Europe’s answer to Boeing comes in an unappealing package for merger arbitrageurs. The $45-billion union of BAE and EADS should be a godsend for deal-starved hedge funds. But there’s no agreement yet and non-financial obstacles abound. Moreover, a “dual-listed company” structure adds risk.
Assume the two companies agree and announce a deal — an absolute minimum requirement for many M&A investors. (The provisional deadline is October 10). Assume, too, that arbs can live with the political and security risks that spring from creating an Anglo-Franco-Ibero-German concern that is the Pentagon’s biggest foreign supplier. And take it as read that both companies’ investors don’t revolt in the meantime.
These are significant assumptions. But even then, the deal’s very structure could be off-putting. That’s because BAE and EADS intend to join forces through a DLC, as already used by several FTSE heavyweights such as Unilever, the Anglo-Dutch consumer products giant.
Under today’s typical DLC structure, both will keep their stock listings and existing assets. One management team will run both, with identical boards at each. Shareholder votes and dividends will be split 40-60, governed by so-called “equalisation” and pooling agreements.
This makes sense. In truly global capital markets, DLCs like this would not be needed. But for BAE-EADS, keeping existing listings soothes national pride, while both firms avoid big tax bills or “flowback” as investors dump foreign shares.
The problem for arbitrageurs is that unlike a typical takeover, this produces two non-exchangeable sets of shares. These should theoretically trade in lockstep — but often don’t. After Thomson bought Reuters, the DLC’s London shares dramatically underperformed the Canadian securities. Hedge funds had assumed the two would converge, but had to unwind at painfully wide levels.
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Granted, the parallels are inexact. The Thomson episode was during the financial maelstrom of 2008, and the London stock was also far more liquid. In contrast, Unilever’s shares trade just a couple of percentage points apart.
But the Thomson experience does suggest DLCs make merger bets riskier. That implies smaller stakes for arbs and, at the margin, perhaps a bumpier ride to the 75 per cent shareholder approval that BAE will need to push this deal through.
