Pitches for ATCO, AGS, LOTZ, OZL.AX, IS, LMPX

AGS – Merger Arbitrage/Potential Higher Offer – 21%+ Upside

ATCO – Expected Higher Bid – 16% Upside

IS – Merger Arbitrage – 27% Upside

LOTZ – Merger Arbitrage – 40% Upside

PORTFOLIO IDEA UPDATES

Great quarterly update from Advanced Emissions Solutions (ADES) as the company continues to benefit from strong customer demand driven by high natural gas prices. APT segment revenues remain elevated while margins have slightly improved. Most importantly, the language around the strategic review has changed completely and management provided some very positive comments, adding that further updates are expected shortly. The stock jumped 20% on the announcement and currently sits at the write-up levels. The intial investment thesis is still very much intact with the catalyst seemingly just around the corner. At current levels, the operating APT business is valued at only 4.4x H1’22 run-rate EBITDA. Meanwhile, the net cash position has hardly changed since the write-up and stands at $86m or 76% of the market cap.

Taiga Building Products (TBL.TO) released Q2 results. While gross margins were suppressed by declining lumber prices during the quarter, the company remains well-positioned for a large capital return early next year. TBL released some of the working capital, leading to a record-high second quarter FCF of $87m. Historically, however, Q3 is when the company releases the most receivables and inventories. Our rough estimates suggest that TBL is on track to have half of its market cap in net cash by the end of next quarter. The business remains very cheap trading at only 2.7x TTM EBITDA and 5.0x at normalized pre-covid earnings. 

A short update on Transcontinental Realty Investors – Q2 filings suggest that the gap between book values reported in the US and Israel has widened. Mark-to-market book value now stands at $95/share versus $44/share recorded under the US accounting rules. The increase is largely explained by a higher value attributed to the Macquarie joint venture in Tel Aviv filings. The sale of the JV properties is expected to be closed in early September, suggesting that we should see an upward price adjustment after that. The stock is up 2x from write-up levels, yet the company still trades at only 11.4x TTM FFO – much lower than other US residential REITs.

CLOSED – Twin Vee Powercats (VEEE) thesis worked out better than expected. This week the company completed a very successful spin-off of Forza X1, with stock shooting +130% on the first day of trading. As VEEE retained 70% ownership in the newly listed company, its own stock also shop-up +100% on the day. As there were no possibilities to hedge FRZA exposure (despite still material discount to SOTP valuation), we closed the idea with 90% gain.

 

NEW QUICK PITCHES

Atlas Corp (ATCO) – Expected Higher Bid – 16% Upside
This is an interesting buyout situation to track, however, certain issues and our limited expertise in the industry do not give us enough confidence in a successful outcome. Look forward to any insights and comments from more knowledgeable SSI members.

Atlas Corp. operates two businesses – containership leasing (89% adj. EBITDA) and mobile power fleet platform (11% adj. EBITDA). The company is run by a prominent value creator CEO David Sokol, who regards ATCO as a ’fee-free investment vehicle into infrastructure assets. ATCO is controlled by two highly sophisticated shareholders – Fairfax Financial Holdings (47%) and the billionaire Washington family (18%).

2 weeks ago, ATCO received a non-binding privatization proposal from a consortium of two above-mentioned shareholders, the CEO and the largest client (total combined ownership of 68%). Consideration stands at $14.45/share (2% spread). However, apparently, the consortium members have signed capital commitments that add up to $18/share cash-out price for minority holders – potentially a sign that they are ready to pay more. The offer will have to be approved by a special committee of independent directors (committee formed yesterday) + a majority of disinterested shareholders. The buyers noted they want to move expeditiously and enter a definitive agreement within two/three weeks.

One minority shareholder, activist Charles Frischer of LFF Partners (he is also present in RHE case), sent a letter to the board saying the offer is lowball and he wants to see at least $16.5/share (16% upside) or he will vote against it. Frischer owns 4.3% of the total minority shares.

The whole set-up is somewhat similar to several recent MLP buyouts and there is a chance that the special committee’s review + minority shareholder opposition will result in a price raise. We are by no means experts in shipping/containership leasing, however, there are certain issues that limit our confidence in a higher bid.

• The offer has already come at a material premium of 25-30% to pre-announcement levels. If the offer fails, the downside could be quite material.
• Valuation support is difficult to find. ATCO trades at around 8x run-rate H1’22 adj. EBITDA  and at 9x 2022 guidance. On run-rate PE basis the company sits at 6.7x. The balance sheet is highly levered (5.6x net debt less 2022 adj. EBITDA guidance). Meanwhile, less-levered peers (CMRE, DAC, GSL, ESEA) trade at substantially lower multiples of 2-4x adj. EBITDA and 3x PE. Some of this premium in ATCO could be deserved given star management team/major shareholders, much better corporate governance, and the youngest fleet among peers. 
• Containership leasing is a highly cyclical commodity business. The cycle is peaking right now with the last 2 years being the most profitable period in the history of this industry. Containership lessors are generating crazy high REO right now and have pretty visible and stable cash flow visibility into 2025 due to fixed long-term contracts. However, these earnings will not be sustainable after the current tailwinds subside and the down-cycle enters. The consortium is offering to take ATCO private at the peak cycle and they definitely have a very clear price limit that they will be willing to pay for the economics to work. Arguing for a further 16% bump is difficult, given the consortium already offered 25% premium to unaffected levels and premium pricing relative to peers.
• Charles Frischer’s letter also reads more like a praise manifesto to David Sokol and management rather than solid financial arguments to back up his demand. However, one interesting speculation that he made was:

The consortium has total capital commitments of $1.605 billion ($30 million from Sokol, $175 million from the Washington Family, Fairfax Financial has agreed to roll their shares into the transaction, and $1.4 billion from One Ocean). Since they already own 68% of the outstanding shares of Atlas, they only need to buy approximately 90 million shares. At $14.45 per share, the cash required is only $1.3 billion. If we assumed they allocated their entire $1.605 billion commitment, they would be paying closer to $18.00.

By the way, worth mentioning that the consortium intends to buy out only common shares and not preferred shares. After the announcement, ATCO preferreds have dropped 11% below par as the market apparently got scared that prefs (non-cumulative) might get delisted afterward. Preferreds pay a 7.6% coupon and could be a potential play for those with confidence in a no-deal scenario.

PlayAGS (AGS) – Merger Arbitrage/Potential Higher Offer – 21%+ Upside
Recently, rumors appeared that US slot machine maker AGS ($300m market cap) received a non-binding merger proposal from peer Inspired Entertainment (INSE) at $10/share. AGS promptly confirmed the acquisition rumors and indicated that preliminary discussions are ongoing. The share price has run up over the last few days but the spread to the offer remains wide at 21%. The proposal comes at a significant premium and values AGS at 6.8x TTM EBITDA versus pre-covid multiple of 6.3x. Similar-sized peer AGI.AX trades at 3.6 TTM EBITDA, larger competitors fetch multiples in line with the current offer – IGT (6.2x) and EVRI (7.1x). Admittedly, the offer price is still substantially below 2018-2019 trading levels, whereas, the business has recovered well since the pandemic – H1’22 results show that the company is on track to exceed pre-COVID annual sales of ~$300m compared to $167m generated in 2020. The merger approval could hinge on the largest shareholder Apollo, which holds its 21% stake in the company since 2013 and controls 2 board seats out of 8. Since the IPO in 2018, Apollo has sold 65% of its shares at prices north of $20, suggesting that an improved bid could be required to seal the deal. Downside to pre-announcement levels is 28%. 

The merger seems synergistic for the buyer who produces both physical gaming terminals and gaming software, with most revenues coming from the UK and Greece markets. Whereas the company’s slot machine business suffered a setback during the pandemic, online offerings boomed, pushing total adjusted EBITDA from $49m in 2019 to $72m in 2020. Since then, operating performance has continued to strengthen. Now, the company is apparently trying to expand its gaming terminal business in the US to capitalize on the end-market recovery in the physical machine segment. Notably, INSE is much less levered at 2.5x net debt-to-EBITDA compared to AGS’s 4.0x, suggesting that the buyer could shore up financing for a higher bid. INSE’s management has recently been actively looking for strategic M&A opportunities and in Jan’22 acquired Sportech Lotteries.

CarLotz (LOTZ) – Merger Arbitrage – 40% Upside
An all-stock merger of equals between two used-vehicle e-commerce businesses. Shift Technologies (SFT) is acquiring LOTZ at an exchange ratio of 0.69. Both companies are busted SPACs now trading at or below $1/share. At the current prices, the spread stands at 41% but high borrow fees (42%) could materially shrink the upside in a hedged trade. Tight borrow remains a risk, however, an unhedged position might also be a good bet as the target trades at a 37% discount to its net cash position (albeit cash burn is also high). The merger is expected to close by the end of the year. With such a timeline, LOTZ’s cash runway would be sufficient to protect the downside. The merger itself is basically an equity raise for the buyer as SFT will issue new shares worth $83m to acquire $112m in LOTZ’s net cash as of Q2’22. Strategically, the merger will allow SFT to launch its platform in the East Coast markets. The companies also expect high post-merger cost and revenue synergies (as is the case with almost every single merger). 

Merger conditions include shareholder approvals for both companies as well as a minimum cash condition upon closing. SFT’s shareholder approval is likely given a net cash injection from the transaction. Meanwhile, two of LOTZ’s largest shareholders – SPAC sponsor and a PE firm – holding a combined 25% stake are already in support. The minimum net cash condition is unlikely to be an issue for both LOTZ (minimum required position of $58m) and SFT (-$10.5m) if the merger is finalized by the end of 2022. LOTZ management has recently closed 50% of the stores which should lower the cash burn to about $20m per quarter – sufficient to satisfy the requirement. SFT currently has only $7m in cash less flooring line of credit – last week the company announced large overhead cost cuts, which would also limit cash burn going forward. In case the merger takes longer than expected the minimum cash thresholds will be lowered by $5m for both companies for each additional month in 2023.

OZ Minerals (OZL.AX) – Potential Higher Offer – 15% Upside
A large-cap arb play. In early August, Australian copper and nickel miner OZL received a non-binding acquisition proposal from mining & energy giant BHP Group at $25/share. Shortly before the proposal, BHP acquired a 5% stake in OZL. The management promptly rejected the bid, claiming that it significantly undervalues the company and is opportunistic given the recent copper price nosedive. The stock has since traded at A$26/share, clearly showing that markets expect a higher offer.

BHP appears to be highly interested in the target to supplement its copper asset portfolio. The companies have overlapping presence in South and Western Australia, suggesting potential sourcing and cost synergies. In fact, reports suggest that BHP was previously considering signing an offtake agreement for West Musgrave which is one of OZL’s key Western Australia assets. Another positive is that shortly after rejecting the bid OZL received the final regulatory clearance to start West Musgrave mine construction. BHP recently reported strong year (ending June) results – the world’s biggest miner generated plenty of cash. Some analysts suggest that a bid at A$30/share (15% upside) might do the trick. The downside to pre-announcement prices is 27%.

FAST Acquisition (FST) – SPAC Liquidation + Litigation – 7% Upside (questionable)
This is an interesting and potentially precedent-setting situation. It was hinted by Greg (thank you). Fast Acquisition is a SPAC that was due to merge with Fertitta Entertainment – the conglomerate of prominent billionaire Tilman Fertitta. This was supposed to be a huge $8.6bn deal. In 10 months during the merger process, Fertitta Entertainment performed way better than initially projected and in Dec’21 decided it doesn’t want to go public anymore at the initial SPAC valuation. The transaction was canceled. Quite unusually, the agreement included a large termination fee – around $1.3 per FST share if FST management doesn’t find a new deal till Aug’22. And the key question is who should get these funds.

Recently the company announced it is liquidating, however, it will return only IPO money (trust value is around $10.02/share). The sponsor has decided to keep the received termination fees (around $33m in total) for themselves. Shortly after, a prominent activist Bulldog Investors filed a lawsuit saying:

We have seen some brazen self-serving schemes by public company insiders over the years but the attempt by a SPAC sponsor, after failing to achieve a business combination, to grab a parting gift for itself and management at the expense of the SPAC’s public stockholders, as it intends to do here, represents a new low in corporate governance.

Recently, one more individual shareholder has filed a suit as well and I’ve heard rumors that several others are also preparing it.

This is the first time we’ve seen such a situation. The termination fee has dropped into the holding company’s account and at least on a quick glance, I’m a bit skeptical whether SPAC shareholders should be entitled to anything more than just the funds in the trust. And not sure if the lawsuits have any legal standing – why should SPAC investors receive anything more than the trust value if the de-SPAC transaction was not consummated? The sponsor, on the other hand, had significant expenses in launching the SPAC, running through the merger process, and in turn, might be rightfully compensated by the received termination fees. Were it not for the involvement of Bulldog Investors, I would have dismissed this case outright.

However, Bulldog Investors and some other shareholders think differently. If they’re correct, investors are paying around $0.25 cents to earn something close to $1 (after-tax). If they’re wrong, the total downside to trust value is not that large (2%).

IronSource (IS) – Merger Arbitrage – 27% Upside
A complex large-cap merger arb with a very wide spread and multiple moving parts was recently covered by Andrew Walker in YAVB blog. In mid-July, IronSource entered into a highly strategic merger agreement with Unity. However, IronSource’s main competitor AppLovin got cornered seeing a significant threat to its competitive positioning from the IS/U combination, and in turn, was forced to make an offer to acquire Unity. With this news, the spread of the IS/U merger promptly widen from 15% to 59% as the APP bid was conditioned on Unity dropping the IronSourc deal.

Unity’s board promptly rejected the desperate APP’s offer before the markets opened on Monday. The spread of IS/U merger narrowed instantly but still stands at 27%. The merger is expected to close in less than 4 months. The key risk seems to be AppLovin coming back with an improved offer and in turn Unity dropping the merger with IronSource. However, after a 25% drop in APP share price after its bid for Unity, an improved offer seems highly unlikely unless they give up a lot more equity and control. 

LMP Automotive (LMPX) – Liquidation/Capital Return – 25% Upside
A note from Clark Street Value on LMP Automotive liquidation (referencing earlier post). Management estimates capital distribution at $10.49-11.49/share and LMPX stock trading at $8.78/share, or 20%-32% upside. The sale of the business is expected to be completed by Oct’22 with distribution likely coming by the end of the year. However, LMPX will go dark on the 25th of August, leaving limited oversight of the company’s management and their treatment of cash flow streams. Apparently, the actors involved have somewhat stained track records.

Exmar NV (EXM.BE)
The idea was recently highlighted in the Value and Opportunity blog. Exmar NV, a Belgian listed holding company with multiple assets in the maritime industry is selling one of its businesses. Specifically, they are divesting their infrastructure segment consisting of two large LNG plants, that have been idle for the last 2 years, and two floating offshore accommodation vessels. On the announcement, the share price shot up by more than 60% but a significant upside still remains. The expected range of proceeds from the sale of the business is between $572m to $694m. At the midpoint, the total proceeds would equal 65% of the current enterprise value of $970m. The transaction is expected to close promptly in the second half of August.

The RemainCo is a stable LPG business that brings in $60 to $70m in adj. EBITDA per year with multiple valuable vessels. Value and Opportunity arrive at a $14/share fair value of the post-sale EXM.BE or a 60% upside from the current levels. Some sell-side analysts such as Kepler expect a rather significant special dividend distribution of 7 EUR per share post-sale. However, thus far, the management has not made any public commitments with the regard to their capital allocation plan. The next earnings release on September 5 should serve as a catalyst with management expected to provide some information on what they plan to do with the excess cash.

 

PREVIOUS QUICK PITCHES PLAYING OUT

All the below-listed cases with the exception of CBIO have already almost fully worked out.

Catalyst Biosciences (CBIO) – Expected Liquidation
An update on Catalyst Biosciences (CBIO) liquidation process that was recently covered in our weekly. Recap: Catalyst Biosciences, a clinical-stage biopharma company, intends to wind down and distribute $2.06/share if it is able to settle with activist JDS1/Sulian Singer (allegedly a bad actor). The activist started a proxy fight to gain control of the company and filed a court complaint against CBIO. Another activist, JEC 2 (owns 8%), supports management’s liquidation plan and calls for both parties to settle.

Eventually, the activist has withdrawn its director candidates several days before the shareholder meeting. Shares are up 10% since we covered the case, but a further 7% spread remains to management’s estimated distributions of $2.06/share and an even wider spread to $2.5/share cash to be sitting on the balance sheet shortly – not clear how much of this cash buffer will be burned till final liquidation, but there seems to be the sufficient margin of safety. 

Hailiang Education Group (HLG) – Chinese Privatization
A great update on Hailing Evolution Group – a Chinese take-private from one of our first weeklies. The stock of this school tutoring company was crushed by Chinese education reform and presented a clear opportunity for management to cash out the minority shareholders at cheap. The bid was/is at $14.31/ADS in cash and the spread stood at 11% at the time. Recently, upon announcement of the shareholder meeting (15th of Sep), the spread narrowed to below 3%.

Tassal Group Limited (TGR.AX) – Potential Higher Offer
The situation was already highlighted a number of times in SSI weeklies. Over the last couple of weeks, Australian salmon and king prawn farming company Tassal Group received and rejected multiple bids from its larger Canadian peer Cooke Aquaculture. For a long time, TGR.AX was trading a few cents above the last rejected offer of A$4.85/share with anticipation of an upcoming higher bid. Meanwhile, Cooke was accumulating a significant stake in the company increasing ownership from an initial 5.4% to 10.5% by mid-July. Finally, the takeover saga might be coming to an end. This week, Cooke revised the offer upwards by 8% to A$5.23/share and the new bid has been accepted by the board of Tassal. The shareholder meeting is set for early-mid November 2022. At this point, the spread stands below 2%.

UEX Corporation (UEX.TO) – Bidding War
This is a final update on the previously highlighted bidding war for UEX. Two large uranium players Uranium Energy (UEC) and Danison Mines have made multiple all-stock offers for UEX corporation over the last month and a half. For the merger to finally go through UEC had to raise its latest bid by a tiny margin from 0.089x to 0.09x. Danison Mine finally relinquished the fight. And the spread was fully eliminated after UEX shareholders approved the transaction. This arb play delivered 15% return for hedged trades since our first mention of the case.