Linde (LIN.DE) – Dual Share Arbitrage – 9.5% Upside

Current Price – €173.4

Price of Tendered Shares – €189.9

Upside – 9.5%

Expiration Date – 24th Oct 2018

Merger Proxy

 

This is a slightly different arbitrage situation involving two different shares of Linde traded on the market – the tendered ones (LINU.DE) and non-tendered ones (LIN.DE). I have seen too little of German M&A’s to have confident say on this, but it seems appealing and I would love to here other more educated opinions.

Linde and Praxair are trying to merge (for couple years already) aiming to create the largest industrial gas supplier. Shareholders of both companies have approved the deal already. Several regulatory approvals across the globe have also been received, while the others are still pending. The biggest concern now is demand from US antitrust to divest more than $4.3bn in assets, which is right at the limit of €3.7bn indicated in the merger agreement, beyond which either party is free to abandon the deal. Eventual divestment requirements are expected to be even higher than this. However, discussions with regulators and between the parties are still ongoing, so the deal is still alive.

I have no idea whether this merger will close or not. This is large cap transaction and I am guessing that Linde-Praxair spread (currently at 9%) correctly reflects the risks involved. Due to German law the companies are under time pressure to close this before 24th of Oct (not sure if the date can be extended). Further details and concerns are well summarized here and here.

The trade I am contemplating is not the straight Linde-Praxair arbitrage, but rather arbitrage between the two types of Linde shares. There is LINU.DE, which trades at €189 and represents shares that participated in the tender (92% of all) to be exchanged effectively into 1.54 of Praxair shares. And on the other side we have LIN.DE which is the remaining 8% of shares that did not participate in the tender and which trade at €173. Management indicated that in case the merger closes LIN.DE shareholders will receive cash compensation without specifying the amount:

To that end, Linde Intermediate Holding AG will enter into negotiations with Linde AG regarding a merger agreement. The merger agreement will contain a reference to the merger related squeeze out of the remaining minority shareholders of Linde AG against adequate cash compensation pursuant to sections 62(5) sent. 1 UmwG in conjunction with sections 327a et seqq. AktG. The merger agreement will be provided to the Linde AG Supervisory Board for approval; it would only become effective in the event of a successful completion of the business combination. An extraordinary shareholders’ meeting which would resolve the transfer of the shares of the remaining shareholders of Linde AG to Linde Intermediate Holding AG against adequate cash compensation would take place following the completion of the business combination.

My big questions are:

- Whether the ‘adequate’ compensation can be lower than what the tendering shareholders have received?

- When will this cash compensation be determined?

- What will this cash compensation be based on? (as tendering shareholders will receive shares in new company instead of cash)

- Can Linde decide not to squeeze out the minority shareholders after it publicly announced it will?

The following explanation on how German squeeze outs work does not clarify things much, but suggests that adequate compensation should be at least equivalent to the offer paid to the other shareholders, but the pay-out might take longer to receive:

The amount of the proposed cash compensation is subject to review by a court-appointed auditor and, in the event of a dispute, by the relevant court. Dissenting shareholders may take legal action against the squeeze-out resolution and delay the date on which the squeeze-out becomes effective by five to six months until a court has cleared the squeeze-out in an accelerated proceeding (Freigabeverfahren). Disputes over the amount of the compensation to be paid are to be dealt with in a separate appraisal procedure, which may easily take years (but does not delay effectiveness of the squeeze-out).

Under the Takeover Act, the bidder can, within three months of the end of the acceptance period, apply for a court decision transferring the remaining shares in the target to the bidder if it holds at least 95 per cent of the share capital. Minority shareholders are entitled to the same compensation as the one paid under the offer (but may insist on being paid in cash). The compensation will be deemed to be adequate if at least 90 per cent of the shares that have been the subject of the offer have been tendered thereunder. Otherwise, the court will have to review the adequacy of the compensation before deciding on the bidder’s request. Minority shareholders can appeal against the court’s decision. As a result, a squeeze-out under the rules of the Takeover Act may be unacceptably delayed unless the aforementioned 90 per cent acceptance quorum has been reached, which is why this squeeze-out alternative is of little practical relevance.

So is this a win-win situation? If the merger breaks (tight deadline of 24th of October), dual shares and spread will be eliminated. If the merger get’s approved, then all depends on when and what kind of cash compensation is paid out in the squeeze out.

This is a very liquid large cap, so free lunch should not exist in such cases.

If anyone knows of any similar precedents or has any other insights on this, would really love to hear it. Maybe I am completely missing the point on this situation.

Published on: September 7, 2018  •  Published by:
Category: M&A
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20 COMMENTS

  1. work 22

    No, unfortunately there’s no free lunch. But let’s start with the deal first: Odds lately have been around 50/50 of closing, one could argue they are 58% against a deal now, 42% for. The spread between LIN and LINU is 14 euros, the deal spread is 19 euros, so you can guestimate payoff odds that way.

    Let’s say there’s no deal. The LIN-LINU spread collapses, you pocket 14 euros (making about 4% on your TOTAL capital, remember, you have to short other side, so its not really 8% since it requires a lot of dough).
    But what if there’s a deal? You lock in a sure loss of 19 euros on your LINU stock. That’s a for sure 10% loss if the deal closes on that segment of capital. Then you have untendered LIN stock, the stock that rejected the invitation to the Praxair party and is now stuck outside in the cold. It may go up, it may not. There’s no promises, or requirement for Praxair to pay close to the original price. And no rush for Praxair to buy out the stub either, which leads to another point.
    Holding LIN could take years in the German courts, for an uncertain payoff, and frankly no deserving necessarily of a higher one. Why would Praxair pay more for those who rejected a perfectly good offer? An interesting precedent, though outside Germany, is Arcelor stock, which sued years later for higher compensation from Mittal and was rejected in Luxembourg. An entire hedge fund blew up over that. Yes they can pay you less than the original offer!!

    Not only that, but holding LIN makes you really hold Praxair equity risk. If PX goes down, then shouldn’t your possible compensation also go down? The court will think so. If PX goes up, that helps, but you could have gotten that anyway by tendering in the first place.

    With MAN in Germany, a cash deal, shareholders won a court case for a higher price and ongoing dividend. They failed in a recent attempt to get yet an even higher price as the economy and company grew. That would be a bull case scenario for holding the untendered LIN. But they had an argument that MAN was purchased on the cheap. Tougher call here with LIN. I’ll let you be the judge!

    1. work 22

      Also, the spread between LIN and LINU would be tighter if the market anticipated a quick squeeze out– that doesn’t seem to be the case, but could be wrong.

  2. dt

    “making about 4% on your TOTAL capital” – this is not the way how the upside from spreads is calculated as you get cash inflow on the short leg. The ‘total capital’ would actually be margin requirement on both legs of the trade rather which is much lower than the simple sum of long and short amounts.

    “You lock in a sure loss of 19 euros on your LINU stock” – I do not follow this argument. If deal is approved and LINU spikes up, then LIN also likely to spike up by the similar amount, so no loss at that point. Eventually short LINU position will be converted to short NewLIN position. So you would end up being long LIN (pre-merger) and short NewLIN. However, I am guessing (but no arguments to support it, it just seems logical) that cash compensation will be based on the price that NewLIN will trade in the market. And if this will be the case, then the spread will eventually close upon cash-out amount announcement.

    “There’s no promises, or requirement for Praxair to pay close to the original price.” – Linde publically stated that minority shareholders will be squeezed out with cash compensation. And based on the law explanations that I read ‘adequate’ compensation should not be below the offer price. Also it is not Praxair that is acquired Linde, but rather the two are merging.

    “no rush for Praxair to buy out the stub either” – again not Praxair but Linde will cash out. And there is a rush as otherwise this would create quite complicated structure with both merged and unmerged Linde trading and having to share different economic interests. Maintaining this would be quite expensive as well.

    “Holding LIN could take years in the German courts” – the quote that I copied stated that although courts can take many years, squeeze out itself is prompt (not sure how accurate this statement is). So in courts minority shareholders are simply seeking incremental payouts if the squeeze-out price was considered inadequate.

    I think the key question remains on how and when the cashout compensation will be determined.

    1. work 22

      Fair enough, feel free to disagree with my points. I didn’t comment on whether or not it was a good idea, it is interesting and thanks for posting it. I am actually considering the trade!! Like many others, I like to look for the bad news and downside first :).

      You asked for thoughts and past experience and whether or not this is a “win win.” My point is more that this is not a “heads i win, tails i still win” situation. Its more nuanced than that, and that’s why LIN is trading 14 euros cheaper. Whether or not its a good bet is up to you. 5-6 months, plus appeals, all that legal jazz make for years, it is rare you get a fast squeeze out. The people who did not tender are most likely seeking greater compensation and will not be squeezed out unless 90-95% etc. And its not because they considered the squeeze out price inadequate, its because they considered the original deal price inadequate (as with MAN trucking). Which could be the same as the squeeze out price as you mentioned. How they and the courts would determine what that offer price is based on NewLIN stock though is unclear.

      I misunderstood that PX is disappearing into Linde. That does increase the odds of a better takeout down the road.

      Short stock at Schwab is counted as full capital against you. Maybe not at IB, I don’t know. Untendered LIN has a high chance of a higher margin requirement, but I do not know.

      The best way for this trade to work is if there is no deal. Which the market seems to think is very very possible.

      Anyway, thank you for posting the idea. I certainly didn’t mean for my comments to seem overly negative! Just pointing out there’s no free lunch, its way more complicated than that. I have traded many of these German deals and there is definitely a real reason for the spread, though perhaps its too wide.

        1. dt

          Work 22, thanks for critical comments. Just meant to keep the discussion going rather than criticize your feedback. My knowledge here is limited and I am mostly guiding myself here by common sense (which probably is not the correct approach). I will have to look deeper into examples you indicated.

  3. Alex15

    I have done research on this merger arbitrage deal and think I am familiar with the procedure.

    The price will be determined by the lower of 3-month VWAP or a valuation according to IDW S1 standards.

    The auditor has already been chosen and my guess is that he has his report done already (of course in favor of Linde instead of the minority shareholders. Linde plc wants this to be done as soon as possible.

    Squeeze out will take a couple of months after the merger closes and then shareholders can and will file a suit against the cashout price. However, that won’t stop Linde plc from squeezing out their remaining shareholders at the to be determined cashout compensation. The court then has years to determine the fair amount for the cash compensation and shareholders will receive the difference plus interest if the price wasn’t fair. In a majority of cases, the court has decided the cashout compensation initially was too low.

    Linde can’t squeeze out shareholders any lower than the 3 months VWAP before announcing the squeeze-out, which is roughly 173,25 € per share in cash.

    1. dt

      Alex, thanks for additional details. Couple questions:
      - For LIN.DE I arrive at higher 3 months average closing price of Eur177 (obviously might get lower/higher depending on when Linde makes the squeeze out announcement)
      - In the German M&A law explanations I have read through there was always a reference of adequate price needing to be higher than the offer price. If I follow you correctly, then the offer price will be irrelevant for the initial squeeze-out consideration, but might be taken into account by courts for additional settlement (potentially many years later). Is this roughly correct?
      - Could you point me to any other recent cases where tendered and non-tendered shares traded simultaneously before the merger closure.

      If this is going to playout as Alex suggests, then arbitrage still works in the scenario where the deal breaks. However, if transaction gets approved then pay-off will be driven by how LIN.DE (untendered shares) react to the news. My expectation is that LIN.DE would still jump higher together with LINU.DE (but likely by lower percentage) as investors will be expecting immediate squeeze out at Eur177 with potential additional payouts after settlements are reached in courts. In other words if the deal gets approved, the immediate loss on this hedged trade will be significantly lower than the 9% spread between LINU.DE and PX.

      So would seems like this trade is still worth taking.

  4. Alex15

    I am not aware of any recent cases and a case like this unique. Wella and Biotest (not a squeeze out yet) are examples that provide some background.

    Linde officially made this announcement on the 25th of April. https://www.the-linde-group.com/en/news_and_media/potential-merger/news-20180425.html

    However, it is still not clear if this is allowed because they would need to own the shares and this not necessarily given since the merger is obviously not completed. Linde plc announced the squeeze exactly 6 months before the deadline on the 24th of October (cannot be extended), which indicates to me that the squeeze out should be done as soon as possible and at a low price.

    I don’t think the dual-class share class is relevant since the merger consideration was in stock. Stada Arzneimittel AG is an example where the cash offer price was lower and the price paid in the profit and domination agreement.

    In the business combination agreement, there is a pro forma valuation (186,77€) (to prove that the merger consideration was fair) for Linde, but this is with synergies (they are not relevant for Linde standalone LIN.DE) and is not fully relevant in my view for other reasons as well.

    Some of the assumptions are too negative and will be challenged in court (I assume they will be applied in the squeeze out as well). Only one shareholder was to file a case in court.

    Not sure if I understand the second question correctly. But let us do a hypnotical example:
    Merger closes on the 24th of October on Linde plc comes up with the auditors opinion and the valuation (which practically is dictated by Linde plc and therefore will be challenged by shareholders in court) determines the fair value of Linde is 170€, then the squeeze out will be done at 173,25€ (3 months VWAP). It is determined by the higher of the two (in my previous comment I made accidentally wrote lower, sorry for that).
    Then in a couple of months, I receive 173,25€. The court is then doing an independent valuation (which takes years). The court can come up with a lower valuation. In this case, shareholders don’t get anything.

    Different calculations by investors who specialized in this field indicate that Linde standalone would be worth ~200€ per share according to IDW S1 standards. I would estimate a range between 180-210€ per share.

  5. work 22

    9/19/18: News out that PX and LIN may make more divestitures to Messer and CVC and continue with the merger. LINU up 7%, LIN up 1%– which makes it seem that the market agrees with Alex on the lower vwap takeout pricing for the leftover LIN shares. Possibly.

  6. Alex15

    Linde and Praxair just received green light from China, which makes this almost a done deal.

    1. Alex15

      The “Independent” auditor did the valuation according to IDW S1 standards. In case the merger consummates (which I think is very likely) the squeeze-out will be done at 188.24 and shareholders will receive that amount in cash.

      Minority shareholders then will take this case to court. If the court decides on a higher fair value, shareholders will receive the difference plus interest.

  7. work 22

    Interestingly now the LIN GY and LINU GY separate lines of stock are trading at approximately the same annualized return, reflecting the same risk of deal/no deal. This shouldn’t come as a surprise really, but amazing how markets move to that level so quickly. Now here’s a question for untendered LIN GY holders, do you take the bird in hand or hold out for 188.24 possibility?

  8. work 22

    Linde is calling for an EGM on December 12th to decide about the minority cash squeeze out. Already trading above 188 as people clamor for more compensation. We’ll see!

  9. dt

    I am moving Linde out from Active ideas. I have never entered the dual share arbitrage position mostly due to Alex and Work comments above regarding how minority squeeze outs work in Germany.

    The determination of the final squeeze out price is still pending (EGM on the 12th of Dec).

    Had I entered the arbitrage position discussed in the write-up I would be at break-even today with non-tendered shares trading at Eur192 (up 10.7%) and tendered shares converted to new Linde trading at Eur138 (or Eur212 pre-conversion, up 11.8%).

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