ALJ Regional Holdings (ALJJ) announced yesterday that the company has entered into a definitive merger agreement to sell their KES subsidary. After the merger is completed the company will basically be an empty shell with approximately $51 million in cash ($0.86/share) and large net operating losses. The company also announced that they will buy back more than 50% of the outstanding shares after the merger is completed at a price between $0.84 and $0.86 per share. For some background on the company I recommend checking out this post at OTC Adventures.
The company has 59,467,498 diluted shares outstanding as of yesterday, and Mr. Ravich, chairman of the board and owner of 13,142,221 shares (22.1%), has indicated that he will not tender his shares. This means that if everybody except Ravich tenders their shares you can sell 64.8% of your position to the company at $0.84/share. If you would buy $1000 worth of shares at $0.72 you would get back ~$750. What you keep are 490 shares with a $244 cost basis, or a 43% discount to the future net cash position of the company.
There are multiple ways to win here. I think it’s highly likely that not all shareholders will tender their shares. The current board, with Ravich as the leader, accomplished a lot the past years, and after the offer is completed the chairman will own almost 50% of the company. And while the tender offer is for roughly the cash value per share it ignores the valuable NOL assets. I imagine that there are investors who want to remain invested.
In a best case scenario the company will buy all or almost all your shares at $0.86/share and you make a quick 19%, but if the proration factor is for example not 64.8% but 85.7% you are already free rolling on your remaining position (assuming a $0.84/share price in this case).
A second way to win is if the discount to net cash value shrinks after the deal and tender offer are completed. If the discount for example would shrink from the current 43% to 20% it would mean that the share price post tender offer would only drop from the current $0.72/share to $0.70/share. Again using a hypothetical $1000 investment: you would own 1389 shares and sell 899 shares to the company at $0.84/share. The remaining 490 shares would be sold for $0.70/share for a total amount of ~$1100 or a 10% return.
The worst case scenario is obviously that the merger isn’t completed and the tender offer is cancelled. In general a very high percentage of definite merger agreements are successfully executed, and don’t think there are any special issues in this deal that makes this one above average risky. The acquirer has executed multiple successful deals in the past, and I don’t think there are potential regulatory or political issues with a small deal like this. A risk is financing since Optima has not yet closed the necessary arrangements, but with Jefferies as an advisor I would expect that they got this covered.
While it’s hard to know how this will exactly play out I think the odds are in my favor at the current prices. If the deal is completed successfully, and I think it will, the worst case scenario is that I bought a cash shell at a 43% discount to net cash value. I’m comfortable with that investment given the big discount and the fact that Mr. Ravich will be a major co-owner. And most likely I’ll effectively be buying less shares at an even higher discount if not all shareholders decide to tender.
Whopper had basically the same idea as me, and you can find his thought here.