May 4, 2020—Equity Financing Window Opens Up with $200 Million Boyd Group Financing and Over $800 Million of SPAC IPOs. Is the Market Signalling “All Clear”?
Mergers Re-Emerge as Silvercorp Announces $105 Million Acquisition of Guyana Goldfields. Are More Deals to Come?
Short Seller Launches Attack Against Merger Target Forescout Technologies. Does the Report Have Merit?
Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.Com.
Julian Klymochko: Welcome, investors to episode 65 of the Absolute Return Podcast. I’m your host Julian Klymochko.
Michael Kesslering: And I’m Mike Kesselring.
Julian Klymochko: Today is Friday, May 1, 2020. A number of interesting events that happened in the market this week. We are going to provide you with some interesting insights off the top:
- The Equity Financing window opened back up with a $200 million dollar Boyd deal from Boyd Group to finance an aggressive acquisition spree. In addition, over 800 million of SPAC IPOS closed this week. Is the market signalling all clear with respect to this coronavirus Bear Market?
- Mergers re-emerge as Silvercorp announces $105 million acquisition of Guyana Goldfields. Are more deals to come?
- Lastly, Short Seller launches an attack against merger target for Forescout Technologies. Does this report have merit?
EQUITY FINANCING OPENS WINDOW UP WITH $200 MILLION BOYD GROUP FINANCING AND OVER $800 MILLION OF SPAC IPOs
Julian Klymochko: I wanted to touch on what has been happening on the equity financing side in the market over the past week and a positive sign that market participants are regaining confidence and risk appetite. Auto body shop consolidator and one of my personal favourites, Boyd Group Services, which trades on the TSX under BYD. They announce a $200 million bought deal, equity financing. Boyd Group they are a consolidator of auto body shops in North America. We are along the stock, so some disclosure there in one of our long/short strategies. I have been a shareholder of this company for many, many years. Fun fact, it has been one of the best performing stocks since 2009.
It hit something like three or four bucks back then, and it is closer to 200 bucks per share. Compounded at an extremely high rate. Well, north of 20 percent annualized for over a decade. One of the best performing stocks on the TSX, and what makes this deal unique is its cashing up Boyd Group to go on an aggressive acquisition spree, which they really specialize in. This isn’t what we’ve seen over the past month or so, some bailout financing, rescue, distressed type financing. This is for Boyd to go out on the offensive, and so this was a $200 million bought deal, equity financing done at a pretty slim discount to the last close. I believe it was priced a tight discount, roughly two percent, and the day when it got announced and closed. The stock actually traded up. Typically, you see stocks straight down on financings, and this was an especially tough tape as well. The market kind of was under pressure this week, but Boyd Group traded up on the news of the deal. This is just indicative of tremendous demand for it, so that is something that investors should note, is that investor confidence is coming back. Risk appetite is coming back after we have gone through this really, really tough march. You had the whole coronavirus pandemic bear market. S&P 500 dropped thirty-five percent peak to trough. TSX, down 38, so really, really tough market for investors. Did have a bit of a bounce back in April, and May is off to a bit of a rough start but we have seen other financings as well, some smaller financings. This Boyd deal was the largest Canadian equity financing completed since the Coronavirus pandemic emerge.
However, we have seen a number of the smaller financings in recent weeks, including two $20 million dollar bought deals by group benefits provider People Corp. and supply chain software firm Texas Inc. We did see two precious metals deals, I believe $20 million dollars for Victoria Gold and I believe Bluenose did something around $80 million dollar deal as well. You are seeing green shoots within the equity financing space and the special purpose acquisition space, which was really dead for about a month. Until last week we saw Social Capital three do a massive IPO. I mean, north of $700 million, which we talked about on last week’s podcast episode. Well, this week we saw three additional SPAC IPOs close. That equity window, that IPO window has bursted wide open. Three deals raised, over $800 million in aggregate and these were generally considered top sponsors. One of them was by Forstress, which is a large alternative asset manager, actually owned by Softbank, another social capital deal. This was a number two Social Capital Hedosophia, which was supposed to launch on March 16, which then they delayed because March 16 was one of the worst days for the equity markets in history. They did end up delaying it, getting it done at the end of April. Last one, which actually IPOed today is a cannabis focused SPAC founded by Bruce Linton and he is the notorious founder and former CEO of Canopy Growth, one of the largest players and one of the largest innovators in the cannabis space. Certainly, some very good green shoots to see here in the market. As you are saying, risk appetite came back in a number of equity financings and an IPO is starting to close. We are starting to see a lot of conditions sort of normalize after this big panic attack that we went through in March. What are your thoughts on these recent equity financings and what do you think they indicate?
Michael Kesslering: No, it is really nice to see. I mean, those equity capital markets, investment bankers, they have to eat, Right? I mean, but no, it is very good to see. I mean, you had first mentioned Boyd Group and then the SPAC and I mean, really, it is just with specific to the Boyd Group. The market just saying they believe in Boyd’s management team’s ability to create value through their acquisition plan, which does make sense historically. As you’ve mentioned, it’s been a very strong performing stock along with, you know, taking into account the issues with SPACs, it is really saying that, yes, equity markets are open for players that are looking at, you know, consolidation, basically. Looking to be a bit aggressive in what market participants view as low valuations currently. That does make sense as well. One thing that I would like to mention just with regards to SPAC is the chatter that I’ve been seeing among the VCs. Both, you know, on Twitter as well as some other sources are really kind of SPAC’s after social capital. They are kind of coming back into vogue where it is viewed as a pretty efficient way to go public for portfolio companies, especially right now as some of these start-ups, especially in the consumer space and areas such as that, where maybe equity capital markets aren’t quite as open. Well, looking at a SPAC, there is typically a couple $100 million dollars of cash on the balance sheet that is able to be used by the company after the completion of a transaction with a SPAC. It is a way to bring in inflow of cash onto the balance sheet and viewed by a few participants in the VC space. As an alternative to direct listings which Bill Gurley; we have talked about whether direct listings were going to overtake the traditional IPO process, and it really is just another alternative. Which also does bring in cash in the door for companies.
Julian Klymochko: Yeah, it is an interesting structure, and we love SPAC just because they provide interesting arbitrage opportunities. The other thing to note with respect to financings is that. I read a stat showing that so far, 60 percent of the financings in the U.S. were via convertible bonds, and there is this notion of increased volatility, making those kind of more valuable, not to mention more downside protection. That is another interesting aspect, because historically, I believe around 18 percent of financings are via convertible bonds. Now we are seeing them as high as 60 percent, probably a temporary phenomenon, but that is something. Nonetheless, does this signal an all clear? I mean, not yet. The VIX is still quite high, north of 35, which is any VIX above 30, there is still a lot of fear in the market. A lot of choppiness, I believe markets are down kind of two to three percent today. Still, investors are a bit squirrelly, but it is great to see that the equity window is back open.
MERGER RE-EMERGE AS SILVERCORP ANNOUNCE $105 MILLION ACQUISTION OF GUYANA GOLDFIELDS
Julian Klymochko: And another window that opened backup is the M&A window. What happened this week was after a bit of a drought. We saw the only M&A deal announced in all of April this week when Silvercorp Metals announced a friendly acquisition of Guyana Goldfields in a cash and share transaction worth $105 million. Small Cap deal, not big. We do got to disclose on this one. We also have a position in the merger arbitrage spread, so long Guyana, short Silvercorp. We do have that position on for disclosure purposes. Wanted to touch on the strategic rationale behind this deal. This deal diversified Silvercorp’s asset base by combining its two underground silver mining operations in China. With Guyana Goldfields’ Aurora gold mining operation in Guyana. Really just trying to diversify their asset base, diversify their products among silver and gold production. Interesting to note that since the coronavirus pandemic and resulting bear market really commenced late February, there has only been three publicly announced mergers in Canada since late February and all three have been in the precious metals sector. Kind of gives you a sense of where corporate confidence lies, CEO confidence really only in the precious metals space because you have a very good macro backdrop for the price of precious metals.
You have CEOs from gold and silver companies willing to do deals. The other thing that I should note is these three deals, if we look at Endeavour’s acquisition of Semafo. Argonaut’s acquisition of Alio Gold and lastly Silvercorp’s acquisition of Guyana. All of these were shared deals, mostly share deals, and we will get into how Silvercorp structured. There is a cash option but at this point, the shares are more valuable. All three of those deals are all share deals, so that is on a relative basis. It is much easier to do an all share deal as opposed to including some cash in a bear market like we are in now.
Getting into details of this kind of Goldfields deal that shareholders will have the option to receive 60 cents in cash or zero point one one nine five shares of Silvercorp for each Guyana Goldfields shares held subject to a maximum cash consideration of $33.2 million, so basically this offers cash. However, it is pro-rated. Then on the shares consideration side, it is not prorated, which creates this interesting additional consideration or additional value for merger arbitrageurs. And most people don’t know about this, so it’s kind of a little trick that ARBs have up their sleeve. That is called election optionality. It is this additional value that you can harvest from this deal because, say, Silvercorp’s shares go up a lot and you are going to elect the all share consideration, right. Because the cash does not change in value. The shares do change in value. So you will elect into two months when this deal is about the clothes. You can elect the all share consideration, but say Silvercorp shares declined quite a bit. You are actually going to select the all cash portion. Now, other people are smart. They are going to want to elect cash as well but typically you get a good allotment on that. There is a bit of optionality within that. If the stock tanks a lot. You can cushion the blow of the downside, so you will be fully hedged and as Silvercorp shares decline. You will make more money off the deal because you can actually increase the value of a consideration by selecting the cash consideration.
There is some interesting proration optionality, some additional value for arbitrageurs, and an advanced arbitrage technique for you on that one. Nonetheless, more details on this transaction, pro forma. Guyana Goldfield shareholders will own seven point one percent of Silvercorp shares and that is a good number because it is under the threshold such that Silvercorp does not need to have its own shareholder vote, which is a key consideration. A key risk that we always want to stay away from, so this one is safe and sound from the buy side vote risk that we’re always concerned about.
Lastly, I got a quote from the Silvercorp CEO on why they are doing this deal. He indicated, “We believe this is a rare opportunity to leverage our underground mining expertise and strong balance sheet to unlock value for all shareholders through the development of the Aurora underground project, as well as aggressive exploration programs in a proven gold district”. There you have it, really Silvercorp sees this as underappreciated asset and one that they can harvest additional value that the current management team can not harvest. What do you think on this one? Do you think more deals are to come?
Michael Kesslering: Yeah. First, just to get back a little bit on what you discussed about some of the techniques that first you pointed out and really described in a good fashion, the upside optionality with proration, but as well with cash proration. Another thing that arbitrageurs will analyse is they will make an estimate of what the proration pro-rated percentage of cash would be. You know, if you elect to 100 percent cash, you are unlikely to get one hundred percent cash in that situation. But what you’ll do is make an estimate of what percentage of cash you’ll get, whether that be 40 or 50 percent of the cash allotted. What you would basically do is look at comparable transactions. See historically where deals have come in terms of pro-ration as well as you can look at some of the trading close to see any insights in terms of if there’s many other ARBs that are getting into the name, that might give you an indication on higher or lower the percentage that you’ll be awarded. I just thought I would add that as well, but specific to this deal, too. Is what I think I found most interesting about the Silvercorp acquisition was that it came out in the Financial Post today, I believe it was that they conducted the entirety of their due diligence online and typically in a merger or acquisition, especially Mine acquisitions. It involves a lot of Mine visits inspecting the geology of the mine in person. You want to get your engineers and geologists, you know, boots on the ground approach, as well as speaking with some of the workers at the relevant mines.
But I thought it was very interesting that they did a virtual tour of the mines and as well, they met with the management team exclusively through Zoom. It is really just M&A in the era of COVID where, you know, in speaking with some venture capitalists, they’ve spoken about how their deal volume and their deal flow has really gone down because they’re not able to meet a founder and, you know, shake their hand, meet them in person and see their facilities. You know, this is a creative way that in a quite a large deal here in comparison to the venture capital space, you know, a relatively small deal by public market standards, but they were still able to get this deal done. You know, looking at Guyana Goldfields, they are down. You know, I believe it is over 80 percent in the last two years. There has been through a significant amount of value destruction. Silvercorp likely was already at least a little bit familiar with their actual operations, but it was interesting to follow and I would like to point out as well. In terms of the M&A market now, this was a deal that was previously announced a long time ago, but did end up closing on Wednesday was Calgary based TC Energy. They completed the sale of two natural gas power plants in Ontario for about $2.8 billion dollars. I mean that is just another example of, you know, deals still closing in this environment, and it has been very interesting to follow.
Julian Klymochko: Yeah, we did see a couple deals close this week. Nvidia $6.9 billion dollar acquisition of Mellanox on Monday. Today, the United Bancshares acquisition of Carolina Financial, that was a $1.1 billion dollar deal, so deals, as you indicated, are closing.
The thing is, you mentioned this new environment where acquirer’s are basically needing to do virtual due diligence, which will be interesting to see if that will continue. And it’s interesting to take a look at the M&A environment, obviously, over the past six weeks or so with this coronavirus bear market, that there has been a bit of a drought in M&A activity, which is way down and you have to think, is that due to the bear market? And people managements are kind of battening down the hatches, not wanting to do M&A, or is it due to the fact that they can’t travel, they can’t do onsite due diligence and things of that nature? Perhaps it is a combination of both. However, with this deal Silvercorp’s acquisition of Guyana, two things to note: the election optionality, the ability to elect either shares or cash as Silvercorp’s shares move. That is some additional value that can be captured by merger arbitrageurs if Silvercorp’s stock decline markedly. You have a bit of a synthetic put there with the ability to elect cash.
The other would be the pro-ration optionality, which basically indicates that if Silvercorp’s shares do decline quite a bit and you elect cash, perhaps you could get more than you expect. Just given some people either don’t elect because they’re whether it be lazy or they’re just not paying attention or they have tax, you know, they want to elect shares for tax purposes. You can actually get a higher than expected fill on your cash and get additional value out of the merger from that sense. It all depends on what the default consideration, what the default election is. That would be disclosed in the arrangement agreement, which for this deal has not come out yet on Sedar, so we are looking for that but really good to see an M&A deal in this environment, especially in an environment where they can’t do any on-site due diligence. Given travel restrictions and people working from home.
SHORT SELLER LAUNCHES ATTACK AGAINST MERGER TARGET FORESCOUT TECHNOLOGIES
Julian Klymochko: Last topic we wanted to touch on today, activist short sellers Spruce Point Capital. They released a short thesis on an M&A target. We are continuing with that M&A theme here Forescout Technologies, which is currently set to be acquired by buyout firm Advent International in a friendly all cash, $1.9 billion dollar deal and I got to disclose on this one.
We do have a position here, so take that into account. The crux of this short sellers report, this Spruce Point Capital Report indicates that the major argument is that the market has gone down and therefore they acquire overpaid for this acquisition and should either terminate the deal or pursue a reduction in the consideration paid, and this argument really just doesn’t hold water and here’s why. Unfortunately, for the short seller, an acquirer cannot negotiate for a lower price after the target company shareholders voted on the deal and in this transaction, Forescout shareholders already voted and approved the acquisition on April 23. The parties cannot renegotiate that price. That ship has sailed, that option is no longer available. The other is an acquired just cannot readily walk away from a definitive agreement if they have buyer’s remorse. If all deal conditions are satisfied, they must close and we have seen in the past, if they are not willing to close, they’ll get taken to court. They get sued and the court forces them to close. There is this provision called specific performance, which can basically force the acquirer to close.
It reminds me of that scenario that we talked about the other week on the podcast with respect to crude oil futures. Where they went negative, I had some retail investors that bought crude oil futures contracts. They’re negative and not knowing what they’re getting into and said, oh, I bought these contracts, they’re negative, so I’ll just hold on to them. What they did not realize is that it is actually a contract like a definitive agreement. You hold that contract; you are going to have to accept 1000 barrels of oil for each WTI crude oil futures contract because those contracts settle physically, and a deal is a deal. You just cannot say actually forget about that contract. I am just going to ignore it, hope that it goes away. Well, no. You are going to get sued and you’re going to be forced to close. With respect to the physical oil delivery, you do have to accept those a thousand barrels per oil delivered and there is really nothing you can do about it. With respect to a definitive acquisition agreement.
You are going to have to close the deal unless certain conditions are not satisfied. With respect Forescout. They have attained shareholder approval. They have attained all regulatory approval. Company guidance indicated they expected to close on May 18. I think this deal is set to close on the terms, 33 bucks a share, which represented a twenty nine point seven percent premium. The other thing to consider is Advent International is a large, reputable private equity firm. They manage $56.6 billion in assets under management. If a buyer just tries to walk away, that is exceptionally bad for their reputation and good luck getting a deal done after that.
You know, especially in a good environment, when your business model is exclusively buying companies, it is kind of hard to buy a company in the future when your reputation is in shambles.
Nonetheless. I mean Forescout Technologies is a software company and it is not like it’s an airline business or a restaurant company that is completely shut down. I mean, software companies are still doing pretty decently in this environment.
And if you look at Forescout, they seem to be holding up. That is really all I had to say on this short seller report on Forescout. I think it is a good trade to fade it. Hence, we are long Forescout stock. We expect to close and we expect a good annualized return on that deal. What are your thoughts on it?
Michael Kesslering: Yeah, just as summarized as well, some of Spruce Point, others’ main argument is that Forescout breached some of their reps and warranties in the merger agreement by not sharing with the buyer their most pessimistic financial forecasts that they produced internally. I am not a lawyer, but so that really would be for the courts to decide if Advent showed any willingness to terminate, which they have not.
Julian Klymochko: Yeah, that is another major issue. I mean, you can make this argument for a lot of other deals. We saw it on Cineplex, which were long. You did see a short seller come out. Then the problem with Cineplex, the acquirer, that’s Cineworld, is in a lot of trouble. I mean, they are having kind of solvency, liquidity issues. So, yeah, I mean, that is fair argument that there is some risk there.
The other one is kind of BorgWarner and Delfi Technologies, which we also have a position in, and that one that the acquire has actually come out and, you know, threatened on that deal and that elevates deal risk, certainly. Right. You go into those deals knowing that they are problematic but in this one, you have not heard anything negative from the acquirer and for all we know they are excited to close the transaction, right.
Michael Kesslering: Yeah and I mean, strictly from Advent side, there has just been nothing, no communication from their side, which is not uncommon with private equity firms. I know it was pointed out that could be pessimistic, but I really would not read into that as that is kind of normal course. Ultimately, if this did go to court in a world where Advent did decide that they wanted to try to back out of the deal and this went to court, they would have to show that Forescout was intentionally misleading them. Now, because your projections don’t come to fruition just because your projections are inaccurate. That is not illegal. That would not be in breach of any reps or warranties in the merger agreement. You would have to show that Forescout was intentionally misleading the company in order to close a deal.
Julian Klymochko: Well, and the buyers are highly reputable private equity firms here that, you know, the onus is on them to do due diligence and they are professional investors. Such that would not be much of a defence saying that they are poor due diligence.
Michael Kesslering: Absolutely, and in terms of, one of other points made was that Advent have fiduciary duty to their own investors. They know they must consider revising the purchase price lower. Was, I think, the direct quote, an absolute Advent should consider revising the purchase price lower but I mean that does not mean Forescout has to agree to that. And also your fiduciary duty as Advent has to their own investors. That is not overriding the duty by law of this contract. You have give it a good example of taking physical delivery of oil. Our society is based on these contracts. They you know, you cannot just walk out on them if you quote cold feet and as we have mentioned multiple times here, we are not saying that Advent is having any of these views. That is kind of just speculation on behalf of some market participants but in the end, I guess I would say that, you know, I would agree that Advent potentially could be overpaying for Forescout but in the end, that does not really matter. Many deals going on right now that are likely to close are likely to be overpays. That does not matter in this situation.
Julian Klymochko: Compared to the current environment right now. But who knows, maybe in a year. Valuations have gone up or businesses have performed exceptionally well and they could be worth a lot more. I mean, you cannot make a major strategic decision like a buyout, typically seven to 10 years. You can day trade them, you know what I mean? Yeah, their stock price could be lower tomorrow but I was looking at the example of BCE, which went through, well, I suppose a leveraged buyout in which the buyers got out of in late 2008 on a technicality where they were supposed to take BCE private and one of the largest leveraged buyouts ever. The deal failed, BCE dropped. They got out of the deal. The private equity firms are breathing a sigh of relief. However, you look at BCE, how they performed, that LBO would have been an unmitigated grand slam. They would have made billions of dollars and I think now they probably deeply regret getting out of that deal because it would have been incredibly successful just based off BCE’s share price. They would’ve probably compounded north of 20 percent annualized, so it is this difference of time frames looking on a daily or a monthly market basis versus long term value creation potential.
And I should note, so far throughout this crisis, you haven’t seen a private equity firm backed out of a public deal. We did have Blackstone recently closed the Tallgrass energy deal, which was highly, highly distressed in a super challenging market. You did also see Thoma Bravo close their deal for Constructor. CPPIB closing the Pattern Energy deal, Digital Colony and Zayo. There are some outstanding LBOs in addition to Advent, and so we obviously continue to monitor them but those I mean, all seem set to close. It will be interesting to watch this one. In summary, on this Forescout deal, we do believe that the short seller report lacks merit.
But, you know, they’re just kind of trying to rattle investors’ cages, get the share price down such that they can cover however long should remain invested here and we believe that it will close, and that’s our opinion.
That kind of summarizes it for our latest episode here. I hope you guys enjoyed it. If you did, please check out more at absolutereturnpodcast.com. You should give us a follow on Twitter.
My handle is at Julian Klymochko, K-L-Y-M-O-C-H-K-O, and Mike where can they find you on Twitter.
Michael Kesslering: It is, M_Kesslering that is K-E-S-S-L-E-R-I-N-G.
Julian Klymochko: Wish you all the best in your investing, trading and speculating this week, and until next week, we will check with you soon. Cheers.
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