NewStar Financial (NEWS) – CVR – 200% upside

Current Price – $11.72

Buyout Price –  $11.44+CVR (valued at $0.84-$1.00)

Upside – 200% (relative to residual CVR price) or 6% (relative to full stock price)

Expiration Date – Q4 2017

Proxy statement

This merger arbitrage transaction was suggested by Jesse.

 

Newstar Financial is being acquired by First Eagle/Blackstone for $11.44 in cash + contingent value right. CVRs will likely have value only if the transaction closes in 2017 due to the new tax bill (more on this below).

CVRs represent the right to receive the net tax refunds that are expected to be received by NewStar following the closing as a result of tax losses generated primarily by this merger (i.e. tax loss carryback to to prior years offsetting taxes for those years). Management estimates that these tax refunds will total approximately $1.00 per contingent value right if the transaction closes in 2017, or $0.84 per contingent value right if the transaction closes in 2018.

NEWS shareholder meeting has been set for 21st of Dec, which still leaves some time  for the transaction to close in 2017. Insiders and their related entities own close to 30% of NEWS stock, suggesting that shareholders are very likely to approve the deal.

As the risk of merger not going through is minimal and $11.44 will be distributed shortly, one is in effect acquiring CVR at $0.28 with the expectation of receiving $1.00 over the next three years.

There is uncertainty regarding the timing of CVR payments:

  • Company expects to file tax refund claims in Q3 2018 and receive refunds from the tax authorities promptly. However, these refunds will still be subject to approval by Congressional Joint Committee on Taxation (JCT) and IRS audit, and therefore could still be claimed back;
  • Upon receipt of these refunds 30% will be distributed in Q4 2018 to CVR holders;
  • The remainder 70% will be put in escrow, pending JCT and IRS approval;
  • 60% of the refund will be distributed upon JCT approval – timing Q2 2019 – Q3 2021;
  • 10% will be distributed upon completion of IRS audit or the expiration of the statue of limitation - timing Q2 2019 – Q3 2021.
  • Additionally, escrowed amount will accumulate interest, so eventual payouts might end up slightly larger.

Assuming merger closure in 2017, we have a situation where investment of $0.28 is expected to result in $0.3 payout in Q4 2018 and then a further $0.7 payout some time between Q2 2019 and Q3 2021. Even if JCT eventually does not approve full refund, the initial payout is unlikely to be claimed back, which reduces the risk of any capital loss from this trade.

And now let’s address the elephant in the room - there is a risk that CVRs do not pay out anything at all (from proxy):

On November 2, 2017 and November 9, 2017, respectively, the House Ways and Means Committee and the Senate Committee on Finance each introduced tax reform legislation under the Tax Cuts and Jobs Act, which we refer to as the “Tax Bill”. The Tax Bill, if enacted under either version, would eliminate the ability to carryback net operating losses, which we refer to as “NOLs” arising in tax years beginning after 2017, subject to limited exceptions not relevant to the contingent value rights. As a result, if the Tax Bill were enacted under either version and the transactions contemplated by the asset purchase agreement were to close in 2018, NewStar would not be able to carryback the losses generated in connection with the closing of the asset sale, and as such, holders of the contingent value rights would not be entitled to any payments thereunder“.

The latest media reports suggest that this ‘Tax Bill’ is very likely to be approved next week (here and here).

With shareholder meeting set for Dec 21st, there will be only a few days left to complete this merger and asset sale. NEWS insiders and their related entities own close to 30% of the stock and therefore are clearly incentivized to finish this before the New Years clock. The acquirer (First Eagle) is majority owned by Corsair, which is 9% shareholder in NEWS. So it seems that both sides should be interested in closing this deal promptly.

17 COMMENTS

  1. Nathan

    Sorry if I have misunderstood but what is the relevance of the 200% relative to the CVR. Isn’t the most upside one can expect here around 6% (which you seem to state) of which a decent part of that could be paid out in 2019. Just confused why you are quoting the 200%

    1. dt

      As you suggest I have stated both figures. I think return relative to the residual CVR value is more important here as I consider only this part to be at risk and because $11.44 will be returned to shareholders shortly.

  2. Jesse Warlick

    Good read on the shared ownership. I hadn’t realized that… that does create an incentive on both sides to get the deal done. Easiest thing for the CFO is probably to wait for January 1.

    Shares traded down to 11.61, presumably on momentum on the tax plan.

  3. RJChicago

    Dt or anyone else – do you know whether the CVRs will be publicly traded after closing?

  4. dt

    I think CVRs will not be transferable. From Proxy:

    “Under applicable SEC rules, the contingent value rights may not be sold or transferred (with certain limited exceptions, including transfer by will or intestacy).”

  5. brian walsh

    As of now, Do we know the last day we can buy the news? or do we have to wait to see what comes out of the Dec 21st meeting?

    1. dt

      During the meeting management might clarify whether they will manage to close the deal in 2017 and therefore be able to apply for refunds. So my guess that after the meeting price will either be higher (due to increased likelihood of receiving refunds) or it will drop to $11.44 implying zero value for CVRs.

  6. brian walsh

    Whether it closes in 2017 or 2018 the cvr should have value?

    ” Management estimates that these tax refunds will total approximately $1.00 per contingent value right if the transaction closes in 2017, or $0.84 per contingent value right if the transaction closes in 2018″

    1. dt

      I do not think that is correct. Management’s calculation here assumes that the new tax regime remains unchanged.

    2. Jesse Warlick

      There’s a note in the 14A about the implications of the new tax plan. They think it will eliminate value to the CVR if the deal doesn’t close this year.

      I got a note from IB saying the deal will be effective 12/21, although it didn’t say what they were basing that on.

  7. Jesse Warlick

    BOSTON, Dec. 21, 2017 (GLOBE NEWSWIRE) — NewStar Financial, Inc. (NASDAQ:NEWS) (“NewStar”) announced today that its stockholders have approved the acquisition of NewStar by First Eagle Investment Management and NewStar’s related sale of a portfolio of investment assets to a newly formed investment fund sponsored by GSO Capital Partners LP. NewStar expects the transactions to close on December 22, 2017, subject to satisfaction or waiver of remaining closing conditions.

  8. greg lia

    This was a good one, Deal approved by stock holders and expected to close tomorrow, 12/22. I sold in AH at 12.01 suppose it could go higher but at these prices you are spending almost 60 cents, (once you get your 11.44 back) to get a1.00 back over four years. Not a terrible deal but still some risk. I will consider opening another position at lower levels but am pleased to be out at 12.01 (cost basis 11.63 two days ago)

  9. Dan T

    Do we need to take action with our broker or will these shares automatically get exchanged?

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