November 9, 2020-China Exerts its Influence and Forces Cancellation of the $37 Billion Ant Group IPO. Why Did the Chinese Communist Party Blow Up the Ant IPO?
SPAC InterPrivate Acquisition Strikes Merger with 4D LiDAR Company Aeva. What Does the Market Think of this Deal?
Dunkin’ Brands to Go Private in One of the Largest Leveraged Buyouts of the Year. Is Private Equity Back in the Game?
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Transcript:
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 podcast listeners to episode 96 of The Absolute Return Podcast. I am Julian Klymochko.
Michael Kesslering: And I’m Mike Kesslering.
Julian Klymochko: Today is a late Friday, November 6th, 2020. If we look at the markets this week, I mean, things were really wild, all that nonsense going on with the election, which we’re going to speak none of in this episode, there’s been too much of that. We hate politics and we like stocks. So that’s what we’re going to focus on. Some of the things we want to chat about this week, off the top.
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- China exerted major influence and forced the cancellation of the $37 billion Ant Group IPO, which was going to be the largest IPO of all time and had just a massive north of $3 trillion in demand, which is pretty shocking to hear. We’re going to chat about why the Chinese communist party blew up this IPO?
- Into some SPAC news. Into private acquisition, a special purpose acquisition company struck a merger with 4D LiDAR company Aeva. What does the market think of this deal?
- And lastly, we’re going to get back into some leveraged buyouts. Private equity is back in the game as Dunkin Brands struck a deal to go private in one of the largest leveraged buyouts of the year. We’re going to chat about some of the dynamics happening in the private equities space.
CHINA EXPERT ITS INFLUENCE AND FORCE CANCELLATION OF THE $37 BILLION ANT GROUP
Julian Klymochko: But real, real shocking news this week. We previously chatted about Ant Group upcoming $37 billion IPO, which was supposed to get completed this week, but it got pulled last minute. After the Chinese Government came out and suspended the listing. Now Chinese authorities, aren’t giving much detail about the issues behind the suspension. Beyond saying that there’s much-anticipated stock market debut of Ant Group couldn’t go ahead because there had been quote, “Significant change in the regulatory environment”. But what really happened here? It was a power move from the Chinese communist party, slapping down Jack Ma. They thought he got out of line and what he did last month at a conference, Jack Ma spoke negatively about Chinese state-owned banks. And in China, that’s a big no-no. You either tow the party line or sometimes, you know, they can take away your wealth, take away your freedom or even your life sometimes, unfortunately, but for this one, it appears like the Chinese Government it’s only taking away Jack Ma wealth for now costing him nearly $3 billion dollars in lost net worth. As Ali Baba Group Holdings shares, the parent company of Ant Financial.
They tanked about 7% on the news. So certainly refusing to toe the party line and criticizing the Chinese Government, or at least the state-owned banks was a super costly mistake for Jack Ma. And this was just a real shocking turn of events for everyone involved. This was supposed to be, you know, a seminal event for the Chinese FinTech industry. Ant Financial was going to have a market value of $315 billion dollars, which is bigger than JP Morgan. It’s four times larger than Goldman Sachs. So, this was going to be a massive, massive market cap. As I said, 3 trillion of retail investor demand, which is just mind-blowing. I know some brokerages were offering 10x leverage for anyone willing to buy the IPO and maybe we’ll shed a tear for the investment bankers missing out on an estimated fee pool of nearly $400 million. So perhaps they won’t be able to buy that third mansion at the end of the year this year. So, sad story for the investment bankers on this deal. Likely, lawyers having a tear in their beer tonight, and it just goes to show you, in China and other markets like that, say Russia and other emerging markets, you know, you never really own these assets. You think you own them, but at the end of the day, the government really can do whatever they want. You really have no claim on the assets ultimately, you know, in contrast to the more free markets of North American and Europe. So that’s something that I wanted to flag for investors is crazy things can happen specifically in the Chinese market. And this $37 billion dollar IPO where the government just wants to go after one guy, truly is shocking. What do you think of these crazy turns of events, Mike?
Michael Kesslering: Yeah, really interesting turn of events. And I guess to go back to what Ant Financial actually is. So, they are the parent company to Alipay, which is the payment platform used on the Alibaba platform. And then your comments around the fact that you really don’t own anything in China as a foreign investor.
Julian Klymochko: Even as a local investor. Does Jack Ma actually, you know, control this now? No, not at all.
Michael Kesslering: Yeah, exactly. He does in theory, but in reality, he does not.
Julian Klymochko: But it’s even worse for foreign investors.
Michael Kesslering: Yes, and so for foreign investors, what happens is there’s a complex legal structure that’s set up to allow foreign investors to participate.
Julian Klymochko: Because they can actually own.
Michael Kesslering: Yes, and it’s called a variable interest entity structure. And so, as an investor in one of these structured, you actually don’t have any rights to the assets. And it’s almost similar in a way to like non-voting shares. Although I would argue with even less ownership rights, but investors have actually been burned by Alipay before, the subsidiary of Ant Group. Back a number of years ago, Alibaba actually set up a VIE structure to raise investment from SoftBank and Yahoo. And that resulted in SoftBank and Yahoo owning about 43% of the company. And Alipay being a subsidiary in this structure, Alibaba in 2011, then wasn’t able to get a license for Alipay from the Chinese Government because of these foreign ownership interests. So, Jack Ma basically just spun out Alipay from Alibaba into an entity controlled entirely by himself so that he could get this licensing.
Julian Klymochko: Tried to just steal the company.
Michael Kesslering: Yeah, exactly. And so, the parties eventually came to a settlement, but the settlement for SoftBank and Yahoo, which is some investors will remember back in 2011, was that over a 60% discount to what their stake would have been worth per spin. So, I guess what you have to consider is this doesn’t necessarily make Ant, or any Chinese company completely un-investible, but I mean, these are some pretty material risks that should absolutely be considered with an appropriate discount being applied because I mean, something like this can happen with any company. I’ve read a ton of thesis on companies like Tencent. I mean, they’re a popular Chinese company. All of these companies are kind of structured under these variable interest entities.
Julian Klymochko: Yeah, many of them don’t own it in North America too, on New York Stock Exchange.
Michael Kesslering: Exactly, and so the ability for somebody to literally just spin out without you no longer having any ownership is a very real risk and something that you just don’t really see in North America.
Julian Klymochko: Yeah, certainly. We want to flag that for investors, some caution behind Chinese stocks, it’s really the wild west over there. Or should I say wild east, with this Chinese Government slapped down of Jack Ma costing him $3 billion dollars and speculators losing out the chance to participate in the Ant Group IPO and our condolences to the investment bankers here. I mean, it’s got to be a tough break on that one, but I digress. Let’s move on to some SPAC news.
SPAC INTERPRIVATE ACQUISITION STRIKES MERGER WITH 4D LIDAR COMPANY AEVA
Julian Klymochko: Interesting deal in the SPAC space. This week, Silicon Valley-based LiDAR Company, Aeva, is set to go public through its merger with special purpose acquisition company, InterPrivate Acquisition, ticker IPV. Got to disclose that we are long of IPV shares and warrants in the Accelerate Arbitrage Fund. Have owned that one for a while. A bit of background on Aeva. Was founded by two former Apple engineers. They do have financial backing from Porsche. It’ll be valued at a post equity valuation of 2.1 billion once the SPAC merger closes. And it really just continues the trend that we’ve seen in the SPAC space over the past, call it four months. We’ve seen increasing deals not just in the EV space, but automotive technology sector. If we look at recent deals such as Velodyne LIDAR, which is now trading on the NASDAQ after completing their SPAC merger, it’s now under ticker VLDR, and that one sure rallied. It went up as much as threefold, but it has gotten cut in half since its peak. It lasts about half its value. It’s worth about 2.2 billion. There’s another self-driving car technology company, Luminar expected to be valued at 3.4 billion after it completes its merger with SPAC Gores Metropoulos. So, it really just continues to trend, what we’ve seen. Continuing to see SPAC doing deals with automotive tech that enables driverless cars, which is, you know, a massive total addressable market that could be profitable and revenue generating a number of years down the line.
But I’d caution investors on these deals. Super, super early stage. That’s why they are raising a ton of capital, really just trying to develop their products, such that they can earn revenue a handful of years out in the future. This specific deal, InterPrivate merging with Aeva, set to close in the first quarter of 2021, in which it then trades on the New York Stock Exchange under ticker, AEVA. Mike, what are your thoughts on this one? So far, market not too impressed, trading at a slight premium, very slight premium to net asset value. So, the stock didn’t really go much. Didn’t see much of a pop at all on this one, but who knows, I mean, it’s not going to close for another few months, so anything could happen.
Michael Kesslering: Yeah, and I mean, they are really relying on a significant amount of the trust being in play for proceeds in this transaction.
Julian Klymochko: It does have a PIPE, though, right?
Michael Kesslering: Yes, it does have a pipe of $120 million, which also includes Porsche, which had already invested. I believe they have invested in two financing rounds in 2018 and 2019, but they’re also included in the pipe. But, yeah, they’ve definitely need to trade above NAV so that their trust value isn’t completely redeemed.
Julian Klymochko: And we talk about that often and I saw a couple of SPACs have deal votes and these were pretty low-quality deals and they lost like a vast majority of the cash in the bank, like to the tune of North of 90% of it, where you’ll have a SPAC that raised over a hundred million dollars and come time to close the deal, given the redemption option. They’ll end up with like $10 million dollars or less, which kind of defeats the purpose of the whole thing,
Michael Kesslering: Yeah, because I believe as the SPAC sponsors would be pitching their entity to the target company in this situation, Aeva. They would be really pitching their trust value, and you know, that this will be around. That they’ll have shareholders, that’ll be around after this SPAC.
Julian Klymochko: Right.
Michael Kesslering: And so, if this happens over and over, it just makes the SPAC less attractive for target companies. But I did just want to mention a little bit on the underlying technology. A couple interesting highlights that I kind of took away. Was number one, I guess, as you had mentioned, Julian, this is the third LiDAR company to go private or to go public via SPAC and really Velodyne, the first one, they’re the market leader in this space. And so, Luminar and Aeva are really trying to take market share from them. So, this is still a very emerging market.
Julian Klymochko: Very speculative, early stage.
Michael Kesslering: Yeah, and just because you’re the market leader at this stage, doesn’t really account for too much, but it is worth noting. Another interesting thing just on LiDAR in general. It’s a technology that really, all the major industry players believe in and they think that’ll be the key to self-driving and autonomous vehicles. And really that’s with the exception of Elon Musk, where he views the focus on Lidar technology as fairly misguided where Tesla uses cameras and radar instead. Now that’s really not to say that I have any idea of this industry.
Julian Klymochko: Yeah, he’s probably a decent expert. He has been running Tesla for a while.
Michael Kesslering: And to be fair, he has gone against the car industry before and as of today is winning pretty massively. At least if you look in terms of market cap, right. But I will say that when you’re looking at the technologies, it is a fairly interesting rabbit hole to fall down on a rainy day. But certainly, a very complex industry that, yeah, I really am not an expert in,
Julian Klymochko: But it’s a trend that we’ll continue to see. SPAC doing deals in the EV tech space, automotive technology sector. This one continues this self-driving car technology, which could be a massive market in the future, we’ll see. But as you mentioned at this point, highly speculative, we don’t really know who’s going to be the winner. And you know, you don’t ultimately know the economics behind this technology. So speculative could work could not, but high risk for certain.
DUNKIN’ BRANDS TO GO PRIVATE IN ONE OF THE LARGEST LEVERAGE BUYOUTS OF THE YEAR
Julian Klymochko: Crazy market animal spirits are back. Massive LBO’s today, $11.3 billion, which is one of the largest of the year in the Inspire Brands. It is a restaurant roll-up owned by private equity firm, Roark Capital. They announced a friendly acquisition of coffee and donut shop, Dunkin’ Brands at $106.50 per share. This represented a premium of about 20%. Now this $1.3 billion leveraged buyout represents the largest LBO of the post-pandemic bear market era. One thing to note is that when the bear market hit in Q1, private equity completely went away. They were nowhere to be found, even though stocks were super, super cheap. No one was going to finance these deals and they were just scared for their own companies going under. So, they had a lot on their plate. No one was in the mood to do an LBO and they effectively waited until markets were back to all-time highs to come back out of the woodwork and start doing deals again, this $11.3 billion buyout is the second largest restaurant buyout on record. And ironically, this is not the first time Dunkin Brands has been LBO. It was actually first LBO by Bain Capital Carlyle Group and Thomas H. Lee Partners for $2.4 billion in 2005. And now it’s being LBO again 15 years later. But to me, it kind of puts to rest a couple of arguments on the advantages of private equity.
Number one is the so-called operational improvements that they say they can enact that apparently public companies cannot. But if you’re in this scenario, Roark will be the fourth private company, private equity company that owns Dunkin after Bain, Carlisle and Thomas H. Lee. Are they really going to make many operational improvements? After three private equity firms, you know, squeezed as much juice as they could out of this one. The other thing is the notion of the illiquidity premium, but if you’re going into the liquid markets and then paying a 20% premium on top of that, where does this illiquidity premium come from? Especially when these deals are getting passed between buyout firms, private equity sponsors, if one person selling or one firm selling the other firms buying, then no, one’s really earning that illiquidity premium, unless one is then the other one’s paying it, right? It’s a zero-sum game. So that really doesn’t exist. If people are pitching you on private equity for operational improvements or the illiquidity premium, you can immediately discount because, you know, as we can see those two effectively risk premiums really don’t exist in private equity buyouts.
But private equity, specifically Roark Capital. This hasn’t been their only move of 2020, give them some credit. They did make a move during the pandemic. They bet $200 million dollars on the cheesecake factory in April, which was like, we pretty well timed a strategic rationale behind this deal. So, Roark owns Inspire Brands and Inspire Brands after the acquisition closes of Dunkin Brands. This takes her total restaurant count to over 31,000 globally, which puts them second to Yum Brands, 50,000 worldwide restaurants. And if we want to talk about valuation, merger arbitrage spread, et cetera, super high valuation on this one, 22.7 times next year EBITDA and oddly, I mean the merger spread super, super tight it’s at 3.4% annualized. Implying a chance of success of 98%. In my opinion, at 22.7 times, EBITDA multiple, not a lot of appetite for over bids in this one, but the market seems to be pricing a bit of it at 98% odds of success, given that this is a massive leveraged buyout. What are your thoughts on this transaction here?
Michael Kesslering: Yeah, I guess in this situation, I’ve looked a little bit into Roark in their playbook and whatnot, and I guess I would push back a tad on private equity’s ability to provide some operational improvements. Now, I would say that you would be right very much so the vast majority of the time, I would point to Roark in particular has had some success with Arby’s where they had quite the turnaround with Arby’s.
Julian Klymochko: Have you ever been to an Arby’s?
Michael Kesslering: No, and I was just going to say, if you can turn around to Arby’s, I mean, that seems like you must have some decent operational chops.
Julian Klymochko: If you know someone that’s ever-stepped foot in an Arby’s, I’d be shocked.
Michael Kesslering: Yeah, you got to avoid that person. But in terms of their playbook over the last 10 years. Believed they were founded in the early two thousand, Roark that is and their focus has been to acquire chains that gave them exposure to franchise fast-food brands. That really had locations that were spread across high traffic areas like malls, highway stops and financial centres. So, as you can imagine, their portfolio likely is impacted a ton by COVID. Just thinking even up the recent trends of malls. I’d imagine they’re doing quite a bit of strategic shifting of their areas of focus just with that exposure in particular. But this acquisition does seem to fit previous model with Dunkin being 100% franchised.
Julian Klymochko: Right.
Michael Kesslering: Very much they’re in need currently in need of a turnaround as COVID has had a massive impact on their business. In particular, I believe Dunkin, they’re just seeing not as much breakfast sandwiches being sold because of people working from home, changing their habits in terms of commute.
Julian Klymochko: Stocks price doesn’t care.
Michael Kesslering: Yeah.
Julian Klymochko: Price has gone up like crazy. And this deal is being done at an all-time high by a large margin.
Michael Kesslering: Yeah, exactly. But in terms of the actual, I guess, some of the unit economics have struggled throughout COVID here, which is not surprising in the slightest. But we’re really looking at Roark, their kind of roots and their founder’s roots, Neil Aronson is in the franchising side. So, he had earlier success in his career with hotel franchising and really took that approach with Roark but a very interesting deal all around. I mean, as you had mentioned, a pretty high multiple that Dunkin getting, whether they’re able to actually juice like returns off of this transaction in particular remains to be seen, but interesting all around.
Julian Klymochko: Yeah, the private equity play book typically is, you know, starve the company of capital. Cut costs as much as you can. So, you know, if you’re a fan of the coffee and donuts at Dunkin’, perhaps some, lowering of the qualities in your future, I’m not sure, but that’s something to keep an eye on.
Michael Kesslering: I would say that’s really difficult to do as well with a franchise model, right? If you’re just cutting costs, you’re just going to pissed off franchisees.
Julian Klymochko: Yeah, we kind of seeing that in Restaurant Brands International, after they acquired Tim Hortons. Used a lot of leverage and it’s kind of controlled by private equity firm, 3G, and they’re constantly fighting with the franchisees and they feel like they’re getting kind of cut worse and worse and worse and worse kind of the economics as time goes on. So, some of these private equity firms really push the line on the franchisees. So, you know, if you’re one of them, I’d definitely be concerned here. But you know, is private equity back in the game? Certainly, $11.3 billion dollar leverage buyout. That’s indicative that animal spirits certainly are back taking Dunkin Brands stock to all-time highs, paying massive, massive premium valuation at nearly 23 times next year’s EBITDA. I’m sure we’ll be hearing about Dunkin Brands in the future. These deals typically last sort of five to 10 years. So perhaps we’ll see an IPO of Dunkin Brands, sorry. The proforma Inspire Brands in a number of years, but that’s about it for episode 96 of The Absolute Return Podcast. If you enjoyed it, definitely check out more on absolutereturnpodcast.com. Give us a review on iTunes and the other platforms. Mention us to all your colleagues or friends, associates, co-workers, and definitely follow Mike on Twitter. What’s your handle?
Michael Kesslering: Is @M_Kesslering.
Julian Klymochko: And you can check me out on the Twitter machine @JulianKlymochko, and until next week. We wish you all the best in your investing. Cheers.
Thanks for tuning in to the Absolute Return Podcast. This episode was brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at www.AccelerateShares.com. The views expressed in this podcast to the personal views of the participants and do not reflect the views of Accelerate. No aspect of this podcast constitutes investment legal or tax advice. Opinions expressed in this podcast should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information and opinions in this podcast are based on current market conditions and may fluctuate and change in the future. No representation or warranty expressed or implied is made on behalf of Accelerate as to the accuracy or completeness of the information contained in this podcast. Accelerate does not accept any liability for any direct indirect or consequential loss or damage suffered by any person as a result relying on all or any part of this podcast and any liability is expressly disclaimed.
