be federal regulators. U.S. regulators can kill a deal if they believe it is in violation of anti-trust laws. This is where the first roadblock to this merger occurs.
Back in July the U.S. Federal Trade Commission entered a second request for additional information on the transaction from the two companies. This will extend the waiting period for regulator approval another 30 days from when both companies submit the required information.
Potential Returns
LoopNet currently trades at $17.42 per share and CoStar Group trades at $54.24. Neither company pays a dividend on their stock. The deal is expected to close by the end of this year, 96 days away assuming December 31, 2011 is the closing date. Due to the large cash portion of this merger the conversion ratio is very small, 0.03702 shares of CSGP for each share of LoopNet, and will leave fractional shares unless 100,000 shares of LoopNet are bought. I’ll use a more manageable number of 100 shares of LoopNet and 3.702 shares of CoStar Group because fractional shares will be redeemed for cash.
As a result, holders of LoopNet common stock and Series A Preferred Stock will receive cash for any fractional share of CoStar common stock that they would otherwise be entitled to receive in the merger.
As always we need to think in terms of cash outflows and inflows. I will exclude transaction fees and margin fees as they are different between brokerages but will need to be factored into a final decision on whether or not this trade makes fiscal sense.
Gross Return
- Buy 100 shares of LoopNet (LOOP) = -$1,741.00
- Sell Short 3 shares of CoStar Group (CSGP) = +$162.81
- Cash portion of merger ($16.50 x 100 shares) = +$1,650.00
- Cash from fractional shares (0.702 x $54.26) = +$38.09
- Total cash received = +$109.90
- Cash return on initial LOOP purchase [( $109.90 / $1,741.00) x 100%] = 6.31%
The cash received from fractional shares will depend on the price of CoStar Group’s stock when the merger is completed and will affect the overall return of the deal.
Annualized Return
- 96 days until the deal closes = t
- Gross return / 100% = 6.31%/100% = 0.0631
- 0.0631 + 1 = 1.0631
- 1.0631 exp (365/t) = 1.0631 exp (365/96) = 1.2817
- (1.2817 – 1) x 100% = 28.17%
The annualized return for this trade would be 28.17% without factoring in trading costs.
This deal is very attractive. Both absolute and real returns are high. Both management teams agreed to the merger and so did both respective shareholder groups. The only overhang is federal regulators. Will they or won’t they approve the deal? It’s tough to see the combination of two small companies focused on commercial real estate information as violating anti-trust laws but stranger things have happened.
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