Applied Materials After Rout Returns 40% With New Bet: Real M&A
August 11, 2011, 9:13 PM EDTBy Danielle Kucera
Aug. 11 (Bloomberg) -- The biggest stock-market rout since the financial crisis is giving traders a chance to double their profit betting Applied Materials Inc. will complete the largest takeover of a semiconductor-equipment maker.
Varian Semiconductor Equipment Associates Inc. traded within $1.50 of Applied Materials’ $63-a-share agreement before equities plummeted in the past week as the U.S. had its AAA debt rating cut for the first time. With the gap at more than $4 a share, arbitragers betting on the acquisition now stand to make an annualized gain of almost 40 percent if the transaction wins antitrust approval from regulators and closes in mid-October, according to data compiled by Bloomberg.
While the slump in U.S. equities is threatening to derail what had been the best year for takeovers since 2007, Applied Materials said yesterday it remained “committed” to the deal. The company, which is spending $4.9 billion to get back into a business it lost to Varian, has already raised more than a third of the total selling bonds and has $3.3 billion in cash. Applied Materials also has the highest credit rating in the industry.
“This is a good buyer with a good balance sheet,” Yemi Oshodi, managing director of M&A and special situations trading at New York-based WallachBeth Capital LLC, said in a telephone interview. In addition, “we don’t see anything that leads us to think there’s going to be any concern on the regulatory front. This is the transaction that I would recommend for any client,” compared with the risk involved, he said.
Acquisition Detail
Representatives for Gloucester, Massachusetts-based Varian didn’t respond to telephone calls or e-mails requesting comment.
Howard Clabo, head spokesman for Santa Clara, California- based Applied Materials, said in an e-mail that the company is “committed to our acquisition of Varian.” He declined to comment on the regulatory approval process.
The all-cash offer from the world’s largest producer of chipmaking equipment was 55 percent higher than Varian’s price of $40.55 prior to the announcement in May.
After the companies disclosed the deal, Varian never fell below $60 until last week, when the Standard & Poor’s 500 Index began its biggest three-day drop since November 2008.
Shares of Varian fell to a low of $56.64 during that span, before rebounding in the past two days to $58.91. Based on yesterday’s closing price, traders stand to make 6.9 percent if the deal is completed by mid-October, which would equal a 39 percent gain over a full year, data compiled by Bloomberg show.
Financial Analysis
“The market sell off last week had a big impact” on the deal spread, Mehdi Hosseini, an analyst at Susquehanna Financial Group in San Francisco, said in a telephone interview. “The arbitrage opportunity is that you buy it here and assume that Applied is going to close this in October.”
Today, shares of Varian climbed 1.7 percent to $59.91 as of 11:03 a.m. in New York.
With $3.1 billion more cash than debt, Applied Materials has the highest reserves among producers of chipmaking equipment in the U.S., data compiled by Bloomberg show. The company also generated $1.8 billion in free cash flow in the past 12 months, more than all equipment makers except ASML Holding NV.
To finance the takeover, Applied Materials already raised $1.75 billion selling five-, 10- and 30-year bonds, the data show. Applied Materials is rated A- by S&P. Based on Bloomberg’s Company Credit Ratings, which analyze borrowers based on indebtedness, market value, profitability, volatility and other financial ratios, Applied Materials has a AAA credit rating.
“I don’t see financing as any issue,” Patrick Ho, a Dallas-based analyst for Stifel Nicolaus & Co., said in a telephone interview. “This is an opportunity to make money.”
Relative Value
Applied Materials is unlikely to give up on the deal because it needs Varian’s 70 percent share of the so-called ion- implantation business to bolster demand, he said. The machines are used in a stage of creation for all computer chips and to make solar panels and light-emitting diodes.
Sales at Applied Materials, which exited the ion- implantation business in 2007, will rise 14 percent this year, analysts’ estimates compiled by Bloomberg show. Varian, which gets all its sales from selling ion-implantation machinery, will grow more than three times as much.
The lack of overlapping businesses increases the likelihood that Applied Materials, which has already gained approval from regulators in Israel, Germany and Taiwan, will get clearance from the U.S. Department of Justice, according to Ho.
The company received a second request from U.S. regulators on June 13, which usually occurs for deals of Varian’s size, according to Peter Lobravico, a New York-based vice president of merger arbitrage trading and sales at Wall Street Access.
Merger Arbitrage
It may take about three or four months for Applied Materials to get clearance from the time of the second request, which means the deal could be completed in mid-October, he said.
Gina Talamona, a spokeswoman for the Justice Department, declined to comment on whether it’s reviewing the acquisition.
The takeover may still get held up as Applied Materials waits for regulatory approval from China, leading some traders to avoid the deal, said Keith Denninger, vice president of event-driven strategies at MKM Partners LP in Stamford, Connecticut. The possibility of a more than 30 percent drop if the deal unravels may also scare away investors, he said.
“Ultimately, I think what’s spooking arbs is the potential downside,” Denninger said in a telephone interview. “If this thing blows up, this will ruin your year.”
For Wall Street Access’s Lobravico, the potential windfall from Applied Material’s deal for Varian more than compensates for the odds it will fall apart.
It’s “obviously a huge spread,” he said in a telephone interview. “I can’t think of a fund manager that wouldn’t want to make a return like that.”
--With assistance from Ian King in San Francisco and Tim Catts in New York. Editors: Michael Tsang, Daniel Hauck.
To contact the reporter on this story: Danielle Kucera in New York at dkucera6@bloomberg.net.
To contact the editors responsible for this story: Daniel Hauck at dhauck1@bloomberg.net; Katherine Snyder at ksnyder@bloomberg.net.
