CWC merger / John Malone liked LiLaC more than Global

I tried to figure out what the CWC merger structure was about.  You can access my spreadsheet here: https://docs.google.com/spreadsheets/d/1c_31Z-eoxXAPc1TfeOMjgdirZu-nk54DHwGKXSlOao8/edit?usp=sharing

Summary:

  • The way the merger is structured is that the Recommended Offer gives you the most value from a merger arbitrage perspective.  However, you will get a very low mix of LiLaC shares.  What Malone is doing here is luring institutional investors into taking a high proportion of Global shares rather than taking (relatively) undervalued LiLaC shares.
  • Since the merger details were announced, Liberty Global has fallen by about a fifth.  So you should do your own homework as to the relative valuation between Global and LiLaC.

Merger details

I will categorize the options as four different choices:

  1. Recommended Offer.  This is the option recommended by the Board of Directors.  This is the default option.
  2. Recommended Offer, with LiLac option.  Like Choice 1, except you get some LiLaC shares instead of zero LiLaC shares.
  3. First Dual Share Alternative.  This is the option that Malone’s investment vehicle CHLLC will elect.
  4. Second Dual Share Alternative.  This is the option that John Risley (Clearwater) and Brendan Paddick (CWC CEO) will elect.

The main difference between Choice 1 and Choices 3/4 is that Choices 3/4 will give a fixed amount of LiLaC stock, whereas Choice 1 will not give any LiLaC stock at all.  From an arbitrage perspective, John Malone is giving up value compared to Choice 1.  In my opinion, Malone clearly thought that LiLaC stock was undervalued relative to Global.  He is choosing the option that will give him the most LiLaC, even though he is giving up value to do so.

Weird unnecessarily complicated options stuff

Also embedded in the deal are options.  If Liberty Global stock were to go up and exceed certain thresholds, those who elect Choices 1 and 2 would give up some of their upside.  It’s sort of like selling a call option on Global stock, and then buying a call option on Global stock at a higher strike price (or selling a call option collar on Global stock).

I’m not sure why this stuff is in the merger deal.  Perhaps the reason it exists is because it makes the takeover premium look bigger than it actually is.

Choice 3 versus Choice 4

Both Malone and other insiders have made irrevocable choices when it comes to Choice 3 and Choice 4.  The way I see it, it reflected their differences of opinion as to what the share price would be after the merger would be announced.  Malone was less optimistic than John Risley (the food guy) and Brendan Paddick (CWC CEO).  Below certain Global share price thresholds, Choice 3 is significantly better than Choice 4.  At very high share prices for Liberty Global, Choice 4 is slightly better than Choice 3.

What I would think about

Choose Choice 2 or buy LiLaC (or Global) stock directly, depending on the merger arb spread.  When calculating the merger arb spread, remember to factor in the weird call option collar.

After the merger closes, flip into LiLaC shares depending on the relative valuation between Global and LiLaC.  Unfortunately, I haven’t done the valuation work.

(Mis)Alignment of Interests

Often with the John Malone entities, Malone will own a greater percentage of one entity than another.  When these entities do deals, these deals will be favorable towards the entity that Malone owns more of.  So in the CWC merger, the deal was favorable to CWC as CWC is being bought out at a premium.

Post-CWC merger, John Malone will own more of LiLaC than he will of Liberty Global.  So you should be careful as a Liberty Global shareholder.

If Global trades at a significant discount relative to LiLaC, then Malone could potentially try to use LiLaC stock to buy Global.  He did a similar move with Starz (spun out, merged back into Liberty Media, and spun out again).  He tried something similar with Sirius XM (though that deal wasn’t really disadvantageous to Sirius shareholders).  If these stocks trade irrationally and Global shareholders agree to a predatory takeover, then you may lose some value as a Global shareholder.  Conversely, if these shares trade at a huge disparity, you could get cute and speculate on John Malone trying to take over the entity he owns less of.

In practice, a smaller tracking stock taking over the much larger tracker is unlikely to succeed.  However, it’s possible that there could be a re-attribution of assets between the two trackers that would be favorable to LiLaC.  More likely, there may be some issues when LiLaC raises capital via debt.

Because these are tracking stocks, Global shareholders basically guarantee the LiLaC debt (and vice versa).  Because both trackers are part of the same legal entity, LiLaC may be able to get debt cheaper than it otherwise would be able to… at the expense of Global shareholders.  From what I understand, LiLaC’s cost of capital is very high in some cases so that may be an important issue.    (This is why I’m not a huge fan of tracking stocks and spinoffs.  They generate a lot of fees for lawyers.  These structures create value leakage.)  In my opinion, the John Malone factor makes Global slightly less attractive relative to LiLaC.

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