Arbitrage opportunities at Star Maritime?

Star Maritime (SEA) is a "blank check" company that seems to offer an interesting "risk free" opportunities that I liken almost to an arbitrage. "Blank check" companies are interesting vehicles that have gained a bit of popularity recently. A blank check company is created through an IPO to raise funds for a management team to search for a potential acquisition. The IPO investors receuve not only shares, but typically also warrants that are exercisable if the acquisition is approved. The shareholders also receive some interesting security. Their funds are held in trust, and management is given only a limited time to find an acquisition. If they don't find one by their deadline, or can't get their choice approved by shareholders, the company is forcibly liquidated and the common shareholders get all the trust cash plus interest returned to them. Even if the deal is approved, the company has to buy back the shares of any dissenting shareholders at a redemption price.

And in the case of SEA, the normal blank check arrangement is even more advantageous to shareholders. SEA sold 20M units in it's IPO (a unit being one share and one warrant exercisable at $8) for $10 per unit. But management bought over 1M units at a cost of over $10M, and have agreed to forfeit those shares if the acquisition is not approved (and the underwriters also have to forfeit their fees). And management only has until the end of June to get a deal approved. So how much would a common shareholder receive in a liquidation scenario?

There are two slightly different scenarios, the first is if the acquisition is voted down, all common shareholders (except management) receive the trust proceeds. The second is the deal goes through but you elect to redeem your shares. Let's start with the first.

As of Sept. 30th, there is 192.7M in trust, and by my calculations, 18.9M shares eligible for distributions, or $10.22. The trust is netting about .34% in quarterly interest after tax/expenses, so on July 1st the distribution should be around $10.32.

In the second scenario, you have the right even in an successful vote to redeem your shares for $9.80 (the $10 minus underwriters fees) plus interest, basically a 20 cent per share difference from liquidation. So I estimate a value of about $10.12 on July 1.

SEA announced their deal this week. The common didn't move, it's been trading around $9.90, so essentially you can get either a 2.2% gain if your shares are redeemed ( 5.1% annualized) or if the deal is voted down, you'll get a 4.2% gain (9.9% annualized). Doesn't sound like much does it? But these gains are essentially risk free, so it looks like SEA is offering you a money market rate in the worst case scenario, with a kicker that doubles your returns if the deal is voted down. And if you can get the shares cheaper (I think they may have hit $9.85 briefly on Friday) returns are even better.

But wait, there is still more upside to the common! By holding common shares you get a free "call option" on any price increase in the common until the deal is voted on. For example, if SEA trades at $11 next week, you can sell and reap some nice short term profits. If it drops to $8, you simply wait until redemption to get $10+. You keep all upside, with no downside!

Now the negatives. I'm not super impressed with the deal and so far neither is the market, but there is still plenty of time left until a vote happens where you might be able to profit from upswings in the price. We have the risk that management files for an extension and doesn't get a vote done until late this year or early next. If that happens your annualized returns in these scenarios decline, though interest continues to accumulate and you get a longer "call option" for any possible price spike.

I've been told that 90% of these blank check deals end up getting approved. I don't know how true that is, it sounds extraordinary because the typical deal requires 80%+ shareholder approval. And SEA is a bit special, they only need 67% shareholder approval, but it still sounds like a difficult hill to climb.

So I can imagine what some of you are thinking right now. "Okay, Randy, sounds like an interesting set of circumstances, but the returns aren't that great. I'm a swing for the fences guy, willing to take big risks for big rewards. What have you got for me?".

Okay, you want some real upside mixed with some real danger? Look at warrants, SEA+ (SEA-WT on Yahoo). They are trading around $1.40 (unfortunately up 20 cents over the previous two days). These warrants have a strike price of $8, so they should be worth $1.90 or more. But they aren't there yet due to two factors, first that the warrants will be worthless if the deal is voted down, and even if the deal is approved the stock may decline sharply afterwards. IIf this deal is approved, the warrants should be worth more than the stock price minus $8, because they are essentially very long term (2.5 years) call options. The value of this long life span means that if the deal is approved they should trade substantially above the price imputed by the stock price. For example, if the common trades at $10 post deal, I would not be surprised to see the warrants trade above $2.50. Their only downside is the warrant's maximum value is capped around the mid six dollar range, as the company has a buyback right when the stock price trades above $14.25 for 20 out of 30 days.

And this isn't an investment you can take a large direct position. So this is where the "arbitrage" came into play. To reduce risk, I bought the common in a ratio with the warrants, so if the deal is voted down I would make a little money on the common to offset the warrants going to zero. And if the deal is approved, I win on both.

Unfortunately I bought my warrants at 80 cents pre-deal, but sold them at $1.20 as soon as the deal was announced because I didn't really think through how valuable the long term call the warrants provided was. As usual, the price you pay will determine your long term return, so getting either the common or warrants cheaply will definitely make these opportunities more attractive. Right now I own only the common, and won't buy more warrants unless they drop back below $1.20, but you need to make your own determination of what you think a reasonable entry point would be.