Quick Pitches For VNET, SGA, PRPL, and DR.TO

VNET – Merger Arbitrage – 36% Upside

SGA – Potential Takeover – 22% Upside

PRPL – Non-Binding Takeover Interest – 11% 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

VNET Group (VNET) – Merger Arbitrage – 36% Upside
Non-binding US-listed Chinese privatization offer from management with 30% spread. Data center company VNET Group became a target of several takeover proposals. In Apr’22, VNET received a buyout offer from a consortium led by Chinese PE firm Hina Group at $8/ADS. Management promptly acknowledged the offer and in the latest Q2 results (about 4 months after the offer announcement) claimed to have higher Citigroup to evaluate strategic options, but a special committee was not formed. Hina Group has some experience in the hosting and related services industry and had a previous relationship with VNET – Hina’s MD of Private Equity was earlier president of the overseas business department in VNET. The PE firm also holds a small position in company’s convertible notes (aggregate value only $17m).

Then the 13th of September, the company received a non-binding offer from founder and CEO Mr. Josh Sheng Chen at $8.2/ADS (or 30% spread). CEO owns 9% economic interest and has 29% voting power. A special committee was immediately formed to consider the offer and the founder invited other parties to join his consortium (including Hina Group). Aside from Hina Group, another interested party might be Asia-focused PE firm MBK Partners (ownership % unknown) – in July, Bloomberg reported that MBK was also considering a bid.

The main issue and probably the reason for the wide spread is likely to be the founder’s withdrawn offer for VNET back in 2015 – the market fears this might happen again. In June of 2015, Mr. Josh Sheng Chen teamed up with Tsinghua Unigroup International and announced a non-binding offer at $23/ADS – 20x TTM adj. EBITDA multiple. A special committee was formed. The offer hovered around for a year till it was dropped in June of 2016 with no explanation apart from “certain circumstances”. During this 1 year period VNET’s share price plunged by around 50% and its financials were starting to deteriorate (revenue decline and compression in margins). It is likely that the buyers saw what was happening and decided to pull the plug.

However, the outcome might be different this time:

• It seems that M&A interest from PE firms in the data center industry is booming right now. The interest in VNET is not surprising either given its cheap valuation. The timing is clearly opportunistic as VNET is hovering at all-time lows.
• The $8.2/ADS offer values the company at 6.8x TTM adj. EBITDA and 7.6x E2022 Adj. EBITDA. Much lower than the previous offer (20x adj. EBITDA), albeit the company’s revenue almost doubled and adj. EBITDA almost tripled since 2015. The company also trades below the historical EBITDA multiples which were in low/mid double digits.
• The current offer comes at a discount to VNET’s US-listed Chinese data center peers CD and GDS, which trade at 12-15x adj. EBITDA multiples. However, worth noting that peers are much larger, have higher margins, and have been growing faster over the last few years.

If a definitive offer gets signed, the spread should narrow considerably. Shareholder support from 2/3rds of votes cast will be needed and given the founders’ control of the 29% voting power, the approval seems likely.

Saga Communications (SGA) – Potential Takeover – 22% Upside
Saga Communications is a $167m market cap owner and operator of radio broadcasting properties in the US. Historically, the company used to be controlled by its founder and long-time CEO Edward Christian who held the majority of voting rights through Class B shares (providing 10 votes for each share). In Aug’22, however, Christian passed away, resulting in the automatic conversion of his Class B shares into Class A stock. Importantly, the conversion has transformed SGA from a tightly-held stock into a company with a somewhat scattered ownership structure. Currently, excluding Christian’s stake, the 5 largest shareholders (mostly large PE firms) hold a 51%. This is rather uncommon for the radio broadcasting industry – other peers, such as TSQ and AUD have closely-held shares. Interestingly, promptly after CEO’s passing, the largest shareholder TowerView filed a 13D, stating that there might be discussions with the management regarding the company’s strategic direction. Coupled with the fact that a controlling entity/person will be unable to singlehandedly block any proposal, this might point to a potential company sale brewing up behind the scenes.

Currently, SGA trades at 4.9x TTM adjusted EBITDA. While most peers trade around similar multiples, including CMLS ($139m market cap, 4.6x) and TSQ ($100m, 5.3x). Notably, these peers have highly-levered balance sheets with net debt positions of $629m for CMLS and $484m for TSQ whereas SGA has almost no debt ($52m in net cash). In Apr’22 CMLS received an acquisition offer, which valued the company at 7.2x TTM EBITDA and was promptly rejected as lowball – instead CMLS launched tender offer for 8% of outstanding shares (worth noting that now CMLS trades materially below the offer and tender prices). Applying the same multiple for SGA would translate into a consideration of $36.6/share or 22% upside. Admittedly, the macroeconomic environment has somewhat deteriorated, however, the company’s exceptionally solid liquidity position could justify such an acquisition multiple. Additionally, SGA’s real estate is what might also make it an attractive target. The company owns the majority of the operated properties/towers. At their conservative estimate – depreciated historical value – real estate assets are currently worth 47% of the EV. A potential suitor might be interested in pursuing a sale-leaseback transaction which is apparently common practice for radio broadcasters (some examples here, here and here).

Purple Innovation (PRPL) – Merger Arbitrage – 11% Upside
Purple Innovation designs and manufactures premium/luxury mattresses and pillows. The products are sold DTC through e-commerce or in PRPL’s retail showrooms. A few days ago the company received a non-binding acquisition proposal from its major shareholder (owns 45%) Coliseum Capital at $4.35/share. PRPL share price jumped up and the spread gradually narrowed to 0% and then widened again to the current 11%. The offer clearly looks opportunistic and timed at historical share price lows. Alas, the valuation support is minimal. PRPL is basically a growth story, which compounded top line at 50% from 2018-2021. The growth was supported by new mattress model releases, the launch of the wholesale business, and then COVID boost on demand. Despite that, the company has managed to reach profitability only once in 2020. This year, as the positive benefit from pandemic subsided, revenues fell over 20% in both Q1 and Q2. The current offer comes at 0.6x TTM sales compared to sales multiples of 4x at post-COVID peak and 0.75x pre-COVID.

Another big question here is shareholder support. Shares are tightly held (mostly by PE firms) and 6 large shareholders own 34% of PRPL – i.e. they have majority of minority vote. For most of these shareholders have cost basis that is materially above the offer price – with FMR and Wasatch Advisors having acquired their stakes at nearly $40/share, peak of pandemic boom. It is not clear if these shareholders would be willing to sell at current prices and book large losses. On the other hand, PRPL burns a ton of cash each quarter and another dilutive equity raise is only 1-2 quarters away – the company has already diluted shareholders by 24% and Coliseum was a major participant there.

PRPL was listed through a SPAC in 2018 and Coliseum Capital was a participant in the PIPE. Coliseum Capital is a small investment firm, which holds several other COVID beneficiaries (e.g. major shareholder in LAZY). PRPL is its 3rd largest position. The downside to pre-announcement levels is 29%.

Medical Facilities (DR.TO) – Odd Lot Tender Offer – C$78 Upside
Medical Facilities operates surgical hospitals in the US. The company has recently announced a tender offer for 10%-12% of outstanding shares at a price of C$10-C$11.5/share. Paid-up capital stands at C$10.98, so withholding taxes will be minimal. Shares are now trading at the middle of the range offering C$78 potential upside if the offer is priced at the upper limit. Management owns <1% of shares and will not tender. The tender expires on the 24th of October. The business is pretty stable (though margins have been compressing by a bit over the last couple of years). DR shares are trading in-line with historical valuations of around 5x TTM EBITDA. We have no arguments in favor of upper limit pricing or potential under-subscription.

PREVIOUS QUICK PITCHES PLAYING OUT

LMP Automotive Holdings (LMPX) – Liquidation/Capital Return – 7%-17% Upside remains
A couple of weeks ago we pointed out Clark Street Value blog’s pitch on LMP Automotive liquidation. Management estimated capital distribution at $10.49-11.49/share with LMPX stock trading at $8.78/share at the time of our highlight or about 20%-32% upside. The sale of the vast majority of the company’s dealerships was expected to be completed by Oct’22 with distribution expected by the end of the year. The main issue was that LMPX was going to go dark on the 25th of August worrying investors of potential value destruction.

Just recently, the company announced a sale of its last remaining dealership re-iterating the liquidation path as a way to maximization of shareholder value. Subsequently, shares jumped by 12% on the news. An 7%-17% upside to the lower end of the liquidation value remains.

IronSource (IS) – Merger Arbitrage – Spread is now eliminated
The idea was highlighted in our weekly newsletter about a month ago. This was a highly strategic merger between two leaders in complementary industries – IronSource (target) and Unity Software. AppLovin (APP), IronSource’s main competitor, quickly realized the threat posed by the IS/U combination to its competitive positioning and promptly submitted an offer to acquire Unity which was conditioned on Unity dropping the IS deal. This caused a wide spread on the IS/U transaction – even after Unity rejected the AppLovin offer, the spread stood at 27%, as the risk of APP coming back with higher offer was still looming. We argued, that this is unlikely due to the material decline in APP share price after it announced the initial offer. Recently, AppLovin officially confirmed that it won’t be making another bid and the spread IS/U merger spread quickly narrowed below 2%.

U.S. Well Services (USWS) – Merger Arbitrage – Spread is now eliminated
In July of this year, we covered a merger in the fracking sector between U.S. Well Services (target) and ProFrac Holding. The buyer IPO’ed quite recently and was on an acquisition spree. The spread to all stock merger consideration was 10%. Shareholder approval is guaranteed and the only reason for the 10% spread seemed to be previous volatility in borrow fees. However, over the last two months, borrow fees have stabilized at under 6%. The spread has now narrowed to 2% with no further merger related updates.