SSI Weekly – Pitches for RAP.AX, CCHWF, LAIXY, POEFF, ASTL, GDNSF

RAP.AX – Merger Arbitrage – 17% Upside

CCHWF – Merger Arbitrage – 13% Upside

LAIXY – Chinese Take-Private – 11% Upside

POEFF – Merger Arbitrage + Spin-off – 6%+ Upside

QUICK IDEA PITCHES

Algoma Steel Group (ASTL)
Canadian (listed on TSX and Nasdaq) steel manufacturer Algoma Steel has launched a large tender offer for 25% of outstanding shares. Price range is US$8.75-US$10.25/share. Includes odd lot provision. Shares currently trade in the middle of the range. Paid up capital stands $4.20, so the idea is mostly actionable to the Canadian and other investors who can avoid withholding taxes (these will be charged on the difference between the final tender price and paid-up capital). Expiration is set for the 27th of July.

The company is visually very cheap on trailing earnings (0.8x TTM adj. EBITDA) and relative to peers. Based on my back-on-the-envelope calculations ASTL trades at 4x forward EBITDA (reflecting price changes for ASTL’s inputs/outputs as per commodity futures prices). The company is also undergoing a transition to a more advanced furnace technology, that will increase operational efficiency, capacity, etc and is expected to increase the market multiple of its stock. The major unknown in ASTL’s valuation is the volatility of commodity prices (inputs/outputs) and the potential earnings squeeze if ASTL’s costs continue to rise while steel prices drop more than expected. Major shareholders (legacy debtholders) own a combined stake of 23%. If they think the outlook has gotten too uncomfortable and tender their shares, the offer will get filled/oversubscribed very easily.

ResApp Health Limited (RAP.AX)
ResApp is getting acquired by Pfizer at A$0.146/share. Currently there is 17% spread to the offer price. The merger is expected to close in August. Approval from 75% of RAP shareholders is required. Given the history of the offer (more below), I do not think Pfizer is walking away. Shareholders are also likely to vote in favor as the latest study of RAPs key technology has failed to deliver satisfactory results and the offer nevertheless comes at a large premium to the levels RAP shares were trading over the last two years. Interestingly, the members of Hotcopper forum – the main place for Aussie retail investors to discuss stocks – are extremely dissatisfied with the transaction (one of the most intense discussions we’ve seen on this forum) and have created a spreadsheet to sign/count how many combined rejection votes they have. Clearly, an anecdotal reference point, but right now that the collected votes amount to 15% of outstanding shares (25% of votes cast are needed to block the deal).

ResApp is developing a self-learning algorithm/phone app for the detection of respiratory diseases and also COVID. Presumably, this app can detect a respiratory disease from the sound of person’s cough. While it definitely sounds crazy, Pfizer is interested in the technology (mainly for COVID detection). The previous screening test done in Mar’22 showed very positive results with 92% sensitivity in detecting COVID. Apparently, that’s when Pfizer became interested.

A bit more background on the offer. In Apr’22 Resapp agreed to be acquired by Pfizer at A$0.115/share in cash or around A$100m in total. The original transaction was expected to close in late June. Alongside the initial offer, Pfizer and Resapp entered into an R&D license/cooperation agreement. After a third-party valuation said that the initial bid from Pfizer was undervaluing RAP, on the 14th of June, the offer got a big bump with 2 scenarios and 2 offer prices: (1) consideration will be increased to A$0.207/share if the next study results from ResApp’s COVID detection tool are satisfactory or (2) the offer will be A$0.146/share if study results are unsatisfactory. A few days ago, the disappointing study results came out with a sensitivity of 84% and specificity of 58% (below Pfizer’s “satisfactory” requirement of 86% sensitivity and 71% specificity). No comments were made by the buyer yet. A$0.207/share consideration scenario is clearly out of the window. But the offer of A$0.146/share still stands and, given the background above, Pfizer has limited excuses to cancel the acquisition due to the app not performing up to expectations.

Cannabis Industry Mergers

The next two pitches below are mergers in US Cannabis industry – strategic, expansionary deals by two major market players. Both transactions are likely to close as expected and the spreads seem to be driven mostly by the overall investors’ skepticism towards the Cannabis industry. A similar overhang was present last year, which caused spreads of most cannabis mergers to stay wide right till the closing date. A number of these mergers had been posted on SSI – CLIQ.TO, ISH.CN, KSHB, ZENA.TO, BMWLF, LHSIF, etc.

Goodness Growth Holdings (GDNSF)
A micro-cap US cannabis company Goodness Growth Holdings entered is getting acquired by Verano Holdings ($2bn market cap) in an all-stock merger at 0.22625 exchange ratio  Currently spread stands at 6%, however, it is quite volatile and frequently fluctuates between (6%-13%). Plenty of shortable shares at 4% rate available for hedging. Verano is industry’s heavyweight and one of the largest multi-state operators in the US. With this acquisition, it will expand into 3 more states (NY, MN, NM). New York is an especially important one as it is one of the largest, yet has a relatively low cannabis penetration. Only 10 vertically-integrated licenses were issued in NY and Goodness Growth is holding one of them. Conditions include approval from 2/3rds of target shareholders votes cast + consent of majority of disinterested shareholders. Approval from 37% of shares has already been secured – it seems that most of these are held by Goodness Growth’s management (which owns 44%) and might be not counted in the minority vote. Shareholder vote date hasn’t been set yet. Closing is expected in Q4.

Columbia Care (CCHWF)
Consolidation of two major US cannabis companies – Cresco Labs is acquiring Columbia Care. Consideration stands at 0.5579 CRLBF shares per each CCHWF. Spread is at 13%. Plenty of shortable shares are available on IB at 3% fee. The combination will create the largest multi-state operator in the US (second largest retail footprint + one of the largest wholesale platforms). Needs to be approved 2/3rds of the target’s shareholders. As of the latest proxy, 18% of Columbia Care shares support the merger. The meeting is set for the 8th of July. Antitrust clearance has already been received. Consents from the individual state regulators still remain outstanding. In certain states, the parties will have to divest licenses in order to meet license caps and other restrictions, however, both firms have been ready for that and stated that license sale proceeds will be used to reduce debt. The merger is expected to close in Q4 2022 with a chance of delays due to the regulatory reviews/license divestments. Overall, it looks like the merger should close successfully, but there are two issues/uncertainties:

The exchange rate is subject to proration adjustment by the amount of Columbia Care shares issued as an earn-out for its historical acquisition from Dec’20. The earn-out will be based on adj. EBITDA performance of the acquired company until June’22. As Columbia Care became public only in 2021, there is no available information to check the likelihood and size of the payment. The maximum earn-out is $58m worth of Columbia Care shares, but the exact number of shares to be issued will be calculated at 10 days VWAP prior to the release of Columbia Care’s Q2 earnings (mid-Aug). At current prices, the maximum earn-out would lower the exchange rate to 0.507689 and reduce the spread to 3%.

Another problem is that downside is very difficult to estimate. Shares of cannabis companies have declined by 39% since the merger announcement (Mar 23), so pre-announcement levels are of little relevance in estimating the downside if the merger fails.

Pan Orient Energy (POEFF)
Pan Orient Energy is a $55m market cap junior O&G company that owns oil and gas properties in Thailand and Canada. A few weeks ago, it entered into a definitive agreement to be acquired by a privately held Asian peer. The buyer is interested particularly in Pan Orient’s Thailand assets, while the remaining assets will be spun-off. Consideration stands at $0.788/share + one share of new-co CanAsia which will be listed on TSXV. The spinco will have $5.5m in working capital and long-term deposits + multiple exploration assets in Canada. The market currently values the spinco at $0.06/share. If you take the working capital/deposits at face value, that alone is worth $0.11/share. Plus you get exploration assets for free. Worth noting that the liquidity here is not great. Once the merger is completed, given the size of the spinco it might be difficult to exit the position.

LAIX (LAIXY)
Tiny $5m nano-cap net net ($9m net cash), but given the size surprisingly decent liquidity. This is a Chinese going private transaction with a definitive agreement signed – to be acquired by management (own 87% voting power) at $1.9/ADS. Netting $0.05/ADS fee, the upside stands 11%. It has a $5m MCAP and negative $4m EV. Interestingly, the definitive offer came at a very substantial price raise vs. the initial bid ($1.13/share) last August. LAIX develops the English Liulishuo app which has, according to the company, over 203m registered users. The app reviews are generally positive. The major caveat is of course that this is a super tiny Chinese company with not up to date financials. Despite the net cash position, the company burns a lot of cash. Some recent operational changes also raise questions, e.g. 50% operating expense drop in FY21 (most recent report), which finally resulted in LAIXY generating profit. If the acquisition gets canceled, the downside could be substantial. It might be no longer relevant, but historically, the absolute majority of Chinese U.S.-listed privatizations with definitive agreements in the pockets used to close successfully.