Cerberus deals come undone

The death of private equity deals has lead to some interesting events. Cerberus Capital is failing the pain of the fallout in a big way. The private equity firm is headlined in all sort of tangled mess from the its buyout deals:

• It is being sued by United rentals for failing to complete their buyout.
  
• GMAC the financial arm of GM lost $2.3 billion last quarter
• Sale of its $4 billion debt for the Chrysler deal is postponed and may face price drop.

The firm is also a part of group to buy BCE Inc, a Canadian telecom provider, in one of the largest buyouts this summer. The BCE buyout is expected to close late in the first quarter of 2008. Earlier this year Cerberus along with the Ontario teachers fund offered C$34.8billion to BCE shareholders to take the company private; it offered C$42.75 per share. The firm has been definitely busy this summer. Can the BCE deal go in the way of United rentals? Will Cerberus Capital walk away here also?

maybe the best way is to look at what the price of BCE is telling us.

An arbitrage opportunity exist in the buyout but the professional arbitrageurs have not exploited it yet due to the inherent risk of financing such a huge deal. Can the investor group raise that enormous debt levels to complete the deal? Is the arbitrage opportunity worth the risk? Lets look at the probabilities:

1. Complete deal @ $42.75 (Probability 85% ) give an expected payoff 9.19% (42.75 less 39.82 (current price) + Dividends: 2 payouts@ $.365)
2. Abandon deal (probability 15%) give an expected loss of -22.8% (share will fall to its pre offer price level of $30+ Dividends)
3. The expected payoff is 4.38% expected pay off
   

I am assigning a 15% that this deal will not go forward and here is my rationale: The probability of completing the buyouts stand better chance than the United rental deal. Cerberus have the deep pocketed teachers fund on its side as well as host of other institutional investors like Merill Lynch. The deal cleared all regulatory hurdles and shareholders approved the merger. But there the pesky bond holders who do not like the deal as their bonds have fallen off from grace (they can hold to maturity!). Those will not pose any material challenge to the deal going forward. What will pose a challenge is the credit market and that is where arbitrageurs have not piled into this opportunity.

This is a very optimistic scenario given the problems in the credit market and the troubles Cerberus is having floating its Chrysler deal. many would have assigned a much higher probability for the deal to fall apart, which is plausible. since the credit crunch many deals have came undone and this will persist with the worsen credit market. But I am an optimistic kind of person.

With a payoff of the BCE arbitrage play at 4.3%, I would rather buy a 90 day TB thank you very much!