Tag Archives : tender offers


Short Nicholas Financial (NICK)

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.

NICK stock chart

 

 


Food for thought

Disclosure: No position in FSIC. This post has been edited to remove details of trading activity. This post is intended to follow up on prior analysis and should under no circumstances be considered an advertisement for the performance of past specific recommendations.

I wanted to share the outcome of another special situation which provides some thoughts on how to identify future similar opportunities. (Also, I realize I’ve been writing a lot about tender offers lately, but it’s a consequence of them being relatively easy to discuss in full. I’m a little bit reluctant to describe my core portfolio investments without presenting an exhaustive, detailed rationale for the position. I haven’t had time to do them justice in writing yet!)

I closed a post about a tender offer last month by saying, and I apologize for quoting myself, “…it would have been possible to accumulate and successfully tender a lot more than 99 shares. Food for thought.” In truth I was thinking of a particular opportunity at that moment. FS Investment Corporation (FSIC) had an ongoing tender offer that I did not wish to publicize, as more participants would increase the odds of proration. I believed that the tender was unlikely to be significantly prorated, despite occurring at a significant premium. A holder could potential tender large amounts of stock at a premium, without worrying about a potential decline in price afterwards. FSIC was conducting a Dutch auction between $10.35 and $11.00, while trading around $10.15, well below its net asset value of $10.27. The tender closed on May 28th, and sure enough, the company bought back 96% of tendered shares at $10.75.

It remains quite difficult to predict with certainty when a tender offer will not be oversubscribed, but there are certain characteristics that make it more likely, one of which is of course that there aren’t a bunch of blog posts talking about how great it would be to participate in the tender. There were several other factors that made FSIC an attractive candidate, however:

  • FSIC was a newly public listing of a previously OTC entity with a largely retail shareholder base (tax sensitive and generally less likely to tender)
  • The offer was large relative to the market cap
  • The company had had an ongoing tender offer policy to provide shareholders with liquidity, and previous offers were recent and under-subscribed near the low end of the Dutch auction range
  • FSIC is broadly diversified and traded below NAV, making it a relatively low-risk short term holding
  • FSIC announced special dividends later in the year for continuing shareholders
  • The minimum increment in the Dutch auction was relatively small ($0.05), making for a smoother supply curve and potentially less proration at any given point

In short, FSIC was an unusually good setup for a tender offer, and based on the size of the offer, it was highly scalable too. I estimate it could have contributed meaningfully to funds as large as $200 million AUM. Such opportunities do not come along very often!


NYRT: a follow-up on odd lots 2

Disclosure: No position in HCT. Long NYRT (pending tender settlement). Watching GSOL.

I’m not going to write about every tender offer I come across with an odd lot preference (take a look at GSOL if you’re looking for one now) unless there’s something interesting to say. The HCT tender paid $11 to tendering holders. However, when I consider the price movement afterwards, I rather wish I had shorted the stock on May 2 instead:

HCT

A substantial decline in the share price after a tender offer is a relatively common outcome when companies tender for shares above market value. It can be very difficult to obtain a borrow on stocks with pending tender offers, and the price movement afterwards lacks the certainty of the price offered by the company. However, such a strategy would not suffer from the odd lot size limitation.

As a quick follow-up to the general discussion of odd lot tenders, I thought I’d highlight one other somewhat unusual occurrence that can similarly render the odd lot preference moot. Tender offers are not always oversubscribed, even if they take place above the market price. Continuing the analogy to the current market structure debate, just because a bid/ask spread is quoted does not mean that large quantities are necessarily available for purchase or sale at the NBBO. The depth of book matters too. When a company offers to repurchase shares above the market clearing price, there’s an element of price discovery that takes place: shareholders may not be willing to sell even at the higher price. This is of course extremely difficult to predict. But imagine if you could!

NYRT closed at $10.25 yesterday, the deadline to tender shares via guaranteed delivery for $10.75.

New York, New York, May 13, 2014 – New York REIT, Inc. (“New York REIT” or the “Company”) (NYSE: NYRT), announced today the preliminary results of its tender offer for the purchase of up to 23,255,814 shares of its common stock, which expired at 12:00 Midnight, Eastern Time, on May 12, 2014.

Based on the preliminary count by DST Systems, Inc., the paying agent and depositary for the tender offer, a total of 12,903,858 shares of the Company’s common stock were properly tendered and not properly withdrawn at the purchase price of $10.75 per share, including 1,119,855 shares that were tendered through notice of guaranteed delivery.

Based on the results of the offer, there weren’t 10.3m additional shares willing to sell at $10.75. But with average daily volume of 1.2m shares at a VWAP of $10.62 since listing last month, it would have been possible to accumulate and successfully tender a lot more than 99 shares. Food for thought.


How odd: sometimes the little guy wins 1

Disclosure: Long HCT, watching NYRT and SPLP

“Odd lot” arbitrage is one of my favorite niches of the stock market.

The recent media firestorm about the costs and benefits of high-frequency trading (HFT) sparked by Michael Lewis’ latest book has prompted a lot of public hand-wringing about whether the stock market is fair to all participants. It most certainly is not. Retail stockbroking is in general marked by high commissions, significant hidden costs, sales loads, information asymmetries, and aggressive sales practices that put an individual investor at a distinct disadvantage to institutions. One thing it does not suffer from anymore, however, is high spreads (on most issues). Decimalization and market-making competition over the past few decades have significantly reduced the cost of market orders.

In fairness, I haven’t had a chance to read Flash Boys, so I’m not going to join the chorus of financial market participants talking their books on the relative merits of HFT. For the record, I think the latency arbitrage HFT strategies publicized by Lewis provide a net benefit to smaller investors by lowering spreads, while making it harder for large traders to execute orders without moving the market. This unusual role reversal reminds me of another instance where the tables are turned. The arbitrage opportunity created by tender offers is another delightful corner of the stock market where investors sometimes can benefit from their smaller size.

An “odd lot” or “small lot” in the US is a position of less than 100 shares. For legacy reasons, exchanges have special handling rules for odd lots, though they are now generally handled automatically. Historically, many brokerages charged additional fees for these lots, and trade pricing was disadvantageous as well. Today, odd lots do not generally incur additional costs, but at brokerages charging fixed commissions, the cost of transacting an odd lot can still be very significant relative to the transaction value.

Periodically, some public companies and closed-end funds will offer to repurchase shares at a premium to the market price. When this happens, economically rational shareholders will tender, and it is common for the offer to be oversubscribed. In such situations, the tender will be prorated, but sometimes companies will include a proration preference for odd lots. The issuer will buy the entire odd lot to spare the small holder the commissions associated with disposing of the small number of shares that would have otherwise gone unpurchased. A typical SC TO-I filing might include language like this:

Odd Lots. The term “Odd Lots” means all Shares tendered by any person (an “Odd Lot Holder”) who owned beneficially or of record an aggregate of fewer than 100 Shares and so certifies in the appropriate place on the Letter of Transmittal and, if applicable, the Notice of Guaranteed Delivery. Odd Lots will be accepted for payment before any proration of the purchase of other tendered Shares. This priority is not available to partial tenders or to beneficial or record holders of 100 or more Shares in the aggregate, even if these holders have separate accounts or certificates representing fewer than 100 Shares. To qualify for this priority, an Odd Lot Holder must tender all Shares owned by the Odd Lot Holder in accordance with the procedures described in Section 3. By tendering in the Offer, an Odd Lot Holder who holds Shares in its name and tenders its Shares directly to the Depositary would also avoid any applicable Odd Lot discounts in a sale of the holder’s Shares. Any Odd Lot Holder wishing to tender all of its Shares pursuant to the Offer should complete the section entitled “Odd Lots” in the Letter of Transmittal and, if applicable, in the Notice of Guaranteed Delivery.

The risk arbitrage set up occurs whenever shares trade below the tender price. An investor can buy 99 shares or fewer, tender at the higher price, and capture the differential within a short period of time (as little as the length of a trade settlement if guaranteed delivery is allowed). The strategy is not riskless, as tender offers can fall through for various reasons, but it is the closest thing to a freebie I have seen in the stock market.

Naturally, I am not the first to discuss these opportunities. They are frequently and often breathlessly the subject of investment blogs. The holy grail of odd lot tenders occurred in 2011 when a Russian nickel company bought back shares with a 999-share odd lot preference (thanks to a 10:1 ADR ratio) at a large premium, resulting in over $10,000 profit potential per accountholder. Most tender offers are quite a bit more pedestrian, worth a few hundred dollars at most.

I almost didn’t bother writing this post after finding an extensive discussion on an investor forum that chronicles almost every odd lot setup over the past year, along with various strategies for exploiting the technique and variations such as odd lot cashouts in reverse splits. There is even one enterprising individual offering a subscription service to send a notification of every upcoming tender offer, although this can be accomplished for free using a simple SEC filings search! Perhaps this literature review will nevertheless be interesting to someone.

Amusingly, articles sometimes spark a backlash from commenters worried the publicity will kill the golden goose. Quite frankly, I fully expect odd lot arbitrage to disappear entirely someday, as trade commissions continue to face downward pressure. Many closed end funds that conduct periodic tender offers have already removed odd lot priority. It will likely persist as long as retail brokerages charge flat fees even for small transactions, but it’s a historical anachronism that is going away eventually.

In the meantime, though, it’s a nice way to recoup some of the costs of investing. Right now, there is an opportunity in American Realty Capital Healthcare Trust (HCT), a healthcare REIT that recently listed on NASDAQ. Shares closed today at $10.20 and the company is conducting a tender at $11.00 that expires on May 2, for a potential return of $79.20 in a few weeks. Details here. As always, do your own diligence before making any investment.

At the moment, there is also a less compelling opportunity in NYRT, another newly listed REIT, and a riskier tender for SPLP, which will only be profitable at the higher end of the Dutch auction range. I am watching both and will participate only if the price falls.

Note from the sample SC TO-I language above that this is not a strategy that scales well for individuals. Separate accounts are expressly excluded. Each beneficial owner is limited to 99 shares. However, as an adviser, Cable Car disclaims beneficial ownership of its clients securities at the time of a tender. For multiple client accounts, odd lot arbitrage is at least worth the effort of this writing. Cable Car is presently long HCT on behalf of clients.

$79.20 may not seem like much, but it is meaningful for the little guy, who sometimes does come out ahead in the end.


INXBW Update 1

Disclosure: Long INXBW.

The transaction closing date has been postponed a few times and is now scheduled to be completed on April 10. Meanwhile, Glori completed an oilfield acquisition, likely representative of its strategy going forward, through a $40m deal with Petro-Hunt. The closing delay is related to unspecified SEC requirements; my best guess is that Infinity received SEC comments requiring a response and/or was required to provide investors more time to evaluate the Petro-Hunt deal.

About a week ago, the warrants traded up to 77 cents, which is still a significant discount to the common but provides less of a margin of safety. Since then, the warrants have been very illiquid. Remarkably, there have been no trades at all for the past 3 trading sessions, a good illustration of why this particular situation is best suited for small accounts. Even small accounts can miss out; since Cable Car manages separate accounts for each client, I have yet to establish a position for one of my most recent clients. That in turn provides an interesting illustration of the pros and cons of separate accounts. On the one hand, my newest client may not be able to participate in this particular investment opportunity. On the other hand, in a pooled vehicle, earlier clients’ proportionate share of the position, provided I could not increase it, would be unfairly reduced by new capital. Of course, one’s perspective on the benefits of participating in any particular idea depends entirely on how it turns out. If the transaction is not completed and the warrants are ultimately worth only 60 cents, perhaps my new client got lucky!

I would still happily buy more INXBW around 70 cents, but at the moment there are no sellers.

I have some ideas for how to think about the value of the post-transaction entity, which is somewhat challenging to value. In order to avoid contributing to further lack of buying opportunities, I will refrain from discussing them until after the transaction is consummated.


INXBW: A different kind of SPAC arbitrage 1

Disclosure: Long INXBW. Please be sure to read the disclaimer — no content on this blog is investment advice.

This is a post originally shared on the investment ideas forum SumZero. It is a relatively illiquid opportunity suitable only for small accounts, but it describes an interesting corner of the stock market. In brief, an investor can buy warrants in Infinity Cross Border Acquisition Corporation (INXB) for about 70 cents today, which will be convertible into shares worth 80 cents in 6 weeks. There is downside to 60 cents in the event a planned merger with Glori Energy falls through and further upside if investor demand for Glori is high after the transaction.


Back in 2009, when cash was paramount and everything was on sale, SPACs (special purpose acquisition companies, i.e. blank check firms that IPO with a mandate to reverse merge with another company later) became a popular arbitrage vehicle for those who still had funds to invest.

A SPAC is typically structured so that the initial investors have some sort of opportunity to get their money back if they disagree with management’s proposed acquisition. Usually this protection is in the form of a mandatory tender offer at the IPO price and/or a liquidation right, again at or near the IPO price, if a deal is not approved by shareholders and consummated by a certain date. During the financial crisis, the price of many SPACs that had yet to find their acquisition targets dropped well below the IPO price, offering investors a low-risk opportunity to buy below cash and then take advantage of the liquidation right or tender once a deal was announced. This often resulted in the deals failing to close, but the original shareholders were usually long gone and the arbitrage could generate 10-20% returns in a matter of months.

There was a certain poetic justice to this, as SPACs are a great example of Wall Street’s excesses. Why do your own diligence on an IPO when you can fund a shell company to do it for you? Why pay a private equity firm fees to manage a portfolio of private companies when you can pay an often untested management team $10-20m in stock options to buy just one? Often the proposed acquisition target won’t even be in the same industry as the SPAC initially planned.

The structure has a colorful history too, as it was first used by (often fraudulent) stock promoters in the 1980s before becoming discredited and more heavily regulated. It reemerged during the last decade with the protections just described, and it was a popular IPO vehicle during the boom. There was a great Steven Davidoff article on a recent SPAC IPO that describes the history in more detail.

Enter Infinity Cross Border Acquisition Corp, traded on the NasdaqCM as INXB, INXBW, and INXBU for the common, warrants, and units (common plus warrants) respectively. Backed by the Infinity Group, an Israeli-Chinese private equity firm, it was originally supposed to buy something in China. But no matter — the SPAC eventually identified an interesting oil extraction technology start-up to buy and take public, Glori Energy. Glori’s VC backers will retain a controlling stake and take INXB shares at the IPO price of $8, with customary lock-ups. Infinity and the Thomas Hicks family office are buying additional shares at that price as well.

There is downside risk below 60 cents if INXB trades below $6 after the transaction. However, with the major investors injecting capital at $8, equivalent to an 80-cent warrant price, buying warrants at 70 cents is like buying into the offering with a $1 margin of safety.

Glori could be a very interesting business if its technology really performs as advertised at scale. Glori has a proprietary biomass system called AERO that is supposed to reduce the decline rate of older oil wells under certain conditions. In principle, this means Glori can purchase a well at standard industry multiples based on the usual recovery rates, then apply its technology and ultimately extract more value from the well over time than the seller could have. The plan is for Glori to roll-up small producing wells with the right geological characteristics — yes, including some in China — monetizing its technology by applying it in the field. If the investor presentation (Jan 9th 6-k exhibit 15.1) is to be believed, Glori may be able to achieve IRRs in excess of 40% on well acquisitions assuming AERO performs as intended.

As an aside, I personally have limited expertise with oil & gas exploration and have no real way to evaluate the technology. It apparently works in some pilot projects, but whether it will scale and Glori’s acquisition strategy will be successful is not a question I have tried to answer for this arbitrage situation. I would welcome comments from anyone with a background in exploration & production.

Back to the opportunity today: unlike many SPACs that required majority shareholder approval and ended up in mandatory liquidation rather than consummating a deal, Infinity learned its lesson from SPAC arbitrage and has a relatively lenient standard in its articles of association for the transaction to proceed. The maximum tender condition is set such that INXB must retain at least $8m in its trust account. In other words, a maximum of 4.75m of the 5.75m public shares may be tendered into the deal, or 83%. Only 17% of the public shareholders need hold onto their shares for the deal to close.

That said, there is still a meaningful risk that the deal does not go through. SPAC arbitrage is still popular, even when the discounts to liquidation value are quite small, as in the current environment any yield is potentially preferable to sitting on cash. For example, INXB common shares currently trade at $7.95 and traded as low as $7.60 early last year, versus an $8 IPO and mandatory tender offer price. It is probable that a substantial number of arbitrage funds who hold INXB will tender into the deal. Based on available filings as of 9/30, it appears that 13-F filers and mutual funds that are or might be arbitrage funds own approximately 2 million of the shares outstanding, but there could be other, smaller arbitrageurs who are not required to disclose their positions. 824k shares were tendered through January 31.

If the deal closes, the tenor and strike price of the warrant change, but they also gain a conversion right during the 30 days after the transaction closes. 10 warrants are convertible into 1 share of stock, so provided INXB continues to trade around $8 after the deal, the warrants would be worth at least 80 cents. If the deal fails to close, the company will liquidate and the warrants will be worth 60 cents in liquidation. There is a parallel tender offer for warrants at 60 cents but it does not affect the maximum tender condition.

INXBW currently has an ask of 70 cents, so the situation sets up a risk/reward trade-off of 10 cents down, 10+ cents up. Although there is a risk that too many shares tender, Infinity and the other deal participants are highly incentivized to ensure that the transaction closes. I’m betting they can convince $8m of investor capital to participate in the deal. The tender expires on March 17, and the warrants become convertible for a one-month period beginning 31 days after the transaction closes.