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Shaw and Rogers are expected to show their hands by making an announcement on the preferred share redemption in late May.

CHRIS WATTIE/Reuters

Rogers Communications Inc . executives have been saying all the right things about their commitment to a $20.4-billion takeover of rival Shaw Communications Inc . Over the next three months, hedge funds are betting the telecom company will show it is willing to put its money where its mouth is.

The hedge fund crowd is putting money into what amounts to a preview of the potentially lucrative, or disastrous, play on Rogers’s takeover by investing in Shaw’s preferred shares, in anticipation of cashing out at the end of June.

For hedge funds that play takeovers – a specialty known as merger arbitrage – the big game right now is buying Shaw’s stock in anticipation of a deal that’s expected to close in the first half of 2022. There is a 20-per-cent-plus gap between where Shaw’s stock is currently trading and Rogers’s $40.50-a-share offer. The discount reflects concerns that federal regulators or politicians could derail the deal over telecom competition issues. For a great many investors, that’s an alluring if risky investment. Trading in Shaw shares hit 20 times the normal volume the day the deal was announced, as hedge funds piled in.

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Arbitrageurs with shorter attention spans believe they have found a way to turn a profit on Rogers’s commitment to the takeover by June 30. Keen-eyed fund managers spotted a clause in Rogers’s 128-page offer that gives the Toronto-based company the right to request changes to Shaw’s capital structure, within reason.

Specifically, the document stated Rogers can force Shaw to redeem $300-million worth of preferred shares on June 30, for $25 each. In return, Rogers pledged it will pay Shaw $120-million if the Calgary-based company redeems its preferred shares, and the takeover doesn’t close next year. That payment would be in addition to the $1.2-billion break fee Rogers will hand to Shaw if the deal falls apart.

From Rogers’s point of view, getting Shaw to buy back its own preferred shares is good housekeeping, according to one hedge fund manager who owns the securities. (The Globe and Mail is not identifying the source because they are not authorized to speak publicly about the fund’s holdings.) These Shaw shares are only redeemable once every five years. If Rogers misses this opportunity, it will be forced to keep paying out cash dividends until 2026. Rogers would rather use that money to pay down debt, or fund 5G networks.

However, there’s a significant gap between where Shaw preferred shares have traded since the takeover was announced – around $21 each – and the $25 a share the company would pay out at the end of June if it chooses to redeem. Wasps at picnics have nothing on merger arbitrage funds that smell a 15-per-cent-plus return in less than three months. This is becoming a popular trade.

The risk for the hedge funds is that Shaw opts to skip the redemption, the Rogers takeover falls apart and the price slides. Prior to the takeover, Shaw preferred shares were changing hands for around $14 each. The same downside exists for hedge funds piling into Shaw’s common stock. The shares were trading around $23 prior to the takeover, and are now changing hands for about $33.

Many analysts say investors are overestimating regulatory opposition to Rogers’s growth plans, and underestimating each company’s resolve. In a report last month, analyst Jeffrey Fan at Scotia Capital said the price of Shaw stock showed the market put a 56-per-cent chance of the takeover closing, while “we would peg a range of 75 per cent to 85 per cent.”

Shaw and Rogers are expected to show their hands by making an announcement on the preferred share redemption in late May. At that point, both companies are committing capital, along with reputations, to their planned union. And hedge funds will start to cash in, or count their losses, on this high-stakes takeover.

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