Taking short-term views to make quick money on the stock market is fraught with danger. As Warren Buffett once said, "our favourite holding period is forever" and so it's best to avoid investing in stocks on a myopic basis.
Accordingly, the current arbitrage opportunity in Cardno Limited (ASX: CDD) makes for one windfall gain that may be hard to refuse for some, although it's probably sensible to take Buffett's advice and stay away.
The mining industry
A slowdown in Australia's decade long mining boom has crippled earnings within the industry, with a host of mining service providers like Monadelphous Group Limited (ASX: MND), UGL Limited (ASX: UGL) and Worleyparsons Limited (ASX: WOR) trading near all-time lows.
Cardno has not escaped the fallout, with its share price following its fortunes down over 60% from an all-time high of $8.24 in 2012. Its decline in value has sent private equity vultures circling with Crescent Capital being the latest predator to lob a proportional takeover offer for the engineering, construction and mining services provider.
The takeover offer
Yesterday, the Cardno board received an unconditional revised takeover offer to buy 50% of all shares (Crescent Capital does not already own) in Cardno for $3.45. This was an increase from its previous offer of $3.15 which the board had rejected.
The Board has recommended that shareholders' decisions as to whether to accept the increased Offer are finely balanced and depend on the circumstances, investment time horizon and risk tolerance of individual shareholders.
The company specialises in delivering housing and infrastructure to mining sites as well as providing feasibility studies, materials testing and project management services to large scale projects. In its most recent financial results, the company reported a fall in net profit of 27%, despite increasing revenue by almost 8%.
The results demonstrate the tough conditions within the mining sector, indicating the wisest course to take is to stay away from the industry as there may be more pain to come. Accordingly, Cardno is not, in my opinion, a long-term buy at present time.
The arbitrage opportunity
In spite of this, an arbitrage opportunity has presented itself in the interim. Crescent Capital has made an offer to buy 1 for every 2 shares owned by shareholders at $3.45. The bidder's statement specifies that pursuant to ASIC Class Order 13/521, "if accepting the Offer would leave you with less than a marketable parcel of Cardno shares, the Offer will extend to all of your shares". The ASX defines a marketable parcel of shares as $500 (based on market price).
Therefore, despite the offer being for 50% of shares, Crescent Capital would need to acquire all shares if the proportional offer resulted in the shareholder holding less than $500 worth after the takeover. The same rule applied when CIMIC Group Limited (formerly Leighton Holdings Limited) (ASX: CIM) received its proportional takeover offer from Hochtief AG two years ago.
Based on the maximum theoretical ex-takeover price of $3.44, purchasing 288 Cardno shares would result in Crescent Capital acquiring all 288 shares (not just 50%). Of course, if Cardno traded above $3.45 (leaving shareholders with a parcel of more than $500 at the end of the offer period), Crescent Capital would not be compelled to acquire all of the shares; simply 50% per the offer. If the latter occurs, it would be prudent to sell the remaining 50% on-market and book the gain yourself making the scenario a sensible play assuming the takeover proceeds.
The reason shares are likely to trade below the theoretical ex-takeover price in proportional takeovers is because the offer is not for all the shares. Instead, it's proportional meaning the big end of town is not incentivised to bid up to the takeover price as they will continue to hold a stake in the company.
The difference between today's Cardno price and the takeover offer of $3.45 is the risk being priced in for continuing to hold 50% of it. This difference demonstrates how risky the market perceives the company to be.
Foolish takeaway
For all its simplicity, the maximum gain that can be made under the arbitrage opportunity is $118.08 (at current prices, before trading costs). For some, that won't be worth the effort; but for many, that return makes it reason enough to participate.
The key to Foolish investing is staying the course for the long term; not just short-term gains. With Cardno about to be majority controlled by a private equity group, it appears best to stay away from the company as the outcome may result in unfavourable changes for the minority shareholder.
