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Disclosure: Short NICK
You would think the long-suffering shareholders of Nicholas Financial would understand risk arbitrage after an acquisition proposal for $16.00/share from Prospect Capital collapsed last June.
Shares fell over 30% to below pre-acquisition levels, prompting the Board of Directors to once again consider strategic alternatives. The outcome of that process was an early Christmas gift for shareholders. On December 22, the company announced its intention to commence a modified Dutch tender offer within 30 days for up to $70 million, or between 36-39% of its outstanding shares. The proposed tender offer range is between $14.60-$15.60, with a $50 million minimum tender condition.
So why short?
Two weeks after the announcement, NICK closed at $14.87, well above the low end of the range. However, the offer has not yet commenced. In my opinion, the current price reflects little or no risk of the transaction failing to be consummated.
NICK had just $5 million of balance sheet cash at last report. Although the company is relatively conservatively levered at ~0.5x debt to financial receivables, it will have to raise additional financing to fund the buyback. Surely I’m not the only observer who raises an eyebrow at a debt-financed buyback for a subprime lender at what could well be the peak of the credit cycle. The company’s CEO has voted with his feet and indicated plans to tender in the offer.
To be sure, NICK appears to have a decently profitable business, and a buyback is notionally accretive for continuing shareholders, depending of course on how it is financed. Admittedly, I know very little about the company’s underwriting standards and the competitive environment in its particular niche of the consumer lending industry.
But I do know that the risk/reward here is favorable. This is a trading position rather than a bearish take on the underlying business, but from a portfolio perspective it is welcome short exposure at low cost. Because of the minimum tender condition, the offer is unlikely to be completed if it trades above $15.60. Assuming the offer is initiated as planned, the risk to the upside during the pendency of the offer is thus approximately 5%. (Barring an upward revision to the offer range, which I consider unlikely).
Meanwhile, markets are fickle, and a number of events could cause shares to drop back to the $12-13 range. In the event credit markets seize up or the company has difficulty arranging financing, there is a possibility the offer may not be consummated at all. Even after being initiated as planned, the offer could be terminated. These are tail risks and not the most likely scenario by any means, but they are the reason most tender offers at a premium to market prices trade at a significant spread. In my view, market participants should price NICK at a discount to the $14.60 tender offer floor.
I believe shareholders are likely to tender at the low end of the range, considering where shares were trading prior to the announcement and the recent history of the company. Clearly, the Board’s pursuit of strategic alternatives did not result in another bidder willing to pay close to $16 per share, or the company would not have pursued a buyback instead. $14.60 is a gift.