Saturday, October 22, 2016 0 comments ++[ CLICK TO COMMENT ]++

Purchase (Special Situation): Syngenta

After pondering this for a couple of months, I decided to take a risk arbitrage position in the Syngenta (NYSE: SYT) takeover by ChemChina, a large Chinese company.

I was vaguely familiar with Syngenta because I did some very preliminary, limited, research on it about 5 years ago when I was looking at non-commodity agricultural businesses such as Bunge. This is one of those deals where the expected return (based on my assumptions) is quite low (5%), which is below my usual target (I like to aim for 10%+, preferably 12%+). The raw return is 9% so if everything goes as planned on time, it is a good return; but I am attaching high negative downside so the expected return isn't as good. I wasn't too keen on a 5% return for risk arbitrage.

In the end, I decided to take a position. The underlying business is great--there are only 3 or 4 other businesses like this at this scale in the world--so even if the deal fails, I would rather own this than many other companies out there. If the deal fails, because I am buying at a high price, the return won't be that great. But this company will be profitable and will be around for another 25+ years (same can't be said of many risk arbitrage companies I take positions in).

The main risk with this deal is the uncertainty over the EU government regulator approval.

The structure of this deal is a bit different from most large mergers one may be familiar with: this is a tender offer by ChemChina so shareholders need to submit their shares once approval granted. As usual there are squeeze-out provisions.

NOTE: All figures refer to Syngenta ADS trading on NYSE. Arbitrage spreads may be slightly different for the actual shares trading on the Switzerland SIX exchange.

Takeover price: $92.95
(tender offer of $93, less $0.05 ADS fee; possible additional $1 per ADS dividend with shareholder approval but I'm ignoring this since I'm uncertain)

Deal closing: 2nd half 2016

Purchase price: $85.22

Prob (success) = 90%
Return  (success) = 9%
Prob (failure) = 10%
Return  (failure) = -35% (assume it drops close to 5-year low of $55)

Expected Return = 5%

As stated above, the expected return isn't that great (although it's good if deal closes this year), but I decided to take a position due to the strong underlying business with good long-term macro background. In fact, I'm thinking of whether to increase my stake early next week.

Buffett's Four Key Questions

(1) How likely is it that the promised event will indeed occur?

Most regulatory agencies have approved (including CFIUS--not too relevant here) but the main approval from European Union is pending. Numerous analysts have commented that the assets of Syngenta and ChemChina do not overlap. The Morningstar analyst report I have access to--the only one freely availabe via my discount brokerage--mentions that combining seeds and crop chemicals likely won't lead to monopoly-like competitive advantage and minor divestitures (if required) should appease regulators. The analyst also suggested that the risk of successful deal closure has declined a bit due to multiple agro-chemical deals on the table (Bayer buyout of Monsanto; Dow Chemical and Dupont merger; and this ChemChina buyout of Syngenta). Morningstar estimates 75% probability of deal closure.

I feel that the probability of success is closer to 90%. I think the businesses don't overlap so there isn't a natural regulatory concern (EU might still be concerned with a Chinese takeover of their premier agri company but China is large future agricultural market and this will enable the company to meet those demands more easily.) Financing doesn't seem a risk given how some news reports suggest that ChemChina has already lined up most of the funding (and the Chinese government has pushed ChemChina to merge with SinoChem to improve the balance sheet). This recent Reuters article is a good summary of the various items. There is a large $3 billion break-fee that ChemChina would have to pay Syngenta so I believe there is high motivation by the bidder and their investment bankers to close the deal.

(2) How long will your money be tied up?

The deal has been extended several times and it is expected to close by the end of this year. Reuters article suggests that the earliest EU decision might be Oct 28. However, there is the possibility of final ruling dragging on for months, especially if divestitures or some other business restructuring is required. I think worst case date for closure might be 6 moths from now (say Q2 2017). If the deal closes by the end of this year, the expected return of 5% is attractive; but if it go to Q2 2017, it isn't such a great return (although if you are bearish like me, it's decent for something not correlated with the market).

(3) What chance is there that something still better will transpire - a competing takeover bid, for example?

There was the Monsanto-Syngenta discussions in 2015 that went nowhere. So there is some remote possibility of a better bid but given the size of the company involved, I don't expect anything better.

(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

Not that one should blindly follow Wall Street analysts but just to give an idea, Morningstar values Syngenta at $78 if the deal does not close (about -10% from here). I have to look into it in more detail and don’t want to go into too much right now, but I did look at this company briefly (not written up on blog) 5+ years ago. I was investigating Bunge as a potential investment and looked at the major agri businesses in the world including Syngenta and Monsanto (as usual, both of these were too expensive). The Swiss-based Syngenta is one of the premier non-commodity agri businesses in the world (top 2 at that time in my opinion, and probably still in the top 3) and is hard to replicate.

At current price, Syngenta's P/E is around 30 and forward P/E is around 20, with P/FCF around 30. Obviously the valuation is really high, which is usually the case when you are buying close to a takeover price. ROE has trended down recently but its 10-year average is around 18%. In the commodity complex, which I have been bearish on for years, agriculture is probably the one with the best future outlook given increasing incomes and population in developing countries (in contrast, oil & gas, base metals, etc, are still a big question mark right in my opinion.) Syngenta isn't a commodity company but it is influenced by the agricultural commodity complex (i.e. if prices of, say, corn or wheat rise, companies like Syngenta, Monsanto, etc will do better). Even if the deal fails, this is one company I wouldn't mind owning (albeit not at this price). In the worst case, I think the share price might fall somewhere near its 5-year low, maybe around $55 (-35% from current price).

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