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Platinum Equity’s Purchase of Covad

By The Prince ⋅ January 16, 2008 ⋅  Email This Post ⋅  Print This Post ⋅ Post a comment

This was a buyout related trade that I was originally turned onto by The Intelligent Speculator.  Here is some background on Covad and The Prince’s rationale for why this makes sense as a 6 month trade.  This is basically a merger arbitrage opportunity without a public acquirer which could generate a pretty sizable return over the next six months.  This is a small acquisition that is probably flying under the radar of many merger arbitrage teams since Covad’s market capitaliztion is around $244Mn.

 
In October 2007, Platinum Equity (a respected Los Angeles PE shop) agreed to buy Covad (DVW) for $304 million in cash, or $1.02 a share.  This deal’s rationale for Platinum was an attempt to capitalize on growth in high-bandwidth services.  Covad agreed to a $12 million termination fee, amounting to 3.95% percent of the equity value of the transaction.  Covad sells voice and data systems to companies.  This includes Voice over IP services and high broadband connections like T1 connections in major U.S. cities.
Covad currently trades at $0.83 and the deal is expected to close at the end of the 2nd quarter of 2008.  If you do the math that is a roughly 23% return in six months if the deal closes as planned. This deal is so small that it will not be hurt by the lack of credit financing.  Platinum could do this deal solely with its own equity. 

The Prince can identify a few risks already that the deal may not close.  The deal has not been voted on by shareholders and there is a  shareholder lawsuit  claiming $1.02 is too low an offer.  However, if the deal fails because of the lawsuit then $1.02 should prove to be a floor for the stock price in the near term.   Covad emerged from bankruptcy in 2001 and made deals with SBC and Earthlink which carried obligations coming due in 2008-2009.  Covad has been issuing shares to pay these obligations so know Earthlink owns 30% of Covad and SBC owns 5%.  It would seem that Earthlink and SBC must approve the deal for it to go through and they are not part of shareholder suit.  Of course, SBC or Earthlink could come forward with a higher offer for the entire company.

 
Also, aside from the merger arbitrage play there is the possibility that another higher bidder will emerge.   If you read the 144 Proxy see that there were 4 other strategic buyers that made offers and some these offers were above $1.02.  According to the proxy, these bidders wanted more time to evaluate the books before signing an official term sheet.  The deal with Platinum might be a way for Covad to start the bidding at 1.02 rather than announce they are “exploring strategic alternatives”.  This puts pressure on strategics to come forward with serious deals that are superior to the $1.02 all cash offer.  Rumors say that the strategics are ATT, DirecTV, Earthlink and Qwest.

Here are some links that may answer my readers questions.  You can find the 144 Proxy through 10-K Wizard or the SEC’s Edgar system.

http://www.covad.com/web/about/faq.html
http://www.covad.com/web/about/newsroom/pressroom/pr_2007/news_release_102907.pdf
http://www.platinumequity.com/site/action/aboutplatinum/

The Prince doesn’t see much downside for this trade.  If the deal doesn’t close because of a shareholder lawsuit he believes another buyer will emerge with the $1.02 all cash offer serving as a floor for a new bid.