Thursday, April 22, 2010

Qwest being acquired for an unpleasantly small premium...but there's no rush for us to sell (Q, CTL)

AlphaNinja readers who bought Qwest shares with me on my January 7th recommendation should not be in a rush to sell this morning, on news that CenturyTel has acquired the company in an all-stock "merger."

We bought shares because Qwest was rapidly improving its balance sheet, and it was trading a fat & juicy Free Cash Flow Yield(FCFY). Today it's being acquired on the cheap, but there are details to like. For instance, the deal is all in CenturyTel stock, so their bargain-basement purchase can be out upside in a combined entity. I usually rant and scream about companies selling too low, but if we're going to be 49.5% owners of the company doing the pillaging, they hey why not?

As of this morning, Qwest shares are up 4.3% today, and up 19% since I recommended them. That's more than four times the market's rise over the same period, but still of little comfort considering where I think fair value is. But with this being an all-stock transaction, we can hold onto shares of the combined company and participate in the upside.

There remains 8.4% "deal-risk" premium, as the street might be a bit worried about this deal being pulled off. Have at it, arbitragers...

From this morning's release:

MONROE, La. and DENVER, April 22 /PRNewswire-FirstCall/ -- CenturyLink (CenturyTel, Inc., NYSE: CTL) and Qwest Communications (NYSE:Q - News) announced today that their boards of directors have approved a definitive agreement under which CenturyLink will acquire Qwest in a tax-free, stock-for-stock transaction. Under the terms of the agreement, Qwest shareholders will receive 0.1664 CenturyLink shares for each share of Qwest common stock they own at closing. Upon closing of the transaction, CenturyLink shareholders are expected to own approximately 50.5 percent and Qwest shareholders are expected to own approximately 49.5 percent of the combined company.
Based on the closing stock price of CenturyLink on April 21, 2010, the per share consideration to be received by Qwest shareholders would be equivalent to $6.02 of CenturyLink stock, which represents a premium to Qwest shareholders of approximately 15 percent over Qwest's closing stock price on April 21, 2010.
The next section shows why you KNOW Qwest sold too low...because it's immediately Free Cash Flow positive...
The parties expect the transaction to be accretive to CenturyLink's free cash flow per share, excluding integration costs, immediately following the close of the transaction. Leveraging CenturyLink's proven integration experience, the transaction is expected to generate annual operating and capital synergies of approximately $625 million when fully recognized over a three- to five-year period following the close of the transaction.
That said, comments from Qwest point out the positives for us:
Edward A. Mueller, Qwest's chairman and chief executive officer, said, "Over the last several years, Qwest has been focused on generating sustainable free cash flow and strengthening the balance sheet, as well as creating innovative approaches to drive efficiency and perfect the customer experience. We are pleased with the progress we have made and believe that the combined company will be well positioned to win in an increasingly competitive marketplace.
"This transaction is compelling for our shareholders, who will benefit from an immediate premium for their shares, an increase of approximately 50 percent in the annual dividend, and the opportunity to participate in the upside potential of the combined company through their ownership of CenturyLink stock. We look forward to becoming part of a larger company with a strong financial profile, an industry-leading local and national network, and a shared commitment to customers, employees, communities and shareholders. We also look forward to maintaining a key presence in Denver."
And important details about the dividend policy, as our dividend gets fatter:
Each company plans to continue its current dividend policy until the close of the transaction. Post closing, CenturyLink expects to continue its current dividend for shareholders of the combined company, subject to Board approval. CenturyLink currently pays an annual dividend of $2.90 per share, which, on an as-converted basis, represents an approximately 50 percent dividend increase for Qwest shareholders.
No rush at ALL to sell here. Either the price gets nudged up, or we keep our shares in the combined entity, which is a still-juicy 17% Free Cash Flow Yield, even before any costs are pulled out of the business. NO new debt is involved here, so if anything the financial profile improves.
For more details on the transaction, see the deal presentation.
And don't worry, our friends are on the scene! The ambulance chasers of the securities industry, with their automated lawsuit robo-blasters...employing all the due diligence of a five year old....

Levi & Korsinsky, LLP Investigates Possible Breach of Fiduciary Duty by the Board of Qwest Communications International Inc. - Q

The investigation concerns whether the Qwest Board of Directors breached their fiduciary duties to Qwest stockholders by failing to adequately shop the Company before entering into this transaction and whether CenturyTel is underpaying for Qwest shares, thus unlawfully harming Qwest stockholders. In particular, at least one analyst has set a price target for Qwest stock at $6.50 per share and the Qwest board has agreed to a strict no solicitation provision and a termination fee of $350 million to be paid to CenturyTel, under certain circumstances.

Copyright 2010 AlphaNinja


  1. I love essentially all your articles, but I'd like to point out the premium (for any arbitrageurs) is less, considering CenturyTel's dividend yield is a good amount higher than Qwest.. and because CenturyTel (as expected of an acquirer, especially in a stock swap) is down today versus yesterday and Qwest is up (otherwise this deal would just be seen as plain BAD), that only increases the negative spread between the two companies' dividend yields. So an arbitrageur would be experiencing negative cash flows on the dividend side of the equation which probably makes it unattractive (and somewhat unlikely) to push the prices too much closer together.. kind of like the old college exercise of forward currency conversions.

    As for me, the deal certainly puts Qwest back on my radar and I'd be interested in any price declines.

    Experience says if the price of the company being acquired falls low enough, usually the deal would have to be renegotiated at better terms, deal might be rejected by stockholders, or a rival bidder may emerge.. all of which happened when CVS was buying Caremark in 2006.. as Caremark falling to $40 a share during the initial phase just shouted bargain. :)

  2. Good point about the dividend yield, David. ARB's might be looking at the difference between the two yields, as well as the expected time until closing, as it might not be a full year, etc. The decline in CTL is reflected in the remaining premium I cited. The CVS deal was part cash, while this one isn't. As a harsh critic of undervalued deals, I'm still comforted that Q shareholders can participate in the upside of the attractive price paid...