A bit more about the Safeway merger arb

One of the great things about running a blog is that you almost always receive useful feedback on your idea’s. My write-up on Safeway was for example lacking a bit in the valuation of the Casa Ley stake, but the spreadsheet shared by “rowerburn” corrects this omission. Since the SEC filings of Safeway only provide information on the earnings and the book value of their Casa Ley stake an in-depth valuation is impossible, but it is enough for a rough ballpark figure:

Casa Ley valuation

I think that the company will be liable for taxes when their stake is sold for more than book value ($0.89/share) so that would slightly reduce the value of the CVRs if it is sold at an earnings multiple above 17.5x. Since that seems to be pretty high I think that is going to be unlikely and that taxes aren’t a major concern. If Casa Ley is sold for $0.75/share the annualized IRR will be 28.7% if it takes the full three years to sell their stake:

IRR sensitivity analysis

Of course, when it takes longer to sell Casa Ley the business has more time to grow and generate earnings. So perhaps we should expect a higher value the longer a sale takes. On the other hand, that would probably mean that there is little interest in their Casa Ley stake. But since CVR holders will receive fair value as determined by an international investment bank if Casa Ley isn’t sold before the deadline that might not be a problem?

Disclosure

Long Safeway

19 thoughts on “A bit more about the Safeway merger arb

  1. Mike Smith

    If we buy Safeway now, and get the $32 and change in cash when the takeover closes, wouldn’t we be taxed short-term capital gains on the cash proceeds? This would amount to ~$10/share in taxes for many people.

    Reply
    1. Alpha Vulture Post author

      If you have to pay ST capital gains taxes the trade is obviously less profitable, but I think you only pay those taxes on gains and not the value of the position? But I’m not paying capital gains taxes, so don’t really care how it works in the US 🙂

      Reply
      1. DavidR

        You are lucky not to pay CG taxes. Where are you such that you don’t have to pay such taxes? I am very jealous.

        Reply
        1. Alpha Vulture Post author

          I’m Dutch and we don’t have capital gains taxes. We do have a 1.2% tax annually on the value of investments and savings though, so it depends on the returns that you realize and how often you trade how this compares with a capital gains tax.

          Think the 1.2% annual tax is pretty good idea though just because it is so much easier than keeping track of ST and LT gains, the tax basis of different lots of shares etc. Now you only need to know the value of your portfolio at the start of the year. Also doesn’t hurt that the 1.2% tax gets better the higher your annual returns are :).

          Reply
    2. DavidR

      The basis (your cost of the current SWY shares) will be divided in some way between the CVRs and the rest. The $32 and change in cash is not a S-T profit so you are not going to be taxed on that. You will be taxed on the difference between the $32+ and the basis of what you have sold. Whenever you are distributed cash you will then have to pay taxes on the difference between whatever you got and its basis.

      Reply
  2. Tom

    I’m far from a tax expert, but I think if you buy SWY now for about $0.20 greater than the proceeds you are going to receive during the current tax year you are probably going to record a small taxable loss in the current year. If the CVR pays out later, you will be probably incur a long term capital gain.

    For what its worth, I’m not holding it in a taxable account.

    Reply
  3. Adam

    What happens if we purchase today and the merger closes on Monday. Will the CVRs be given to us even though the shares haven’t settled? The owner on record would still be the previous shareholder.

    Reply
    1. Alpha Vulture Post author

      I think you would still get the CVRs. Not sure about the exact mechanics though. It could be that they pay the merger consideration and the CVRs after all trades have settled (It always takes at least a couple of days to get the cash when a merger closes) or it could be that the shares trade together with the right to receive the CVRs (just like what happens with other special corporate actions such as big dividends).

      Reply
  4. BG

    Gents – I’m just curious if anyone knows how the Casa Ley CVR would be treated if the holdco which will own Safeway goes bankrupt. This isn’t a far-fetched scenario as S&P has already downgraded Safeway’s bonds to junk status (below BB).

    Reply
  5. Josh

    The FTC cleared the SWY merger on 1/27 after the market close. Are people still worried about closing? I was surprised that there wasn’t any increase in price on the 28th or today. Once I thought closing was a 100% sure ting, I added to my position in SWY as much as I could.

    My portfolio is over 25% and if it wasn’t for some illiquid positions and tax considerations, I would have put 100% of my portfolio into it. What am I missing? Or is the talk based on before FTC approval?

    Reply
    1. Alpha Vulture Post author

      I don’t think anyone needs to worry about closing anymore. Perhaps the muted market reaction is the result of index funds selling SWY since it is removed from the S&P 500. Or perhaps the Casa Ley stake isn’t as valuable as we think!

      Reply
  6. Brian

    I was short Safeway and now it shows i’m short both the LEY and PDC CVR, can anyone help me figure out what I have to do? I know I need to pay 34.92 but the impact on these shorts?

    Reply
  7. Brian

    I was short the time the merger was passed unknowingly, I understand to pay the 34.92 but what happens to the CVRs?

    Reply

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