Seven Corners Reiterates Buy Rating on the Genworth Financial (GNW) / China Oceanwide Merger Arbitra
Today Seven Corners Capital Management reiterated its "BUY" rating on the Genworth Financial (GNW) / China Oceanwide Merger Arbitrage. Specifically, we are long GNW, believing that the most recent closing price of $3.30/share presents an attractive 49% return to the expected value of $4.93/share. Our thesis on the Genworth arbitrage is summarized as follows [NOTE: To find a PDF containing our full updated GNW writeup, please visit our Research section [link here]]:
The buyout of Genworth Financial Inc. (NYSE: GNW) has been, to say the least, under a cloud of doubt recently. The stock last traded at $3.30/share on January 30th versus the $5.43/share cash buyout price agreed to with China Oceanwide last October. As the parties as recently as last week reiterated that they expect the deal to close in mid-2017, this means that an arbitrageur buying the stock at the current price stands to gain $2.13/share before taxes, or 65%, in about 6 months if the deal closes as expected.
As more fully set forth in the writeup posted under the Research tab on our website (see link above), we have reached the following conclusions regarding the arbitrage:
(1) The large arbitrage spread is mainly attributable to fears regarding the regulatory risk that the merger could be blocked, the perceived risk that China Oceanwide could attempt to renege on its agreement to acquire Genworth for $5.43/share and the potential for further substantial reserve increases when Genworth announces its Q4 2016 financial results on February 7, 2017. However, we believe these fears are largely unfounded. First, both China Oceanwide and Genworth's regulators are incentivized to see the transaction close on its originally agreed terms (as are, obviously, Genworth's shareholders, given the current market value assigned to the company's shares). Second, while Chinese regulatory approval is admittedly a wild card, we incorporate this uncertainty into our 75% percentage estimate that the merger is consummated as scheduled. Finally, based on the disclosures in the definitive merger proxy statement and Genworth's prior earnings releases for Q1 through Q3 of 2016, we do not expect a massive reserve hit to occur in connection with the release of Q4 2016 financials, such that China Oceanwide would be entitled to terminate the merger without the payment of a termination fee (and for that matter, due to the timing of Genworth's annual reserve reviews, neither do we expect this to occur with respect to financial results for Q1 or Q2 2017).
(2) There has been considerable misinformation in the marketplace recently regarding the transaction, namely that China Oceanwide could unilaterally cut the merger price by $2/share and/or that Genworth's financial position is hopeless if the China Oceanwide deal fails to close. None of these arguments, which have obviously taken a recent toll on the share price over the past week or two, hold up to closer scrutiny, as we explain further below. In fact, despite the arguments of the bears, Genworth's future prospects have actually brightened considerably since the announcement of the merger, mainly due to the substantial increase in long-term interest rates following the U.S. presidential election last November.
(3) We estimate that Genworth's current Expected Value (or EV) is $4.93/share, or 49% above the closing stock price of $3.30/share on January 30, 2017. Importantly, this estimate incorporates a 25% probability that the deal does not close, due to the risks we describe herein. However, even if one were to increase this to a 50% probability of not closing, our EV for Genworth would only fall to $4.43/share, still 34% above the most recent share price. In effect, we believe that at current levels a buyer of Genworth stock has relatively minimal downside risk but considerable upside potential, presenting quite a favorable risk/reward calculus for such a purchase.
Again, please visit our Research section on our website to obtain our full updated report on Genworth shares (GNW). Thanks again for reading.