Quick Pitches For BATRA, CNCE, ELSE

BATRA – Split-Off/Potential Takeover – 41% Upside

CNCE – CVR – Multibagger Upside on CVR

ELSE – Merger Arbitrage – 27%+ Upside

UPDATED MERGER ARBITRAGE LIST

I have updated SSI review of all current merger arbs with wide spreads. TLDR – changes since the previous review have been rather minimal and all of the more attractive and more actionable cases have already been covered on SSI as portfolio ideas or quick pitches. The remaining opportunities are mostly in the ‘too hard’ category for me, as they involve significant regulatory or antitrust approval risks. The market is likely pricing these risks correctly.

NEW QUICK PITCHES*

The Liberty Braves Group (BATRA, BATRK) – Split-Off/Potential Takeover – 41% Upside
Liberty Media owns a popular Major League Baseball team Atlanta Braves together with the club’s stadium and a mixed-use development project nearby. Investors can gain exposure to these assets through tracking stocks BATRA/BATRK, which contractually ‘track’ the business performance but do not entail actual ownership of the underlying assets. In November, Liberty announced a plan to split off Braves – effectively converting the tracking stock into a standalone asset-backed company. S-4 was filed in December. The tracking stock is already up 10%+ since the announcement and the stock trades at a visually hefty valuation of 4.8x TTM revenues. However, as one of the best and most popular MLB teams (here and here), Braves is considered to be a trophy asset, and sky is the limit for the valuation. A few activists/BATRA shareholders (including Gabelli) say there is at least 40%-50% upside in the takeover scenario. Precedent private market transactions of less popular/successful sports teams suggest 6x-9x revenue multiples are attainable. At a relatively non-demanding 6x revenue valuation, Braves would trade at $50/share offering 41% upside from the current levels.

Activist investor Breach Inlet Capital (owns 0.4m shares) wrote an open letter back in November, just before the split-off announcement, arguing that Braves is undervalued due to being a tracking stock and would trade much higher as a standalone company. In the recent S-4, Liberty’s management emphasizes pretty much the same dynamics, stating that this split-off transaction would remove the current tracking stock discount (page 100, emphasis is mine):

Separating SplitCo will allow the Split-Off business to receive greater market recognition in the hands of a standalone issuer and is expected to provide greater transparency for investors with respect to SplitCo’s dominant business, the Braves, which is expected to result in a trading price of the SplitCo common stock that reflects a reduced valuation discount than that currently applied to the Liberty Braves common stock. The Split-Off is also expected to reduce the trading discount currently associated with the Liberty SiriusXM common stock. The historical discount to Liberty’s tracking stocks is due to the complexity of the Liberty Media capital structure and uncertainty of future corporate opportunities, among other things, and by reducing such complexity through the separation of SplitCo and continuing to explore opportunities to simplify its portfolio of assets, Liberty Media believes the trading prices of the SplitCo common stock and the New Liberty SiriusXM common stock will reflect a reduced valuation discount than that currently applied to the Liberty Braves common stock and the Liberty SiriusXM common stock, respectively, although there can be no assurance that this will occur.

Another important reason for this split-off is that the conversion from the tracking stock into a standalone asset-backed company effectively sets the stage for the sale of the Braves sports club. I do not fully understand the tax issues involved in this, but it seems that tax accounting rules for tracking stocks create complications for potential asset disposals. Therefore, tracking stocks are often converted into asset-backed companies before the eventual sale. Liberty’s CEO Maffei confirmed this as well: “what it does mean is if somewhere down the road the team is to ever be sold, we can avoid corporate-level tax”. While the CEO also noted that Liberty does not yet have any plans to dispose Braves, a major BATRA shareholder Gamco Investors (owns over 6.2% stake) thinks the sale won’t take long to materialize. Two weeks ago, in CNBC interview Mario Gabelli said that given the increased M&A activity for MLB teams (3 out of 30 MLB teams are currently for sale), the Liberty Braves could also become a takeover target shortly. Gabelli sees an upside of 50% gain within 1-2 years. Gamco has been a frequent buyer of BATRA in the open market, with the latest purchase at $33/share (7% discount to the current levels).

Sports team franchises that were sold over the recent years:

• Miami Marlins (ranking towards the bottom range among MLB teams) was sold for almost 6x revenue in 2017. Multiples generally went up since then.
• A bit more popular team, the New York Mets, was sold at 7x revenue in 2020. According to Breach Inlet Capital, this was an ‘effectively a forced sale process’ and the valuation could have been easily been higher.
• Last year, NFL team Denver Broncos was sold at nearly 9x revenues.

Concert Pharmaceuticals (CNCE) – CVR – Multibagger Upside On CVR
After successfully completing Phase 3 trials, biopharmaceutical company Concert Pharmaceuticals is being acquired by Sun Pharma for $8 per share in cash, plus a non-tradable CVR worth up to $3.5/share. Currently, Concert Pharmaceuticals trades at $8.3/share. The merger is expected to close shortly in Q1’23 with easy passes expected from shareholders and regulators.

The CVR consists of two parts that depend on the commercial success of CNCE’s leading drug candidate, Deuruxolitinib. $1/share will be paid upon reaching $100m US net sales in any fiscal year till Mar’27. Another $2.5/share will be paid if US net sales are $500m in any 4 consecutive quarters till Dec’29. Given the positive results of the successful Phase 3 trials, FDA approval is likely, which is probably the main reason why Sun Pharma is buying CNCE. Additionally, it seems likely that the drug will reach the sales milestones at least for the first CVR payout.

Deuruxolitinib is an oral JAK inhibitor that aims to treat Alopecia Areata (ref. AA). JAK inhibitors are a class of drugs that suppress the immune system. Alopecia Areata is an autoimmune dermatological disease when the immune systems’ attack of hair follicles results in partial or complete loss of hair on the scalp and body. Until recently, there have been a very limited number of treatments available for AA, and even those were mostly unsafe (not approved by FDA) and ineffective for more severe cases. JAK inhibitor treatments attempt to change that. Aside from CNCE’s Deuruxolitinib, there are 2 other fresh JAK inhibitors that target AA disease – Eli Lilly’s Olumiant (already approved in Jul’22) and Pfizer’s Ritlecitinib (NDA submitted in Sep’22 with approval expected in Q2’23). CNCE expects to file NDA for Deuruxolitinib in H1’23. If priority review is granted, the approval is expected at the end of this year. All three drugs target moderate (20%+ of hair loss) to severe cases (50%+) of AA. So far, Olumiant and Deuruxolitinib target only adult patients, while Pfizer’s Ritlecitinib is expected to get approval to treat teenagers (12 years+) as well.

CNCE’s management is very vocal that Deuruxolitinib has the best-in-class efficiency. Information on Pfizer’s drug is very limited, however, CNCE’s drug definitely seems to treat AA more effectively than the already-approved Eli Lilly’s Olumiant. Both drugs have completed two Phase 3 trials with the primary endpoint being hair recovery on at least 80% of the scalp. With the highest possible dose of Olumiant, 33%-35% of patients were able to achieve this in 36 weeks (17%-22% achieved it with a lower dose). Meanwhile, Deuruxolitinib achieved the same primary endpoint for around 40% of patients with a higher dosage and around 30% with a lower dosage in just 24 weeks. It’s important to note that Deuruxolitinib safety profile is clearly not as good as Olumiant’s (see here for Olumiant and here for Deuruxolitinib), however, CNCE’s management, and apparently, Sun Pharma, is confident that it is safe enough to secure the FDA approval.

Now onto revenue potential and CVR milestones. In this article Mizuho Securities estimates $800m peak sales for Deuxurolitinib. Analytics firm Clarivate estimates AA market size in the US to reach $2.5bn in 2030, mostly driven by JAK inhibitors. Given Deuruxolitinib’s superior efficacy over the other two drugs, reaching 4%-20% market penetration (required for the CVR to payouts) does not seem impossible even with competitors already ahead timeline-wise.

CNCE’s management said that Deuruxolitinib’s pricing will be in line with Olumiant’s, which is priced at $2.8k to $5.5k per month with a temporary higher dosage for the most severe cases. Assuming the lower end of the range, back-of-the-envelope math indicates annual revenues per patient at c. $34k, meaning, Deuruxolitinib will only need 3k patients to reach the lower CVR target of $100m sales and 15k patients to reach $500m sales for the full CVR payout (Note: I might be somewhat off with this calculation, as revenues per patient per month might refer to cost for the patients/insurers rather than the revenue line for the pharma companies, but the difference between the two is probably not very significant). CNCE’s management suggested that the target market for AA in the US is several hundred thousand and ‘up to 1.5m’. However, a recent study done in 2020 indicates that the US population with moderate to severe AA cases is a much lower 300k. While that is still more than sufficient for the CVR payouts, there are certain arguments suggesting the real achievable market potential might be significantly lower than the figures indicated above:

• As I understand, AA is an elusive disease that, while not curable, can onset and disappear randomly. For example, a person gets AA and loses some hair while the disease is in effect. However, after some time AA might fade away (the hair then often regrows) and then reappear again in a few months or years. This source says that one episode of AA usually lasts from several months up to a year. Therefore, most patients that have AA might need the drug only temporarily/several months per year and might not need to use it every year continuously. Therefore, the actual target market here is clearly significantly lower than might appear at a quick glance.
• Probably, a decent part of all target patients will not use JAK Inhibitors at all as they are considered risky (due to suppressing of the immune system) and have a heightened risk of causing various heart disease complications and cancer. The class has been scrutinized by EU regulators and received the recommendation of the ‘last resort treatment’ for patients in the risk group. FDA has also asked JAK inhibitor developers to update warnings.

Electro-Sensors (ELSE) – Merger Arbitrage – 30%+ Upside
This is a speculative nano-cap merger with the downside mostly protected by the target’s net cash and owned real estate. However, liquidity is very limited with $15m market cap and $5-10k ADV. Monitoring and process control system manufacturer Electro-Sensors is being acquired by privately-owned Mobile X in a reverse merger transaction. As I understand, the sole purpose of this merger is for Mobile X to get a public listing. ELSE shareholders are set to receive a cash dividend of $4.83/share ($18m in total) and retain approximately 11% ownership of the combined entity. The cash portion alone offers 5% spread. Estimating additional potential upside from the 11% stake in the combined entity is quite tricky given limited visibility into Mobile X’s business and financial position. However, there are a couple of reference points:

• After the transaction announcement, for a few months ELSE was trading close to $6.0/share. I.e. the market was valuing the 11% ownership in the combined company at an additional $1.17+ per ELSE share.
• A third-party equity investor is committing $20m of new equity in exchange for 13% ownership in the combined company. At this valuation, the 11% ownership in the combined company is worth $4.5 per ELSE share.
• Finally, ultra-conservative estimate – the combined company is unlikely to worth less than the standalone ELSE, in which case the 11% stake would be worth an additional $0.5/share.

The point I am trying to make here is that, assuming this transaction closes, the upside for ELSE holders is likely to be substantial. The majority of shareholders on both sides are already in support of the merger. Regulatory approvals are unlikely to present any issues given the tiny transaction size.

The main uncertainty here seems to be the already prolonged merger closing timeline and a lack of explanations for the delay. The merger was originally anticipated to close by the end of Oct’22. But then in late September, without any additional details, Mobile X’s financing commitment letter was extended from Oct’22 to the end of Jan’23. The expected merger closing date has also been pushed from H2’22 to H1’23. Management is keeping shareholders in the dark and the reasons for these delays are not clear, but it seems that the above-mentioned third-party equity investor is delaying the matters as the merger is conditioned on the $20m PIPE investment. After January 31 either side might walk away from the merger without paying the termination fee.

On top of that, the activist shareholder Activist Investing sold its 6% ownership stake in ELSE at a material loss back in October after the announcement of the delay. The activist previously acquired the stake in early 2022 and was pushing for a strategic review, which eventually resulted in the current merger. The activist’s sudden u-turn combined with the low liquidity of the stock resulted in shares crashing down 20% to current levels.

The good news is that the company is already trading below the pre-announcement levels. Also, in case the merger breaks the current valuation ($15m market cap) is somewhat supported by $10m of cash, $2m of working capital, and another $2m in the owned office/manufacturing facility (25.4k sq ft in Minnetonka, MN, with nearby properties listed for sale at c. $50-$100 per sq ft). The operating business runs at breakeven and does not burn cash.

Mobile X is a mobile virtual network operator (MVNO) established in 2021. The company has already signed a network access partnership agreement with Verizon and is currently in beta (testing) stage. Mobile X was founded by Australian businessman Peter Adderton who previously established several similar-profile businesses, including $1.6bn market cap mobile platform Digital Turbine (ticker APPS) as well as another MVNO Boost Mobile (sold in 2003 and later acquired by DISH for $1.4bn in 2020). Adderton pursued a similar reverse merger path with Digital Turbine. Overall, Adderton seems to have decent experience in building businesses from the ground up in the mobile/wireless space.