Steel maker and iron ore miner Arrium (ASX: ARI), formerly known as OneSteel, is on the defence after receiving a takeover offer priced at 75 cents a share from a consortium of Asia domiciled companies.
Arrium's steel business is suffering from the same issues as those faced by Bluescope Steel (ASX:BSL) — a high Australian dollar, which reduces competitiveness, and soft construction demand. In response to the takeover offer, CEO Geoff Plummer focussed on highlighting the prized iron ore assets of Arrium and noting that the iron ore spot price is back above $100 a tonne.
More importantly, Plummer believes that the long-term pricing outlook for iron ore is strong — a view shared by the management team at Fortescue Metals Group (ASX: FMG). This is critical to determining the value of Arrium, as it is currently bringing a substantial increase in iron ore production capacity on line.
While the market is breaking its 52-week high, there are many companies touching their 52-week lows. When a suitor comes knocking under these conditions, as is the case for Arrium and for TPG's recent proposal for surf retailer Billabong (ASX: BBG), it always puts management in an awkward position. Ironically, it can be harder for management to outright reject a low-ball offer than a fully priced one. A look back to the rejection of offers such as the 2007 $5.45 private equity offer for Qantas (ASX: QAN), shows how management can react to a generously priced offer.
Foolish takeaway
With the share price of Arrium continuing to rally on the expectation of a higher offer, some Fools may be considering buying into Arrium. This type of investment is known as take-over arbitrage — although some would call it speculation.
Takeover arbitrage is when an investor purchases a stock below the offer price on the expectation that the takeover will proceed and boost the share price. Buying the shares above the offer price on the expectation that not only will the takeover proceed, but that it occurs at a higher offer price adds an extra layer of complexity and requires even greater care.
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Motley Fool contributor Tim McArthur owns shares in Billabong. The Motley Fool's purpose is to help the world invest, better. Take Stock is The Motley Fool's free investing newsletter. Packed with stock ideas and investing advice, it is essential reading for anyone looking to build and grow their wealth in the years ahead. Click here now to request your free subscription. This article contains general investment advice only (under AFSL 400691). Authorised by Bruce Jackson.
