Reward Outweighs Risk In Arbitrage Of Apache-Mariner Deal

The Gulf of Mexico oil spill will have many lasting and painful effects, but the scuttling of the Apache Corp. (APA) purchase of rival oil and gas company Mariner Energy Inc. (ME) doesn't look to be among them.

Apache and Mariner announced the merger in April, just days before the Deepwater Horizon oil-rig explosion, and concerns have mounted that fallout from the worst oil spill in U.S. history will derail the deal. Worries about Mariner have been exacerbated because some of its proven reserves are in the Gulf's deep water, where the Horizon disaster occurred and where the future regulatory picture remains both murky and disconcerting.

Wall Street's sell-off of oil-related stocks hasn't been limited to just those of BP PLC (BP) and others involved directly with the Deepwater Horizon. Apache and Mariner watched the spread on their merger deal jump from 1.2% at the close of trading on April 15, the day the merger was announced, to 12.2% at the close on June 1. The spread has since narrowed to 6.4%, but that's still wide enough to indicate investors are worried and it makes for a potentially lucrative trade should the deal close on schedule in the third quarter.

"Arbs are all over it," said one New York arbitrageur who spoke on condition of anonymity. "Is the deal guaranteed? No," he said, and it's "not for the faint of heart," but it's an arb trade he continues to play and is reasonably confident of its success given his research.

Arbitrageurs profit by capturing spreads. In this case, the trade would involve selling short Apache shares at recent levels around $91.05 apiece and buying Mariner shares near recent prices around $21.91 a share. In the cash-and-stock deal, Mariner holders would receive $7.80 in cash plus Apache stock worth about $15.52 right now, for total consideration of $23.32 per share, $1.41 above Mariner's current price.

That spread could mean pocketing a more than 6% return sometime before the end of September, for at least a 21% annualized return. The earlier in the third quarter the deal closed, the greater the annualized return would be. A collapse of the deal could spark outsized losses for arbs, but experts seem convinced of the merger's certainty.

Neal Dingmann, an analyst a Wunderlich Securities, believes the deal will close and said the arbitrage makes sense. Apache executives have consistently maintained their commitment to this deal, and even if they wanted to walk away, there don't appear to be any loopholes that Apache could use to exit without an uphill legal battle, he said.

Brad Pattarozzi of Tudor Pickering Holt & Co., agreed, and said Apache just isn't the type of company that backs out of pacts.

Dingmann said he believes Apache over the long-term will get what it wants out of Mariner, regardless of ramifications of the Gulf spill, which further bolsters his belief that Apache will complete the merger.

This merger agreement, like many deals, contains a material adverse change clause, or MAC, which could allow Apache to flee following certain negative changes at Mariner. However, the clause in this deal says Mariner can't be found to have experienced a MAC because of changes in markets or political conditions, general industry changes, commodity prices or as a result of "any change in applicable law or the interpretation thereof."

This seems to shield the deal from the Deepwater Horizon fallout, even if the government or regulatory agencies effect measures that make Gulf deepwater oil drilling onerous or forbidden for any length of time.

Brian JM Quinn, an assistant professor of law at Boston College Law School, agreed that Apache would have a difficult time invoking a MAC on Mariner, even if it wanted to do so, which analysts and Apache say isn't the case.

A Mariner spokesman referred all comment to Apache. Tuesday afternoon, an Apache spokesman told Dow Jones Newswires it remains committed to closing the merger, though he wasn't promptly available to reconfirm this on Wednesday. The Mariner spokesman noted that less than half of its reserves are in the Gulf of Mexico, and only 15% to 20% of that resides in the deepwater area, meaning Mariner still has significant reserves onshore in places like Texas that would be unaffected by any regulations relating to deepwater drilling.

-By Maxwell Murphy, Dow Jones Newswires; 212-416-2171; maxwell.murphy@dowjones.com

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