Thursday, July 3, 2008 0 comments ++[ CLICK TO COMMENT ]++

Penn National Merger Falls Apart

If you want to see an example of why risk arbitrage can be lethal, you need not look further than Penn National (PENN). Penn National is dissolving the proprosed deal and has chosen not to fight the case in court:

Penn National Gaming said Thursday that it has terminated its $6.1 billion sale to two private equity firms, after agreeing that completing the deal would not be possible without a lengthy litigation process.

Under the terms of the now-terminated deal, the casino operator would have received $67 a share in cash from Fortress Investment Group and Centerbridge Partners. Instead, Penn National will receive $1.475 billion, including both a $225 million break-up fee and a $1.25 billion equity investment by the two firms, due in 2015 or repayable by an equivalent amount of stock.

Penn National seemed to have signed a good contract with the takeover parties but it chose not to fight. I think it could have got more by fighting in court but that would have seriously damaged its performance while the court case dragged. I think the "consolation prize" is reasonable for shareholders, although risk arbitrageurs wouldn't be happy at all.

I considered this deal before going with BCE. I chose the lower potential BCE early this year because the risk with Penn National seemed high. Good thing I didn't go with PENN but it also shows the risk.

I considered it several times over the last 6 months and never felt confident with the deal. Risk arbitrageurs would have taken a massive beating over this failure. They would have levered up at prices over $55 and it would have been hard to hedge a cash offer like this. Most of them were probably out of the market by the time the sotck plunged below $45 but that would still have been a big loss.

When I was evaluating it a few months ago as a risk arbitrage play, the advantages for PENN were the seemingly strong contract it signed (hard for bankers and takeover parties to leave without big penalties), high return potential (it was trading 20% to 50% off the takeover price at various points over the last 6 months), and the seemingly attractive casino industry. The downsides were the high valuation of the company (P/E in the 20 back then, if I recall), regulator risk (need approval from many gaming commissions), and the questionable state of Fortress Investment Group (it wasn't doing well as you can tell by its stock price). Penn National had no backdoor if the deal failed so that always kept me at bay. I am ok with owning something like BCE if the deal fails but a high P/E PENN is not my idea of something to hold through an economic downturn.

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