Google’s On2 Technologies Acquisition Is At The Mercy Of Merger Arbitrageurs

December 8, 2009

We live in an era of bumps in merger payments that the buyer thought had been negotiated, and Google (GOOG) is about learn this the hard way in its $106 million acquisition of On2 Technologies (ONT). As the stock market continues to rally shareholders whose companies get acquired are depressed to see that they are stuck with stale valuations from the time their mergers were first negotiated. In the meantime, Facet (FACT), Diedrich’s (DDRX), Hiland and others see their buyout prices bumped up. So we have sympathy for the owners of On2 Technologies who refuse to vote in favor of the acquisition of their stock by Google for $0.60 worth of Google stock.

That’s not $0.60 in cash but $0.60 worth of stock independent of Google’s stock price. The problem is that $0.60 worth of Google stock are a lot fewer shares today than back in August when the merger was announced. Google has since risen from the $450s to the $580s, or 29%. The merger consideration has remained constant $0.60. Had management negotiated a fixed exchange rate of, say 0.0013 shares of GOOG for each ONT, then shareholders would receive $0.77 worth of Google stock for their shares now.

The flipside of a constant merger consideration is that it has become much less dilutive for Google. Instead of issuing roughly 235,000 shares based on Google’s August share price, Google will now have to issue only 182,000 shares (assuming the VWAP for GOOG will be around $580).

Management is in a frenzy to line up enough votes to get the deal approved in the December 18 shareholder meeting. Every day another SEC filing is made extolling the advantages of the deal and threatening the dire consequences if shareholders vote it down. This is a clear sign that they lack votes to close the deal.

Merger arbitrageurs are the joker that will determine the outcome of the shareholder vote on December 18, The arbitrage community holds a significant share of On2. Technologies. We attribute holdings some 15% of the shares to holdings by arbitrageurs, based on our analysis of 13F holdings data collected by Whale Wisdom:

Name Holdings on 06/30/09 Percentage on 6/30 Holdings on 09/30/09 Percentage on 9/30 Change in shares
ARBITRAGE & TRADING MANAGEMENT CO

6,545,681 3.71% 6,545,681
SHOREWATER ADVISORS LLC

5,313,966 3.01% 5,313,966
ARNHOLD & S. BLEICHROEDER ADVISERS, LLC

2,631,744 1.49% 2,631,744
LOEB ARBITRAGE MANAGEMENT, LLC

2,290,893 1.30% 2,290,893
GLAZER CAPITAL, LLC

2,147,252 1.22% 2,147,252
CENTAURUS CAPITAL LP

1,803,675 1.02% 1,803,675
AQR CAPITAL MANAGEMENT LLC

1,604,076 0.91% 1,604,076
GLG PARTNERS, INC.

1,348,228 0.76% 1,348,228
WATER ISLAND CAPITAL LLC

1,026,059 0.58% 1,026,059
BARCLAYS GLOBAL INVESTORS UK HOLDINGS LTD 1,003,273 0.58% 999,683 0.57% -3,590
GAMCO INVESTORS, INC. ET AL

722,969 0.41% 722,969
CREDIT AGRICOLE S A

722,466 0.41% 722,466
CALIFORNIA PUBLIC EMPLOYEES RETIREMENT SYSTEM 367,430 0.21% 486,430 0.28% 119,000
DIMENSIONAL FUND ADVISORS LP 424,063 0.25% 423,263 0.24% -800
HARRIS FINANCIAL CORP 305,000 0.17% 305,000
GEODE CAPITAL MANAGEMENT LLC 185,014 0.11% 272,299 0.15% 87,285
CNH PARTNERS LLC 257,729 0.15% 257,729
LONGFELLOW INVESTMENT MANAGEMENT CO LTD PARTNERSHIP 200,000 0.11% 200,000
UBS AG 845 0.00% 199,995 0.11% 199,150
VERITABLE, L.P. 252,400 0.15% 118,600 0.07% -133,800
RENAISSANCE TECHNOLOGIES LLC 114,000 0.06% 114,000
BANK OF NEW YORK MELLON CORP 112,490 0.07% 112,490 0.06%
NORTHERN TRUST CORP 96,374 0.06% 110,345 0.06% 13,971
MORGAN STANLEY 49,292 0.03% 104,325 0.06% 55,033
KNIGHT CAPITAL GROUP, INC. 62,353 0.04% 62,353
HUNTINGTON NATIONAL BANK 50,000 0.03% 25,000 0.01% -25,000
BLACKROCK INVESTMENT MANAGEMENT, LLC 19,400 0.01% 19,400 0.01%
FISHER ASSET MANAGEMENT, LLC 17,700 0.01% 17,700 0.01%
PRUDENTIAL FINANCIAL INC 10,100 0.01% 10,100 0.01%
WELLS FARGO & CO/MN 2,000 0.00% 3,000 0.00% 1,000
METLIFE SECURITIES, INC 2,000 0.00% 2,000 0.00%
AMERIPRISE FINANCIAL INC 1,900 0.00% 1,400 0.00% -500
VANGUARD GROUP INC 971 0.00% 1,364 0.00% 393

This was per 9/30, a full two months prior to the record date for the meeting. We would not be surprised if their holdings of shares have since doubled. As we pointed out in our book about merger arbitrage, the outcome of many mergers is driven by the arbitrage community whose holdings often reach the 30-50% range during the merger process. A study by Micah S. Officer (“Are Performance-Based Arbitrage Effects Detectable? Evidence from Merger Arbitrage,” Journal of Corporate Finance 15, No. 5 (2007), 793–812) gives examples of the percentages reached historically in some mergers.

Arbitrageurs generally try to take a quick gain and move on. With the current price of On2 Technologies the spread comes to around 20%, depending on your assumptions about commissions and the closing date. So it will be tempting for arbitrageurs to support the deal and take that quick and easy return. However, it is also possible that the arbitrage community has smelled blood and will reject the deal, challenging Google to increase its consideration. Some of the arbitrageurs on the list are of the more aggressive variety and we would not be surprised if they challenged management.

For Google, this is its first purchase of another public company. So they are still learning and probably won’t mind bumping the price, especially not if the transaction is so small that it is a mere rounding error in their financials. They simply have to increase the exchange ratio to the level they were willing to pay back in August. That would boost returns to shareholders significantly and win over the support of the arbitrageurs.

We doubt that the transaction will collapse completely. It makes sense for Google from a strategic point of view. Building their own video compression software is certainly a possibility, but in the typical tradeoff between buy or build they are probably better off acquiring a firm that has a technology that actually works. Not to mention that in acquiring On2 Technologies they can use the technology right away. Time is of the essence if they want to use video as a driver to push their Android operating system into the mobile market. Therefore, we think that Google will eventually increase the exchange ratio to 0.0013 so that investors get as many shares as they would have in August. There remains upside in On2 Technologies beyond $0.60.

Disclosure: Thomas Kirchner manages the Pennsylvania Avenue Event-Driven Fund (PAEDX), which engages in merger arbitrage and owns shares of On2 Technologies. He is the author of the book Merger Arbitrage: How to Profit from Event-Driven Arbitrage (Wiley Finance, 2009).


Paul J. Isaac’s Conflicted Role In American Community Properties Trust Buyout

November 30, 2009

The extent to which the buyout of American Community Properties Trust (APO) by Federal Capital Partners is flawed was revealed in the company’s recent proxy filing. One of the unhappy shareholders, Paul J. Isaac, was given the opportunity to continue to own ACPT even after the buyout. The other shareholders will forgo the opportunity to get full value for their shares.

The Wilsons and Issac together own 69% of the shares and have the ability to force the deal Read the rest of this entry »


Where’s The Arbitrage In The New Merger Arbitrage ETF?

November 10, 2009

ETFs have been encroaching the turf of active managers for some time and are now taking head on hedge funds. The promise of hedge funds at ETF costs is very appealing but raises the inevitable question: can they do it? The upcoming IQ Arb Merger Arbitrage ETF (ticker will be MNA) is an example of one that is likely to fail.

The first thought is, of course, you get what you pay for. If this line of thinking has some validity, then Read the rest of this entry »


High Water Marks Bring Yet Another Bias To Hedge Fund Returns

November 3, 2009

Survivorship and backfill bias in hedge fund returns have been written about extensively. A recent article in Hedge Fund Alert drew out attention to yet another problem with the reporting of hedge fund returns. It turns out that last year’s carnage has left so many hedge funds underwater that the returns posted for this year are not actually what you will earn if you are a new investor.

Hedge funds have high water marks so that managers do not receive the 20% performance fee until the fund has reached its prior high. That is one of the reasons why so many managers simply shut down their funds and launch new ones not subject to that constraint. But it also leads to difficulties with the reporting of returns. Performance fees Read the rest of this entry »


Clarium’s Peter Thiel Is Bearish On Innovation

October 19, 2009

Peter ThielAt Thurday’s 2009 Investor Leadership Forum hosted by the Argyle Executive Forum and Capital IQ Peter a speech by Thiel of Paypal and Clarium fame linked future economic growth to innovation and technology rather than government stimulus.

Peter started by noting the difference in the type of question asked today of emerging markets and the developed world. Read the rest of this entry »


The End Is Near For Wilshire Enterprises

August 25, 2009

Wilshire Enterprises (WOC) finally launched its $2 tender offer for 4 million shares, roughly half of the outstanding shares. It is a bad deal for shareholders and we anticipate that worse is to come because public shareholders will be minority holders in a firm whose management has a record of poor decisions, such as the refusal to sell at $8.50 to Mercury Real Estate Partners a few years ago. Read the rest of this entry »


Pershing Square Misleads About General Growth’s Equity Value

June 8, 2009

Pershing Square LogoPershing Square Bill Ackman’s presentation about General Growth Properties (GGWPQ) at the Ira Sohn Investment Research conference has us wondering what he is up to. The tone of the presentation clearly targets an audience that is not familiar with bankruptcy investing. At the same time, his financial projections for GGP are overly optimistic and do not square (no pun intended) with current results. We believe that some of his analysis is very misleading. Read the rest of this entry »


Looking For Outperformance? Invest With An Emerging Manager!

June 1, 2009

An ill-advised, persistent and costly error among institutional investors and their consultants is their reliance on large brand name money management firms to look after their assets. We had the privilege of attending and speaking at the recent Emerging Manager 2009 conference, from where we return with some very persuasive statistics that show the outperformance of small money managers over the large mainstream firms. Read the rest of this entry »


Porsche At Risk Of Bankruptcy Over VW Option Trades

May 25, 2009
Porsche CEO Wendelin Wiedeking with CFO Holger Härter

Porsche CEO Wendelin Wiedeking with CFO Holger Härter

These days, liquidity is in short supply for all hedge funds, and it comes as no surprise the hedge fund wannabe Porsche (POAHF) suffers from the same liquidity squeeze symptoms as many of its hedge fund brethren. The liquidity situation for Porsche will be critical over the next three weeks.

Recall that Porsche engineered a massive short squeeze of Volkswagen common stock (VLKAF) just a few months ago. Volkswagen’s common had been shorted by arbitrageurs who went long the undervalued preferred (VLKPF) at the same time. When Porsche announced that it had acquired 75% of Volkswagen through options and intended to take over the firm, the common stock soared while the preferred didn’t budge. This led to large losses for the hedge funds when they had to cover their short positions in the common.

The flipside of Porsche’s large position in VW option is Read the rest of this entry »


Welcome, AQR. Seriously.

May 5, 2009

Welcome, AQR. Seriously.

Welcome to the most exciting and important marketplace since the hedge fund revolution began with Alfred Winslow Jones 50years ago.

And congratulations on your first mutual fund.

Putting real investment power in the hands of the individual is already improving the way people invest, think, build portfolios, and will spend their retirement years.

Financial literacy is fast becoming as fundamental a skill as reading and writing.

When we launched the first event-driven mutual fund, we estimated that millions of investors worldwide could justify the investment in alternative strategies, if only they understood the benefits.

Next year alone, we project that many more will come to that understanding. Over the next decade, the growth of alternative strategies mutual funds will continue in logarithmic leaps.

We look forward to responsible competition in the massive effort to distribute these strategies to the investment world.

And we appreciate the magnitude of your commitment. Because what we are doing is increasing financial capital by reducing portfolio volatility.

Welcome to the task.

paf


Read the rest of this entry »


Is A Sale Of Wilshire Enterprises Imminent?

March 30, 2009

The shareholder meeting of Wilshire Enterprises (WOC) has been adjourned for the second time. This is actually the third delay of the shareholder meeting, which was originally scheduled for February 26 in Wilshire’s preliminary proxy materials. The meeting was then set for March 24th and at the last moment adjourned to March 30th. Today, the meeting was adjourned again to April 20th. Read the rest of this entry »


Wilshire Enterprises’ Future Decided This Tuesday

March 20, 2009

Wilshire CEO Sherry Wilzig Izak with Mina Otsuka, her brother "Sir Ivan" and friends (left to right)

Wilshire CEO Sherry Wilzig Izak with Mina Otsuka, her brother "Sir Ivan" and friends (left to right)

The end of the first round is approaching in this years most underreported proxy fight, the battle over Wilshire Enterprises (WOC) between Phil Goldstein’s Bulldog Investors and Wilshire’s CEO Sherry Wilzig Izak. Two directors will be elected at Tuesday’s meeting, and shareholders will also vote on proposals to end the staggered board, seek a liquidity event and abolish the poisons pill. We have written extensively about the battle previously (here, here). Read the rest of this entry »