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News recently broke that Public Storage (NYSE:PSA) is launching a hostile takeover bid for competitor Life Storage (NYSE:LSI). The deal is a throwback to the 1980s when hostile takeovers by corporate raiders were about 10x as common as today. The rise of the hostile takeover was among the wilder innovations in the history of finance. Activist investors like Carl Icahn used their battering rams on management teams that were perceived as bloated, making billions of dollars in the process. The practice helped inspire the 1987 movie Wall Street, where young Bud Fox (played by Charlie Sheen) plays a stockbroker who gets in too deep with corporate raider Gordon Gekko (played by Michael Douglas).
Even before the rise of the hostile takeover, merger arbitrage became a parallel force in finance, with clever early arbitrage adopters like Warren Buffett and Ed Thorp earning 20% or higher rates of return from buying shares in companies and waiting for acquisitions to close. However, for reasons I will get into, I think this deal belongs in the past, along with boomboxes and neon tracksuits.
Hostile Takeovers Are Rare For Good Reasons
Hostile takeovers aren’t as common as they used to be, although they still happen occasionally, most famously with Elon Musk’s (initially) hostile bid for Twitter (TWTR). More recently JetBlue (JBLU) made a high-profile offer for Spirit Airlines (SAVE) while Spirit was already “engaged” to Frontier Group (ULCC). JetBlue won after a long soap opera, but since the company was already in play, the hostile takeover made more sense for SAVE shareholders. This deal has a few oddities that make it not like the others. My takes:
Strike 1: If this is intended to be Public Storage’s final offer, the deal is offering below-average compensation compared with the typical successful merger. Long-running studies show an average merger premium of about 30%, while this deal is about half of that. Hostile takeovers, by their very nature, tend to have higher premiums than friendly deals. They’re also less likely to close.
Strike 2: This is a stock deal, so LSI shareholders are forced to deal with the price risk of the broader market. In traditional cash mergers, the acquiring company bears the risk of the market declining. Why wouldn’t PSA offer cash here? I don’t know why, but I would want to know if I were a large shareholder. Potentially adding insult to injury, the deal is currently structured as taxable, in contrast to typical stock deals that usually are non-taxable!
Strike 3: Naked hostile takeovers (with no other bidders) rarely make sense anymore. Back in the 1980s, part of why hostile takeovers were so common was that there was ridiculously low-hanging fruit for corporate raiders. For example, it wasn’t uncommon for companies to have overfunded pensions, so corporate raiders could buy target companies and pocket the excess pension funding. Similarly, merger arbitrage didn’t have nearly the amount of competition in those days, which allowed outsized profits to intelligent investors who understood it. Legal defenses to hostile takeovers are much better than they were in the old days, so companies that don’t want to sell now have better options such as poison pills than they did decades ago. I don’t think this deal is any different. The engine that makes roll-up M&A work is combining back office functions and gaining economies of scale. Hostile takeovers tend to require too large of takeover premiums to justify their use for this kind of acquisition. Extra Space Storage (EXR) and National Storage (NSA) have done a better long-run job of compounding investor capital than LSI and PSA, so I’d favor those instead. PSA and LSI are very similar, both trade for about 20x FFO with very similar business models.
Strike 4: You don’t get 4 strikes in baseball, so let’s say one of our previous ones was just a foul ball. Anyway, my view is that the DOJ is likely to block this deal. Big self-storage companies tend to use algorithms to price units, which has led to allegations of collusion and other anticompetitive behavior. Storage companies are also dealing with vulnerable sections of society with families of the deceased, divorcees, students, etc. The deal would give PSA about 15% market share over self-storage in the United States, and a much higher percentage in certain markets. Similar lawsuits have been launched against large residential landlords and Las Vegas hotels, and those are likely to win. Biden’s people are going to look at this and ask how this deal is good for consumers. I’ve driven by LSI locations that are a block or two away from PSA locations, so are the companies going to close some? Maybe. Are they going to rebrand and coordinate pricing? Likely. This is too easy to politicize and too hard to defend from an antitrust perspective for it to be worth trying, in my opinion. I could be wrong, but again, this is a strange deal all around.
Merger Arb Rule #1: Don’t Lose Money
Hostile deals fail at roughly 6x the rate of friendly deals. LSI stock is up big off of the deal news, but long-running research shows that deals like these have rather high failure rates. There are a number of ways this could play out going forward. Public Storage could raise its bid, in which case the deal goes friendly and it’s more likely to close. Even then, Biden’s antitrust people could still block the deal. Alternatively, Life Storage may adopt poison pill measures that kill the deal before it even gets there.
If you want to dabble in merger arbitrage, sticking with friendly deals helps you obey rule #1-avoiding losses. Merger arb is still a nice strategy in certain cases, but your success depends in part on your ability to avoid overcooked deals. While Public Storage could sweeten its offer, I’d sell LSI here if I owned it. Several points about this deal are currently unattractive from a merger arbitrage standpoint. Without a switch to a cash deal and a higher offer, I’d avoid this situation and sell LSI while it’s high.
Share ratings
LSI – Sell
PSA – Hold
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