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Island Investing

Riffs, rants, and the upside of investing from way off Wall Street


Spillover from Twitter on $FCEC

Quick note: the below will probably make little sense to most readers, but I wanted to put some more thoughts down for a couple of guys on Twitter…and it’ll take longer than 140 characters to do it. It deals with evaluating a potential merger arbitrage investment among a couple of small banks in Pennsylvania. I passed on investing in it in Tarpon, and below is why.

Adam and Plan,

Here’s where I’m coming from on that last tweet about FCEC’s exchange ratio in the merger with Tower:

Net charge-offs for the six month period ended June 30, 2010 for FCEC were $2.3 million, and during the fourth quarter of 2009, net charge-offs were $16.6 million, which were obviously huge. So right now…

$16.6M plus $2.3M plus whatever charge-offs will be through August (assuming this is the month prior to the transaction closing) puts the cumulative net charge-offs at around $19M to $20M, ballpark. Add that to Delinquent Loans of $57M (Total NPAs from Q2 ‘10) and you get at least $77M as the Value for Charge-offs Post 9/30/09…and if you plug that in as per the line-item in slide 5 here, you get the adjusted exchange ratio. Based on that math, the ultimate ratio could be considerably lower than the market appeared to expect – at least up until yesterday.

I say that because with an exchange ratio of 0.291 multiplied by a recent TOBC price of $18.70, FCEC investors will only effectively get $5.44 in deal value per share. Until the big drop in FCEC yesterday, shares were priced well above this expected closing price. So perhaps someone else was doing the same math I was late Wednesday night – though now the gap seems to be narrowing as I type.

In any case, I may have missed something in the above, as I did not review every filing after the initial agreement. Did not talk to the management teams, either, though the deal at first glance seems highly probably to go through. I suspect perhaps because both stocks are so thinly traded the values have been out of whack…but as is, unless FCEC continues to drop and/or TOBC spikes, I’m passing. At least on the merger arb angle. Tower is probably worth a closer look post-merger, regardless.

Would appreciate any other insights you might have.