Events Trader #24: Take your profits in National Express - and a review of our portfolio

I’ve decided to get in touch a bit early this week, because after everything that’s been happening with National Express, I think it’s time to take profits on our short trade now.

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19th October 2009

  • Take profits in National Express
  • A 9% gain on our first merger arbitrage trade

Dear subscriber,

Welcome back! I've decided to get in touch a bit early this week, because after everything that's been happening with National Express, I think it's time to take profits on our short trade now.

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It's also time to close the first merger arbitrage trade we played back in May, and I'll take some time to review a few of our other open trades. More on all that in a moment first, what's been going on at National Express?

Take profits on National Express for now

On Friday, private equity group CVC and the Cosmen family said they would not proceed with their 500p a share bid for transport group National Express, after undertaking due diligence on the company's books for the past four weeks.

The news took the market by surprise, and the shares tanked as low as 310p at the open of the session, before short cover buying interest (I guess we were not the only ones shorting the stock!) pushed the price up 50p, so that it closed at 362p.

CVC and Cosmen did not give any reasons for their withdrawal, but they did say that it wasn't because there were any problems financing the deal. So if you read between the lines, it looks as though they walked because the problems facing National Express are quite big, pretty risky, and need to be dealt with sooner or later.

These issues (which we first highlighted back in July) are a net debt of close to £1bn, half of which matures next year and needs to be refinanced; and the unresolved issue of the East Coast main line and the fate of its other rail franchises.

The company will now go ahead with a rights issue to try to raise around £400m. This will be supported by the Cosmens, who are still the largest shareholders with an 18% stake in the group.

Now today, National Express also said that it had held very preliminary talks with Stagecoach over a possible merger, which would result in National Express shareholders owning no more than 40% of the combined group. Management stressed that the offer is highly preliminary and that the offer has to be recommended by the National Express board before anything happens.

Again if you read between the lines you can see that the statement was not made with Stagecoach's approval, and that Stagecoach submitted the proposal at the request of National Express board. To me all this means that National Express is pussyfooting around to try to lift the share price ahead of a highly dilutive rights issue (which will still take place). You can read the story here: National Express Gets $2.8 Billion Stagecoach Offer (Update3).

We may revisit National Express in the future

For a start, let's close the short position that we opened on the 15th September (in issue 19). We were short at 480p, so at around 390p the position is worth closing. Although I expect the stock to drift lower before the start of the rights issue, most of the move has happened already, and there's a chance that the banks guaranteeing the rights issue may try to stabilize the price before the rights issue starts.

Also, as you've seen, the stock is very volatile, and that's unlikely to change any time soon. For one thing, the management team will do everything it can to lift the share price. But more importantly, it's very difficult to stay short before the share goes ex-rights, because you will have to tender the share and the right at the same time (I won't bore you but this process is a legal minefield). This is probably the reason why the stock rallied short covering ahead of the ex-rights date.

The story is still interesting, and we'll cover it again in the future, this time with a view of going long (if the price reaches a reasonable level). But for now, let's wait for the details of the rights issue to be announced. It could be quite a large one, as much as £400m, which means they could have a 1:1 issue (one new share per old one you own) at 260p with a 33% discount to the current price. As you've seen with Ladbrokes, this tends to weigh heavily on the share price.

No fresh news has emerged from the corporate side in the last six weeks. Importantly, we still don't know what the government will do to the other rail franchises. But the noises coming out of the political parties lately suggest that an anti-business stance might gain a few more votes. So the possibility that the rail franchises will be stripped away has risen. Meanwhile, no indication has been given as to how the operating businesses are doing. The last update came on 30th July along with the half-year results.

One last thing I've already received a few e-mails about National Express, but if you managed to get into this trade and made any money, drop me a line. It helps me to know which trades are of most interest to you and also, if you're coming to London any time soon, you can buy me a beer with the profits!

A great result for our first merger arbitrage play time to close the Pfizer-Wyeth trade

This merger was completed on Thursday 15th October and as a result Wyeth shares are not traded any more. This means that our merger arb strategy which we've kept open since the 26th May is finished and we should now have locked in the 8.8% profit that was available. The good news is that the merger completed less than five months on from our recommendation. That means the annualized return on this trade is 21.1%.

If you followed the strategy, then you'll have bought Wyeth stock from a broker, and shorted Pfizer with a spread bet. You will find that the brokerage account where you held your Wyeth stock, now holds cash and Pfizer shares in its place. If you stuck to the ratio I gave you, you should find that the number of Pfizer shares you own are the same as the number of shares you are short.

So what you do now is simple. You sell the Pfizer shares, and at the same time you close your spread betting position. Do try to close both positions at the same time (or within minutes of each other). That means that you only lose the spread between the bid and offer prices, which should be quite small; and you may possibly suffer a small intra-day movement. On the other hand, if you waited three hours or even a day between closing the two positions, you'd take the risk that the stock could move against you, hitting your profits.

For more information on the original trade please review the piece written in May (available on the Events Trader Archive, issue 3. This week's password is: Mahogany).

An update on our outstanding merger arbitrage strategies

So what's going on with the rest of our merger arbitrage strategies? Lets start with Merck and Schering Plough.

HOLD your positions in Merck / Schering Plough

The merger is still on track and is expected to close in the fourth quarter. Shareholders in both companies approved the deal as expected on 7th August, and agreed on the management team which will lead the new merged company. The next event is the release of Merck's results on 22nd October, where more information on the merger timetable may be released. For now, the company is in the "quiet period" before the release of its financial results.

No objections have been raised by the US antitrust authorities or the European Commission (EC) so far. Since the other mega merger in the pharmaceutical industry completed last week (Pfizer-Wyeth, as noted above) I doubt any objections will be raised on this one. So I would expect the merger to be completed before Christmas perhaps, with a bit of luck, by mid-November.

Keep your position open if you have one, but if you don't, then don't bother opening one as the current spread is just 1.2% and commission charges will eat nearly all of your profit.

BUY Sun Micro if you haven't already done so

The Oracle and Sun Micro deal is a different story. As we suspected back in July, this merger was delayed. The reason, as you know, is that the EC decided to open a phase two enquiry into the deal. A decision will be made by 9th January next year. The EC is concerned that because Oracle is the largest provider of databases it could decide to hamper the development of MySQL, an open-source database supported by Sun Micro.

In my view this is a non-issue. MySQL is open source, which means the code is already out there for anyone to use and improve on. Even if Oracle wanted to kill the project it wouldn't be able to do so MySQL would just carry on with some other company offering support.

After the EC announcement, the shares fell to $8.90, but have since recovered to $9.12 (a 4.12% discount to the $9.50 bid price) and in total, have fallen by 1.2% since we recommended them at $9.24 on 28th July.

Both companies are still supporting the deal, even after Sun published results that Wall Street considered disappointing. To me, the risk of the EC blocking the deal is quite remote. The only deal involving US companies that the EC has ever blocked was GE/Honeywell back in 2001, but that was for different reasons.

If you are already long of Sun stay long. If you're not, in this case the trade is still worth going for, as you could make 4.1% in three months (16.4% on an annualized basis). So if you haven't yet taken a position in Sun, then go for it (you can read the original recommendation on the Events Trader Archive, issue 12. This week's password is: Mahogany).

Other interesting news from last week

Three pieces of news caught my attention last week. First there was the news that banking group Lloyds is deciding whether to try to raise £16bn via a rights issue. This means that the markets have recovered from last year's shocks and are now functioning well. We'll wait for further news, but I think this event could be played.

Secondly, there's been a lot of talk and anger about bankers' bonuses. And I could not help but think that if we had a repeat of the banking crisis, this time it would be very hard to politically justify a bailout of the system. Think about it. They got saved last year and they still did not "get it". Steal from me once and you're a thief but if you steal from me twice, then I'm an idiot! So if we had a second leg of the crisis perhaps due to souring commercial real estate loans or private equity loans that can't be rolled over then what might happen?

The third piece of news regarded the desperate attempt made by Donington Park to raise the money needed to host the 2010 Formula 1 British Grand Prix. The group is looking to raise £135m by issuing 7-year high-yield (junk) bonds with a 15% coupon, callable after four years at the discretion of the issuer. These bonds are issued by a private company so not much is known about the state of its finances, but I suspect that they'll have to use the racing track itself as a guarantee.

This means that if the bonds default, they'll still have a high recovery value and you might end up owning part of the real estate. Again, let's wait for more details to be announced and for the prospectus to be issued, but I have a feeling that if the bonds are issued we might play them in the future, especially if they start to trade below par value.

That's it for this week! As usual if you have any questions please e-mail me at and as I mentioned above, let me know if you managed to profit from the National Express trade, or how you're getting on with any of my other trades for that matter.

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Riccardo Marzi

Events Trader

Your capital is at risk when you invest in shares, never risk more than you can afford to lose. The share recommended is denominated in a currency other than sterling. The return from such shares may increase or decrease as a result of currency fluctuations. Spread betting is not suitable for everyone - ensure you fully understand the risks involved and never risk more than you can afford to lose. Prices can move rapidly against you and resulting losses may be more than your original stake or deposit. Please seek independent personal advice if necessary.

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Profits from share dealing are a form of income and subject to taxation. Tax treatment depends on individual circumstances and may be subject to change in the future. Editors or contributors may have an interest in shares recommended.

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