Friday, January 20, 2006

Consolation price

With the recent wave of private-equity deals, another sort of financial gambit is going virtually unrecognized. Let’s call it “passive accretion.” Or, in non-financial-eze, “how to make millions without really buying.”

Case in point: How the fortunes of the investor groups Newcastle and Steel Partners have changed since they jointly tried to bag Fox & Hounds, the 84-unit pub operator. At the time, Fox & Hounds had already endorsed a stock-tender offer from Levine Leichtman for $14 a share. Newcastle and Steel, both shareholders in Fox & Hound, formed a company called F&H Acquisition and bid $14.75, then, inexplicably, lowered it to $14.50.

Levine countered with a higher offer. F&H, in a move that defied reason, merely matched it.

At the time, lots of onlookers scratched their heads in bewilderment. In an auction, why merely match what the other guy is offering? Then F&H raised its bid again, by 25 cents. An apparent lapse seemed to be nothing more than that.

Levine had to hike its offer yet again, to $16. And Fox & Hounds accepted the offer yet again. As of this moment, it appears that Levine will end up with the company. Of course, it’ll have to pick up the administrative, transactional and legal expenses involved in buying all of the chain’s stock. But it could build up the value of the company and divest it at a later date, for a big kill.

Contrast that with the immediate benefits afforded Newcastle and Steel. If they sold their collective holdings today to Levine, they’d take in some $20 million more for their 10 million shares than they would have if Levine’s initial bid had gone unchallenged.

And that’s if they sold today. If Levine wants to buy all of Fox & Hound’s shares outstanding, and Newcastle and Steel control 10 million shares, or roughly 8.3% of the stock, they presumably have some bargaining flex.

In hindsight, F&H Acquisition may have matched rather than topped one of Levine’s intermediary bids to send shareholders a signal: Stay tuned. Don’t sell out. Maybe we’ll be back with a better offer.

Even after Levine’s $16-a-share deal was accepted, shares were trading above that level, suggesting that some stockholders expect a sweetened offer from F&H. Maybe, maybe not. In any case, the more the price creeps, the more pressure Levine will feel to raise its bid, and the more Newcastle and Steel stand to make.

Perception or anticipation could similarly prove a boon to Pershing Square Capital Management, the hedge fund that wants McDonald’s to spin off a share of its company-run restaurants. On Wednesday, when managing partner Bill Ackman revealed a new plan for the restructuring, he projected that the proposal could boost McDonald’s share price to $50, a 51% pole-vault from the current level.

Pershing controls 4.5% of McDonald’s stock. Whether or not its plan is ever enacted or even accepted, the fund would benefit handsomely if a critical mass of investors merely believed it might be.

Unfortunately, that expectation hasn’t yet materialized; McDonald’s shares have increased by a few cents, not by double digits.

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