DRS buyout advances; Aladdin says 'no' to Vector; Freddie, Fannie surge continues for fourth day

By Paul Deckelman

New York, Aug. 28 - The planned acquisition of U.S. defense contractor DRS Technologies Inc. by Italy's Finmeccanica SpA moved one step closer to fruition on Thursday, as federal anti-trust regulators cleared the deal. However, the transaction must satisfy other regulatory conditions and be okayed by DRS shareholders.

Aladdin Knowledge Systems Ltd. declined to give an OK to the unsolicited $13 per-share buyout offer that the company received from Vector Capital. It also rejected an alternative deal to sell its digital rights management business to Vector, saying both bids are too low.

Also on the M&A front, Waste Management Inc., Republic Services Inc. and Allied Waste Industries Inc. were continuing their three-cornered mating dance, with waste-disposal industry top dog Waste Management still pursuing Number-Three player Republic. The latter has already trashed its bigger rival's unsolicited $6.7 billion takeover offer as inadequate, and in turn is preparing for the closing of its own previously announced acquisition of Number-Two Allied.

Shares of Freddie Mac and Fannie Mae were again surging, as investors in the two giant government-sponsored enterprises grew more confident that a federal bailout that would wipe out common shareholders and would likely do the same to preferred holders, may not be necessary. Lehman Brothers added its voice to the chorus, saying Fannie's capital picture may be better than it appears.

On Wall Street, the bellwether Dow Jones Industrial Average rose 212.67 points, or 1.85%, to 11,715.18, while broader indexes also rose. The Standard & Poor's 500 index advanced 19.02 points, or 1.48%, to 1,300.68, and the Nasdaq composite index rose 29.18 points, or 1.22%, to 2,411.64.

Feds clear DRS deal

The planned sale of DRS Technologies to Italy's Finmeccanica for $4 billion jumped a regulatory hurdle when the two companies announced that that U.S. Justice Department and the Federal Trade Commission have cleared that deal, bringing an early end to the 30-day review process outlined under the Hart-Scott-Rodino antitrust law.

On Monday, Italian regulators had given their stamp of approval to the Rome-based aerospace and defense company's planned acquisition of DRS, which sells products, services and support to military forces, government agencies and prime contractors worldwide. The company provides electronic gear for U.S. military and intelligence agencies, including thermal imaging devices, combat display workstations, power systems and air combat training systems.

Next up for the deal is approval of the $81 per share all-cash bid by the Committee on Foreign Investment in the United States, a Treasury Department body which examines national interest issues when U.S. companies like the Parsippany, N.J.-based DRS are acquired by overseas firms.

Assuming such an approval would be forthcoming, the deal, first announced in May, is still subject to among other conditions, the approval of DRS's stockholders. DRS has scheduled a special meeting of stockholders for Sept. 25.

DRS (NYSE:DRS) was down four cents, or 0.05%, to $79.48.

Aladdin rejects Vector buyout try

Aladdin Knowledge Systems turned thumbs down on an unsolicited takeover bid from shareholder Vector Capital, and also rejected a bid by the San Francisco-based private-equity company to acquire its Digital Rights Management business.

The Israeli computer security company termed both the $13 per share offer for the whole company received from affiliates of Vector, and the alternative proposal for Vector to acquire the DRM operation for $125 million to $135 million, as being not in the best interest of the shareholders. It said that the buyout bid "significantly undervalues the company."

The company said it turned Vector down after "a through review" by its board of directors. "We are confident that, through execution of its strategy, Aladdin will create substantially greater value for shareholders than either of Vector Capital's proposals. Vector Capital fails to recognize the intrinsic value of the company's business and strategic initiatives," Aladdin said in a statement.

Upon receiving Aladdin's formal rejection, Vector Capital - which through its wholly-owned subsidiary, SafeNet, Inc., is a direct competitor of Aladdin - petitioned the company to call an extraordinary general meeting of Aladdin shareholders to consider, among other things, certain changes Vector would like to make on the company's board. The board is reviewing the request.

In a research note to investors Thursday, analyst Joel Fishbein of Lazard Capital Markets wrote that he believes Vector may take its proposals directly to Aladdin's shareholders through a proxy fight, or could seek to enter talks with the company aimed at producing a mutual accord.

Aladdin Knowledge Systems (Nasdaq: ALDN) fell 28 cents, or 2.20%, to $12.47.

Fannie, Freddie rebound rolls on

Fannie Mae and Freddie Mac made it four in a row Thursday, with investors hopping aboard the big government-sponsored enterprises' bandwagon in increasing numbers, apparently believing that the mortgage buyers won't need a Treasury Department bailout. Such a bailout would be ruinous to common shareholders, and according to some observers, preferred holders as well. By one estimate, Freddie Mac's shares have soared some 85% on the week, with Fannie Mae showing a robust 40% aggregate gain over the past four sessions.

Investor confidence was buoyed by several factors, including the management shakeup at Fannie announced Wednesday, which saw three top executives leave the embattled company, including two who had held their posts for only a relative short time.

That housecleaning led to the exit of Fannie's chief financial officer, Stephen Swad, who only came aboard last year from Time Warner Inc.'s AOL division, and its chief risk officer, Enrico Dallavecchia, who had joined the company two years ago, coming over from JPMorgan Chase & Co. Swad will be replaced by David Hisey, formerly Fannie's senior vice president and controller, while Michael Shaw, formerly a senior vice president for credit risk oversight, replaces Dallavecchia. Peter Niculescu will take over as chief business officer, replacing the retiring Robert J. Levin, a 27-year company veteran.

Also helping was the successful completion of short-term debt offerings, since previously, the financial community had worried that the GSEs might lose their vital access to the capital markets; McLean, Va.-based Freddie sold $2 billion of short-term debt on Monday, while Washington-based Fannie matched that financing on Wednesday with its own $2 billion sale.

And some analysts now believe that the GSEs may be able to avoid giving their shareholders a severe haircut via getting a Treasury bailout. Lehman Brothers analyst Bruce Harting said in a research note Thursday that Fannie's capital position "appears much stronger" than people believe.

Harting said that neither GSE company is in immediate danger where it would need capital right away. Even though both companies are expected to continue to absorb credit losses "well into 2010," strong margins and the normalization of credit costs in late 2010 should return them "to profitability long before the economic capital in the company could be depleted."

That less-pessimistic assessment echoes the tone of earlier commentary during the week from Citigroup, Barclays and Goldman Sachs; the latter opined that said the Treasury could take several steps to shore up Fannie and Freddie before taking direct take control of the mortgage finance companies.

Pessimism about investors' prospects in the event a bailout was necessary had decimated the stocks of both companies over the last month - although not everyone was feeling bearish about that - one market source with a contrarian bent told Prospect News that his shop would see a move by Treasury to take over the GSEs' "as a major positive for the U.S. and other banks! While everyone is running around whining about size of the losses they will have on any GSE preferred shares they hold, they fail to take into account the far larger holding of GSE mortgage-backed paper that will now be same as U.S. government debt in ratings."

Additionally, he said such a bailout "would free up a huge amount of Tier 1 capital, since there will no longer be a haircut of 20% on their holdings of such."

Nonetheless, with most investors taking the conventional view that a takeover would decimate common and preferred shareholders, anything seen heading that off is considered good news, pushing the shares up. Freddie Mac (NYSE: FRE) jumped 53 cents, or 11.16% to end at $5.28, on volume of 129 million shares, almost double the norm, while Fannie Mae (NYSE: FNM) did even better, zooming $1.47, or 22.69%, to close at $7.95. Volume of 126 million shares was about double the usual turnover.

Analyst: WMI must up bid again to succeed

Among the companies which specialize in turning garbage into money, industry leader Waste Management said that it had received a request from the Justice Department for more information about its proposed $37 per share cash acquisition bid for Republic Services. The Houston-based waste-hauling giant said that although it had already "voluntarily supplied the DOJ with substantial market information in advance of a second request," it would continue to cooperate further with the regulators.

While all of this was going on, Fort Lauderdale, Fla.-based Republic - which has already rejected both Waste Management's original $34 per share July 14 offer as well as its $37 per share Aug. 11 revised offer as inadequate - is proceeding with its own $6 billion-plus acquisition transaction with Phoenix-based Allied Waste, announcing earlier this month that it had lined up financing commitments for the deal from its bankers, and saying that it expects to close the acquisition in the fourth quarter.

With Waste Management having so far failed to budge Republic from its opposition, even after having upped its price by $3 per share, it will have to open its corporate wallet again and raise the ante once more, said analyst Brian Butler of Friedman, Billings, Ramsey Group., Inc. in Arlington, Va.

"If Waste Management wants to buy Republic, I think it can - but I think the price has to be $40." He said that the bigger question is not whether Waste Management has the money - but does it want to spend the extra approximately $546 million that it would cost to raise its price by $3.

"If [Waste Management CEO David P.]Steiner wants to put up the cash, they'll probably have to raise a little equity to do it at that level," Butler said. "I think that's where the Republic shareholders are willing to acquiesce and let the company be sold, versus merging with Allied Waste."

He cautioned that it would be a waste of time - absent a higher offer - for Waste Management to try to go over the heads of Republic's management and present a tender offer at $37 directly to the shareholders, "because there really are no shareholders urging [Republic's] board to consider [Waste Management's offer]. I don't think they would be very successful" going the hostile tender route.

The analyst noted that when he was recently interviewed on CNBC about Waste Management's uphill battle to win over Republic's management, "he said the Republic deal is not essential for Waste Management. In other words, they entered into this as an opportunistic deal," no doubt prompted at some level by a desire to not see Waste Management's two biggest competitors unite to form a stronger challenger to its industry-leading position (although in terms of annual sales, number of customers and most every other measure, it would still be bigger than a Republic/Allied hybrid).

"They're hoping to get it done at a reasonable price, which they believe that $37 is - hence, the question of 'are they willing to pay up' the additional $3 [per share] to get this deal done. In my opinion, they started this process with a number in their head - they said 'we're not going to pay over this amount.' I'm not sure whether that's $37 or $40. If it's $40, I think they can do the deal. If it's $37, we'll probably see this bid sit out there and linger for some time."

Butler predicted that "if we don't hear from Waste Management in the next week or so, or two weeks - if Waste Management doesn't come back with a reply or with a higher offer, I think the market is going to start to look at it as being very unlikely that Waste Management is going to come back [and prevail]. They want to get this done as quickly as possible, and if they're going to wait three or four weeks, that's probably going to be perceived as too long in many people's minds."

However, even if Waste Management doesn't sweeten its bid again to the point where Republic would accept it, "it doesn't really hurt them to leave the bid out there."

Since the DOJ has also been studying the potential antitrust ramifications of a successful sale of Allied Waste to Republic as well as Waste Management's offer to the latter company, when Justice does come back with its divestiture requirements for Allied Waste and Republic, Butler said that "if there's a pending, or potential higher offer or bid out there from Waste Management, I don't think you'll see Republic or Allied Waste fight the DOJ on their requirements," versus if Waste Management were to drop its bid. "Without the Waste Management bid out there, Republic and Allied Waste will fight the DOJ tooth and nail over what has to be divested."

The analyst called such a situation "almost a consolation prize" for Waste Management.

"If they leave the bid out there, Allied/Republic will probably roll over to whatever request the DOJ puts out there and this maybe forces them to divest more assets than they originally claimed." He estimated that the feds would force the Allied/Republic combination to unload assets generating about $500 million of the roughly $9.1 billion of pro forma annual revenues the two companies could generate. They would seek about $900 million to $1 billion of revenue divestiture, out of total pro forma revenues of about $16.4 billion, should Waste Management succeed in wooing Republic.

Butler believes that a combination of Republic and Allied "creates a more balanced kind of competitive environment" in the $52 billion U.S. waste disposal industry - which besides the big three includes a handful of smaller public companies and a number of private companies, though "no one of significant size," as well as municipal waste disposal operations.

Should those two companies get together, what would be left would be "two now really large players and a bunch of smaller players." Even so, it's still "probably a positive for Waste Management, because you'd end up with still a larger number of landfills in a smaller number of hands, which reduces the possibility that you would see any real break in pricing discipline on landfills. More pricing discipline is a positive for the industry - and at some level, a positive for Waste Management, for sure."

Waste Management (NYSE: WMI) rose 64 cents, or 1.85%, Thursday to $35.27. Allied Waste (NYSE: AW) was up 27 cents, or 2.07%, to $13.32. Republic Services (NYSE: RSG) gained 47 cents, or 1.43%, to end at $33.24. Volume for all three companies was less than half the usual turnover.

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