Quick Pitches For OIIM, KNBE, CCHWF, ATCO, LSF, MN

OIIM – Chinese Privatisation – 25% Upside

KNBE – Merger Arbitrage – 15% Upside

LSF – Merger Arbitrage – 67% Upside

MN – Merger Arbitrage – 5% Upside

SSI WEEKLY NEWSLETTER

The intention of this weekly newsletter is to share the most interesting event-driven situations we looked at over the week as well as other updates and highlights from SSI. We review dozens of different situations on a weekly basis and most of them never appear on SSI for one reason or the other. However, our members might have very different selection criteria for ‘an attractive play’ than we have. So aside from the updates on the currently active SSI cases, the newsletter will feature quick pitches on various other situations as well. We also intend to cover the relevant picks discussed by other authors/bloggers. This is very much a work in progress that is going to evolve over the coming months. In time, we’ll see what works best and will adjust the format/content/scope of the highlights accordingly.

NEW QUICK PITCHES

O2Micro International (OIIM) – Chinese Privatisation – 25% Upside
The OIIM pitch below was prepared before this morning’s news that the company entered into a binding agreement at $5/share, or 25% upside to the current trading prices. We were due to post this as a portfolio idea later today. It is unfortunate we are one day late, but at least it is good to see our conclusions vindicated. Substantial upside still remains. We will post another update after we have more time to review the revised proposal. The pitch below was written with $3.25 OIIM price in mind.

An intriguing situation with a potential 50% upside and a short timeline. The caveat, of course, is that this is a non-binding offer a US-listed Chinese company. O2Micro International is a fabless chipmaker. The products are used for power management in LCD and LED lightning and for controlling, monitoring battery charging in portable electronic devices. Integrated circuits are sold to OEMs and ODMs including Acer, Bosch, Dell, HP, Lenovo etc. This year the company became a privatization target:

• In March 2022 the company received a non-binding takeover interest from a Chinese PE buyer with a strange name – FNOF Precious Honour Limited. Consideration stood at $5.50 per ADS. A special committee was formed to consider the offer. OIIM share price jumped to $4.20 and then gradually dropped below $3/share in May.
• On the 20th of May, the buyer released an announcement reiterating its offer at the same price of $5.50 per ADS, however, this time OIIM CEO/chair and CFO have joined the consortium. These insiders own 13.4% of shares. The share price has replayed the previous move – jumping again to $4.20 and gradually drifting back to $3 in the following months.
• After 4 months of silence, last Monday (September 19) the buyers have revised down the non-binding offer to $4.90 per ADS. The market showed a milder reaction reaching $3.50 and now settled around $3.25/share for a 50% spread to the revised proposal.

The market is highly skeptical that intentions are serious. The spread is very wide even for a non-binding Chinese privatization transaction. Maybe this is not that surprising given that the situation has several attributes to make it appear quite ‘shady’ on a quick glance, e.g. extremely prolonged proposal review despite management actually joining in the consortium, long gaps of silence and limited updates around the review process. Plus a Chinese buyer with a name that might trigger scam-alert for some, etc. Part of the spread is also likely explained by the market’s stubborn skepticism towards anything China-related.

However, there are some arguments indicating that the setup might be more attractive than it seems.

While such long review processes and offer revisions are rare, they are not unusual in US-listed Chinese privatisations. Even our Analysis of US-listed Chinese Going-Private Transactions (although probably slightly outdated by now) shows that there were a number of similar cases before – GSUM, CYOU, KZ, JASO and DATE. For these cases, the time gap from the initial announcement till the revised offer ranged from 3 months to even 40 months. And then another 3-6 months between the revised non-binding offer till the definitive agreement. Notably, none of the transactions with the revised offers have failed. The offer price changes usually came after a strong shifts in the targets’ financial performance. The same applies to OIIM – since the original offer announcement in Mar’22, semiconductor industry has been facing strong headwinds from client inventory corrections and the resulting drop in demand. OIIM H1’22 revenues fell -12% and Q3 revenues were guided to drop 30% YoY (this compares to 29% growth in 2021). These headwinds are expected to continue into early 2023. The point I am trying to make here is that the prolonged review and the offer price revision might be not a negative thing here, but rather a rational price adjustment due to industry-wide demand shifts as well as a confirmation of buyer’s continued interest in this transaction.

Contrary to the initial appearance, the buyer is not some kind of a sketchy no-name PE firm with no information or track-record. FNOF is a vehicle of Forebright Capital Management, a spin-off from a prominent and public-listed Chinese investment firm China Everbright (US$1bn market cap, US$25bn AUM). Forebright Capital claims that it has “successfully completed several going private transactions involving China-based US-listed issuers in recent years, and the market valuation of these privatized companies exceeded, in aggregate, US$850 million”. The only privatization that I’ve been able to find is Jinpan International and, interestingly, the developments there somewhat resemble OIIM situation. Jinpan International received a non-binding offer from FNOF at $8.80 per ADS in Sep’14. Target’s chair/CEO joined the buyer’s group. 3 months later the offer was withdrawn without any explanation. In Sep’15 the buyer came back – this time with a $4.5 per ADS offer – and 4 months later a definitive agreement was signed with the acquisition price revised upwards to $6. The transaction closed successfully 3 months later. Interestingly – last year in March, Forebright relisted Jinpan on the domestic Shanghai market (now called Hainan Jinpan Smart Technology). The current market cap of Jinpan is US$1.8bn vs the privatization price of US$100m.

A similar playbook might be in the plans for OIIM as well. The company has no debt, so it’s possible that Forebright Capital intends to lever up the balance sheet and relist the company on the domestic market a few years later. Chinese companies trade at much higher valuations on the domestic markets vs US listings – one of examples is the recently covered HOLI situation, where the rumored privatization offer values HOLI at 21.5x TTM PE vs Shanghai-listed peer trading at 64x PE.

OIIM’s Shanghai-listed fabless semiconductor peer is Amlogic (US$4bn market cap). Forebright has also been an investor in Amlogic since Nov’16. Unfortunately, Shangai’s stock exchange page provides only outdated Amlogic’s financial information from 2020 and earlier. However, data provided on WSJ  (2020 and earlier financials are in line with Shanghai’s exchange numbers) shows that Amlogic now trades at 33x 2021 PE, whereas info on FT.com indicates TTM PE of 24x. In comparison, at the revised offer price of $4.9/ADS OIIM is valued at only 11x 2021 earnings and 16x TTM earnings. This seems to make OIIM an attractive target from the valuation perspective.

Finally, the fact that management including, Chairman/CEO and CFO, have recently joined the consortium is highly positive and increases the chance of a successful outcome.

KnowBe4 (KNBE) – Merger Arbitrage – 15% Upside
KnowBe4 runs a SaaS business offering cybersecurity training to raise employee awareness of potential cyber-attacks, improve behavior to lower threats, and automate workstreams to respond/remediate the attacks. The company has received a non-binding offer from one of the major shareholders (owns 9%) PE firm Vista Equity Partners. Consideration stands $24/share (39% premium). Initially, the spread narrowed to 6.5%, but then gradually increased to the current 15% with a general market sell-off. Special committee has been formed to evaluate the proposal. The downside to the pre-announcement price stands 20%.

Vista Equity Partners also mentioned it is open to considering the possibility of certain other significant shareholders rolling a portion of their stake. In this case, the approval from a majority of disinterested shareholders would be needed. Other major shareholders are Elephant Partners (VC focused on software and tech) with 20.3%, KKR with 12.7%, and entities affiliated with Goldman Sachs with 5%. All 4 of these major shareholders have taken KNBE public in April 2021 at $16/share. The share price initially spiked to $31+, but then quickly settled in a range of $22-$24/share (then declined further this year together with the tech sell-off). After the IPO, the 3 remaining major shareholders except for Vista Equity Partners (KRR, Elephant Partners, and Goldman affiliates) have significantly trimmed their stakes in the two secondary offerings – August’21 at $20.75/share and November’21 at $25.75/share.

KNBE is a growth stock, which increased its top line nearly 5x since 2018 and continues to grow at a 35% annual rate. The company is also profitable and generates a relatively small but continuously growing FCF stream. The current offer comes at 12x 2022E sales and 54x FCF – not cheap by any means. All of the peers are private, whereas other cybersecurity firms are trading at quite scattered multiples – PANW – 2.2x forward sales, FTNT – 8.9x, CRWD – 16x. M&A activity in the software sector is quite high at the moment and the median sales multiple is 6-8x according to SEG. Vista Equity Partners has already made one more (and much larger) software acquisition this year – Citrix Systems (cloud computing and virtualization) for $13bn at 5x sales.

Vista Equity Partners is a reputable, highly knowledgeable buyer that has taken KNBE public before and likely has access to insider information, etc. In the letter announcing the proposal, it emphasized that this takeover intent is “informed by significant work that we and our advisors have completed and by exploratory discussions about valuation with the Special Committee of the Board of Directors (the “Special Committee”) and its advisors about the possibility of a potential transaction”. This suggests that the price might’ve been pre-agreed with the special committee already and that the board approval is just a formality. Given a considerable price premium and elevated valuation multiple, approvals from the remaining major shareholders should pass easily, especially as they had already been trimming their stakes before at similar prices and now have a chance to either fully exit the position or roll a part of the remaining stake.

Columbia Care (CCHWF) – Merger Arbitrage – 16% Upside
Previously highlighted consolidation in the cannabis space. As a quick recap – Cresco Labs is acquiring Columbia Care creating the largest multi-state operator in the US. Consideration stands at 0.5579 CRLBF shares per each CCHWF. There are plenty of borrow for hedging at 4.4% annual fee. Both the antitrust and shareholder approvals have already been received. The merger consummation is expected in Q4 2022 with only individual state regulator consents remaining. Both parties stated their willingness to divest licenses in certain states to meet the license cap restriction satisfying state regulators. Despite all this, the spread recently widened from below 10% to 16% without any merger-related news.

The only remaining uncertainty is the potential exchange rate proration adjustment that is based on the amount of Columbia Care shares issued as an earn-out for the previous acquisition in Dec’20. The final exchange ratio surprisingly has not been declared as of yet, but even if we assume a maximum earn-out ($58m), the exchange ratio would be 0.507689, lowering the spread to 5%. Given the relatively short timeline with almost all the conditions satisfied, the current spread looks quite attractive, especially, if the exchange ratio does not get set at the lowest range.

Atlas Corp (ATCO) – Merger Arbitrage – 12% Upside
The initial pitch is here. Quick recap – last month containership lessor ATCO received a non-binding offer from a consortium of insiders, major shareholders, and the largest client (own 68% combined) at $14.45/share. Minority shareholder approval was needed. At least two large minority shareholders were opposing the deal. Right after the offer in August, the largest minority shareholder Charles Frischer notified the board through a letter that he wants at least $16.50/share. Later in September, the second shareholder, Albright Capital, argued that the standalone value of ATCO is $23+/share.

A few days ago, the buyer consortium increased its bid to $15.50/share, or about a 7% bump on the initial offer. Currently, the spread stands at 12%. ATCO made a press release saying that the special committee did not want to recommend the initial $14.45/share bid, but is now evaluating the updated price. At this point, rejecting the revised offer will be much more difficult. Given the current macroeconomic backdrop – all ATCO peers are down 15%-20% since the initial bid, and charter rates have fallen down as well. The revised price looks much more attractive today than it would at the beginning of August. Instructively, both of the opposing minority shareholders have been silent thus far.

If the takeover doesn’t work out, the downside is around 30%, which partly explains the current spread. If the offer gets approved, the spread will be eliminated immediately.

Laird Superfood (LSF) – Merger Arbitrage – 67% Upside
An unusually large spread even for a takeover at a non-binding stage. On the 17th of August, Laird Superfood announced a non-binding takeover interest from investment bank EF Hutton at $3/share. Special committee has been formed to review the offer. The spread has initially hovered around mid-teen levels gradually increasing to 30%+. This week, prompted by the market sell-off, it widened to 60%+. The buyer has partnered with one of the largest shareholders – Thomas Wetherald, who owns 8% of LSF and will support the deal. The buyer said that financing will be raised through an equity issuance and that it is highly confident in finding interested investors/clients to finance the transcation. Given the sharp market downturn since the offer announcement (SPY fell 15%), the market is clearly skeptical about both – the financing prospects and buyer’s intentions to proceed at the announced terms. Overall, at this point the transaction is a pure gamble, however, here are some aspects suggesting the setup is at least worth tracking:

• The sheer size of the spread. Assuming the buyer is still interested, there is a substantial margin of safety even for a large price cut.
• The proposal hasn’t been rejected/withdrawn for over a month yet, which might indicate that negotiations are ongoing.
• LSF management/other major shareholders are in a difficult situation right now. The company’s offerings (premium natural superfood coffee creamers, organic sugars, snacks, etc.) clearly belong to the discretionary product category. The pandemic boost of sales is subsiding together with the revenue growth, while margins (and, seemingly, demand) are pressured by inflation. LSF is a cash-burning machine and the burn is accelerating – only about a year of runway remains at the latest reported cash position of $25m. The market is wary that in this environment the business will find it very difficult to raise more cash. Not surprisingly, the company’s only credit facility with Wells Fargo got recently amended – the term was extended by one year, but the available facility was reduced from $9m to $5m. CFO also resigned a couple months ago. The company has already tried turning the business around by changing the management team and reducing the workforce by 20% this year, however, it this wasn’t enough. All of this increases the chance that management could look favorably towards selling.
• Despite all the ongoing issues, LSF has no debt and is now technically a net-net (not for long though), so it’s possible to see why a financial buyer could be interested in running a standard PE playbook on Laird’s brand.
• EF Hutton used to be a legendary name on Wall Street (the second largest broker in US), which ended up as a part of Citigroup in the 90s. The brand was revived as a financial services firm after the GFC and went bust in 2019. In 2021, investment bank Benchmark Investments has revived EF Hutton name once again as a rebranding of one of its subsidiaries. Since then, EF Hutton rode the SPAC boom hard and helped to raise over $10bn – half of it through SPACs. I am guessing that EF Hutton might be looking to expand into asset management with LSF as the first acquisition for its new fund EF Hutton SPV I. It’s questionable whether the bank would be willing to risk reputational damage by walking back on its first acquisition attempt.
• Thomas Wetherald, a major shareholder who partnered with EF Hutton, was sitting on LSF board from 2017 till Dec’21. He also had roles of CFO in 2018-2019 as well as Chairman from 2019 to 2020. The letter of intent states that he and EF Hutton agreed to ‘work with each other on an exclusive basis to negotiate and consummate the acquisition of all of the outstanding Common Stock of the Company in a going-private transaction’.
• One of the pre-IPO backers of LSF was Danone, which invested $10m in April’20 and another $2m in the IPO (Sep’20). Danone now owns 9.4%. Founders (two friends including surfing star Laird Hamilton) own around 11%. FMR is with 15%.

Manning & Napier (MN) – Merger Arbitrage – 5% Upside with closing in October
Merger in the asset management industry – Manning & Napier is getting acquired by a privately-held peer Callodine Group at $12.85/share in cash. The merger was announced in April. MN shareholder approval has been secured at the beginning of last month. The remaining regulatory approvals – FINRA and New Hempshire Banking Department – shouldn’t be a problem for a merger of this size (<$200m EV). Initially, the closing was expected in Q3, however, the regulatory approvals took longer than expected and the merger was approaching a preliminary termination date (October 1). Silence from management scared the market and during this week’s sell-off the spread temporarily increased to 9%, despite previously hovering at 1% post shareholder approval. The spread has narrowed to 5% – elevated levels given that on Wednesday management finally gave an update that the regulatory approval process is advancing, the termination date has been extended and closing is now expected in October. According to this tweet, the delay so far has been caused by the understaffed New Hempshire regulators – not a big worry. So despite a modest nominal return, the setup offers a substantial IRR opportunity given very short closing timeline.

The market might also be cautious about lackluster MN performance since the acquisition announcement – AUM declined >10% from April to August. However, it is quite unlikely that the buyer will walk away because of that. The offer price already looks lowballed for a takeover and comes at just 4.9x TTM EBITDA. Even for a shrinking industry like active asset management, this does not look expensive. Much larger peers trade at significantly higher multiples – Blucora ($936m market cap, 10.6x TTM EBITDA) and Wisdomtree Investments ($699m, 9.7x). Another peer Waddell & Reed Financial was acquired last year at 17.1x 2020 EBITDA. This transaction comes as the third acquisition for Callodine Group and is quite important. Callodine was formed in 2018 by Fidelity’s veteran James Morrow and focuses mostly on yield-based investments like credit or real estate. It has $2bn AUM. Since its inception, Callodine has already made two takeovers – Gordon Brothers Finance Company (in 2020) and Thorofore Capital (in 2021). The buyer is also backed by US billionaire Pegula family that is apparently a long-term partner and a good friend of James Morrow. MN transaction will expand Collodine into equity investments and this mix between credit/equity is apparently the new strategy of the buyer:

Because you’ve got this intersection of credit markets and equity markets, there’s not a lot of natural investors. And we think there’s a real opportunity in that uncomfortable, in-between space.

The transaction will boost Callodine’s AUM by 10x and will offer cross-selling opportunities. The termination fee is also very high – around 10% of EV.