Reverse Morris Trust

[knibloe]

Ecolab is divesting itself of part of one of it's businesses and is offering a Reverse Morris Trust. I have worked for them for over 20 years and have a fair amount of stock. Basically their intent is that for each $100 in Ecolab Stock you recieve $111 in Apergy stock. To me that seems like a good deal. I know that there are a lot of what ifs and it is not just that simple. I see the bigest risk in holding the Apergy stock because of the unknowns post merger.

How will this be treated for tax purposes? What happens if I want to sell the Apergy to collect the 11% premium and get out? I bought some of my Ecolab at $20 and it is now trading at $197. If I sold it, I would pay capitol gains. on $177. If I take a share and convert it to $218 of Apergy and sell it immediately, do I pay capital gains or regular income tax? Can I tell my ESOP that I want to trade the last shares I bought at $210 and are now at $197? If I do that and convert it to Apergy do I then only have to pay tax on $8? Woudl that be capital gains or regular income?

[Recyclersteve]

I’ve participated personally in a number of Reverse Morris Trust transactions over the years. I worked for a major brokerage firm (Schwab) for almost 20 years and was also a very active trader and day trader while I worked there. I have been completely out of the biz since 2017 and am seni-retired.

That said, it sounds like you are saying you are an employee which is a whole different matter.

Many of these deals (the majority to perhaps the vast majority) have clauses buried in the fine print saying that if you have 99 or fewer shares of stock in the original stock it will be converted to the new stock without you being prorated. Proration is a fancy way of saying they only take part of your shares because there is so much demand for the deal that they can only take maybe 10-20% of the shares tendered. So that is why the odd lot clause was created- to give smaller shareholders a decent shot.

Several thoughts:
1) I have no idea how this is different for an employee than it is for an outside shareholder.
2) The whole COVID virus situation has muddied the waters on deals like these. I am, frankly, surprised to see one out so soon.
3) In the past with deals where they had a 99-share clause, I have on a number of occasions bought (in separately titled accounts) 99 shares for my wife, myself and my daughter. Generally they’ve worked very well and we are way ahead over the years on the deals we did.
4) That said, a recent one came out just before the COVID term started being used every day in the news. The timing couldn’t have been much worse. The recent one was McKesson (MCK) and Change Healthcare (CHNG). Even after getting an incentive of perhaps 7-8% to do the deal, I am still under water by perhaps 20-30%. I still own CHNG and am not panicking about it. But it is a very small position and a tiny portion of my net worth. So I can be patient for years. Even if the stock went to zero, I wouldn’t jump out of a building. The main point is that even with an incentive to do these (often around 7-8%), they can turn into very negative situations.
5) RMT deals are often tax-free to the company doing them, but that doesn’t mean they will be tax-free to you and I. To make them tax-free you could consider doing them in a retirement account. Also, if you have losses you can use from a taxable account (even potentially losses from many years ago that were never fully taken) consider taking those losses to offset potential profits in a non-retirement (taxable) account. I am NOT an accountant, so confirm anything you read here with a competent person.

I will look a bit more closely at this in the upcoming several days to week or so and add comments as I see fit and appropriate to do so.

[Recyclersteve]

A few more items. The odd lot clause that I mentioned is indeed in effect for shareholders, but might not apply to employees. As usual, the odd lot clause means that if you buy 99 or fewer shares PER TAX ID (SS# if you will), you are almost virtually assured they will take all our your shares instead of returning the majority or vast majority to you. This part I like a lot.

Also, this is set up to provide a targeted “profit”, if you will, of approx. 10-11%. Many others have worked out well with a targeted profit of 7-8%.

Back of the envelope calcs: ECL is close to a $200/share stock. 99 shares costs close to $20k. Even a 10% profit would be $2k and I’ve seen profits of 20% or more before (even when the target was 7-11%).

If it wasn’t for the COVID situation, I’d be very interested in participating. I’m still not saying no, but I need to think a bit more about it. Good luck to anyone who participates. I am curious to hear everyone’s comments.

The granddaddy of these deals was the Lockheed Martin (LMT)/Leidos (LDOS) deal. LMT was something like $255-260 a share. I personally knew of about 100 people who did this one. The AVERAGE profit was over $5k per person and keep in mind there were plenty who didn’t have an extra $25-26k to invest. So my friends Combined made over HALF A MILLION on that deal. It was like a nice bonus for many of them. That was without a doubt the best of the deals I’ve participated in. That was August, 2016.

Another VERY important point. Forget about the official exchange deadline date. YOUR BROKER (whomever that is) will likely have a deadline that is a few days earlier and it might be around market close as opposed to 11:59pm that night. So, for God’s sake, check with your broker ahead of time for the deadline and don’t be late. It could be a very expensive mistake.

[knibloe]

Thanks for the input

My stock is in the ESOP so my "broker" is compushare. Their transaction date is 5/29. I think this is terrible timing. However, it has been in the works for over a year and a half so it is time to move forward. Apergy is an oil and gas support company which we know isn't a great business to be in right now. I don't think I would want to hold the stock after the split. If I then sell it and have to pay regular income tax, I could lose a lot of the profit due to the higher tax rate. I did not see anywhere in the information that they sent me that there was a limit, however, the book they sent we was over 250 pages.

I suppose that I will first contact Compushare to see how they treat what I have (can i use fifo or lifo)? Then I will contact my tax advisor.

[Recyclersteve]

Knibloe:

Don’t expect any real “advice” from Computershare. They might even read from a script. Not singling them out. They are merely an information agent and trying to provide factual info without opinions. So I would say the same thing about their competitors.

One VERY important piece to let your tax person know about is the extreme volatility of Apergy stock. To go from $26 to $2 and back to $9 in short order is EXTREME volatility. For me this is merely a stock trade with a fairly small part of my net worth, so not such a big deal. If I was an employee of ECL and had worked there for years, it would be a WHOLE DIFFERENT MATTER. I can’t truly say I know what I’d do if I was you.

To me, there is no question that ECL is the more stable stock and company of the two.

You should consider a potential worst case scenario. What if you did the exchange and the Apergy stock you got went down close to zero in a few months? Even in a bankruptcy situation, it would still likely trade for perhaps 10-50 cents a share.

Are you debt free? Is your house paid off? What percentage of your liquid net worth is in Ecolab stock?

Also, you don’t have to go all or nothing. You could tender part of your ECL shares and realize you would almost certainly be prorated, that is, have a bunch of shares returned to you. The percentage of shares that would ultimately be returned to you is virtually impossible to figure- so don’t get hung up using mathematical models to try to calculate it. This will change rapidly from day to day. In general, the worse the deal looks as it gets closer to consummation, the higher the percentage of shares that will be taken.

Another important think to check out with Computershare- What if you decide you don’t want to do the deal several days AFTER you’ve tendered shares? How long do you have to call and take the shares back?

For others who are thinking of this as a stock trade, it shouldn’t be nearly as difficult to do as it would be for a long-time employee where it represents a big percentage of net worth.

And, yes, the COVID situation definitely muddies the waters. With oil futures dipping BELOW ZERO recently and gas prices cheap in many areas, you’d think there would be LONG lines at the gas pumps everywhere. I’m certainly not seeing long lines, except occasionally at Costco. So you have a very unusual situation here, to say the least.

Good luck to all.

[Recyclersteve]

To clarify one thing from the original post- Yes, you’d get $111 of Apergy stock for $100 (a 10% discount). But, even WITH that discount you could still lose $ on Apergy, even if you sold it the first day the shares show up in your account. It is hard to explain this in depth, but essentially a rapid decline in Apergy stock near the deadline for the transaction could cause it. So don’t think of it as a guaranteed 10% even if you sell right away...

[knibloe]

Steve,

Thanks for hashing this out with me. I think that most all the things you asked and mentioned were already considerations of mine. The confirmation was appreciated. I would in no way risk a large portion of my net worth on this. If it was 6 months ago and the oil market was stable, I would be a lot more excited to make some additional money. The other problem with the ESOP, is I cannot decide what price I want to sell at. I tell them I want to sell, and it is executed at the close of the next day. A lot could happen in a day. I should have transferred my ESOP stock to another account that I have more control over ahead of this offer. That would have made me more flexible in the back side of the transaction. I probably should still do this regardless.

Chris

[Recyclersteve]

I agree that this would have been a much easier decision 6 mos. ago.

[Lemon Thrower]

Steve, there are really 2 questions for you: Can you tack your holding period in Ecolab when you sell the Apergy? I think you can, and this should be explained in the federal tax section of the prospectus you recevied. If its a straight merger with no boot I think that is the result. Second, are you willing to take the volatility risk in the Apergy stock. Keep in mind, what was called a $111 offer may have already changed if Apergy's stock price has changed, and it may fluctuate further between the time you commit to the transaction and are able to sell the Apergy stock.

[Recyclersteve]

Steve, there are really 2 questions for you: Can you tack your holding period in Ecolab when you sell the Apergy? I think you can, and this should be explained in the federal tax section of the prospectus you recevied. If its a straight merger with no boot I think that is the result. Second, are you willing to take the volatility risk in the Apergy stock. Keep in mind, what was called a $111 offer may have already changed if Apergy's stock price has changed, and it may fluctuate further between the time you commit to the transaction and are able to sell the Apergy stock.

I'm not sure how to answer the tax question, so I respectfully punt on that one. I don't plan on reading the prospectus and giving tax advice- you or anyone else on this fine site (maybe a professional accountant) can try their hand at that.

They don't literally mean $111, as Apergy is an $8 stock. They are just trying to say that when they do their calculations, the APY stock will be granted at a 10% discount to the price after using the formula they use. $100 is exactly 10% less than $111.11, so that's why these use those numbers. 10% is normally very nice and is better than the average stock does in a year, but, in this market APY could go down more than 10% in a day!

In fact, just for grins, I went back and looked at the price action on APY stock each day since the markets blew up (IMHO that day was 2/24/20). Here are the days (just since 2/24) where APY went down more than 10% in a single day:

2/27
3/6
3/9
3/12
3/16
3/17
3/23
4/15
4/16
4/30

So that is 10 times that this stock would have given up the entire 10% discount and more in just a single day over less than a 3-month period. I'm already talking myself into going into a more defensive posture on this one. So think this one through carefully. Look up the word "conservative" in the dictionary and I guarantee you will not see a picture of the APY stock chart.

Another way to play this is by buying ECL stock, and, if it goes up a decent amount in the next 1-2 weeks, not submitting to exchange shares at all, but rather just selling ECL outright and pocketing your profit without taking the risk of doing the conversion and being left to hope APY doesn't crater thereafter. If my net worth was a bit higher and my wife was more likely to embrace me taking the risk, I'd be very tempted to have no qualms about doubling down on APY a few times and then just saying "Oh well- live and learn" if they went kaput. I could do it on a small scale, but don't want to do it with $20-60k invested.

Because of the risk involved I do think there will be a sizeable amount of people who will wait to the very last minute before deciding whether they want to do the deal. Call your broker about that if that is what you are thinking about because there might be some rules involved. For instance, the buy of ECL may have to settle (2 business days) before you can tender to exchange those shares. That also could vary from broker to broker. Brokers have a lot of in-house rules that can be stricter than general rules that most people adhere to. One good example of this is in regards to buying stocks on margin. Many brokers will not loan money to people who want to gamble on stocks that have gone up 500-100% in just a few months. And, frankly, I don't blame them.

Also, for those who aren't aware, it is possible at many brokers to indicate that you want to exchange shares of ECL for APY, then change your mind later and take the ECL shares back before the deal closes. Just PLEASE be on top of your broker's in-house rules for this process and whether or not they will allow it. Also, be prepared for a potentially long hold time getting through to someone who can actually help. This is often a very small department only in during normal business hours.

Good luck with this one, Lemon.

[Recyclersteve]

FYI- my daughter and I are totally OUT of ECL stock. Combined, we netted slightly over $100 profit. Even if I have left a lot of money on the table, I won’t look back.