Comtrex Systems merger completed

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Last Friday, the merger between Comtrex Systems (OTCMKTS:COMX) and Zonal Hospitality Systems closed. When I wrote about the  company the stock was trading at $9.40/share while the merger consideration, according the press release, was GBP 7.46/share (after a bit of a negative FX movements currently worth ~US$9.70/share), but subject to certain adjustments. My guess was that these adjustments were most likely some kind of price adjustment based on the net working capital balance at the time of the merger closing. While that proved to be true, the specific implementation in this case was not very favorable for shareholders.

When the proxy statement was released it became clear that the adjustment could only be made downwards, not upwards, and a large part of the consideration will be held in escrow for two years. Of the total payment of GBP 12,300,000 a hefty sum of GBP 2,000,000 will be held in escrow for two years while GBP 150,000 is earmarked to fund costs of the stockholder representative. The initial payment is going to be $8.02/share while another $1.58 might be coming in two years time, and it’s probably going to be a safe bet that the money earmarked for the stockholder representative will never be paid out. We will have to wait a long time before knowing how this deal will work out exactly, but we can unfortunately be pretty sure that it’s not going to be great. Even if the full escrow is released, and that is a pretty big if, we would be looking at a mediocre internal rate of return because of the long escrow period.

Disclosure

Author is technically still long COMX

Half-year portfolio review, 2018 edition

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With June behind us it’s once again time to see how my portfolio has been performing so far this year. It’s getting repetitive, but there is little I can complain about given the double digit return and the solid outperformance compared to the MSCI ACWI. With global equity markets going up year after year, I started investing at a very favorable moment, and I absolutely don’t expect that I’ll be able to keep generating performance numbers like this in the future. At some point some negative return numbers are probably going to be mixed in the list, and that would evaporate a (potentially large) part of the current compound annual growth rate.

Year Return* Benchmark** Difference
2012 18.53% 14.34% 4.19%
2013 53.04% 17.49% 35.55%
2014 27.72% 18.61% 9.11%
2015 20.23% 8.76% 11.47%
2016 43.58% 11.09% 32.49%
2017 30.12% 8.89% 21.23%
2018-H1 12.06% 2.40% 9.66%
Cumulative 483.20% 114.66% 368.54%
CAGR 31.16% 12.47% 18.69%

* Return in euro’s after transaction costs, dividend withholding taxes and other expenses
** Benchmark is the MSCI ACWI (All Country World Index) net total return index in euro’s

As you can see in the performance attribution graph below, a large part of the return can be explained by just a couple of positions. Especially HemaCare has been a driving force behind my portfolio thanks to a 155% gain in share price. Conduril and Viemed Healthcare also contributed nicely, but the rest of the positions were a mixed bag with small losers and winners.

The contribution to the portfolio of the special situations with 259bps doesn’t look bad, but is actually a bit disappointing. In the first half of the year I had a couple of nice situations play out such as the Casa Ley CVRs (contributing 59bps), a BINDQ liquidation payment (contributing 67bps) and the Tejoori liquidation (contributing 86bps). Unfortunately lots of the gains inside the special situations bucket were offset by a couple of deals that went sideways. The biggest one was the Rosetta Genomics merger that failed spectacularly, causing a 207bps loss. Another (undisclosed) merger subtracted 87bps from the performance while some other deals also generated small losses. Hopefully things will turn around a bit in the second half of the year.

The composition of my portfolio doesn’t contain any big surprises. It’s a fairly standard (for me) split between long-term value stocks and special situations. The observant followers of this blog will notice that there are in the overview above a couple of positions I haven’t blogged about previously. One of them is Scheid Vineyards, a name you might have heard before. I used to own a single share just to keep track of the company, but after reading the latest letter to shareholders my interest was piqued again.

This year the company managed to rezone about 130 acres of farmland bordering the city of Greenfield into commercial and residential land. They are planning to sell this the coming years, and will probably realize a handsome profit on it. They also got their vineyards and winery appraised earlier this year for $190.5 million while the company has a market cap of just $80.4 million. There is a lot of debt that needs to be taken into account as well, but there are also other assets such as the 130 acres mentioned earlier, and a large wine inventory. All-in-all I believe that the intrinsic value of the company is more than twice the current price, which makes it a pretty sweet deal in my book.

Disclosure

Author is long everything in the portfolio overview

Exited Deswell Industries after six years

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Deswell Industries is one of my longest held stocks. I bought my first shares more than six years ago on March 6, 2012 and sold my position last week after reviewing the latest annual results. The company isn’t exactly expensive, but it’s not longer a net-net since NCAV is $3.13/share while the current price is $3.25/share. If we take the value of all non-operating assets, and slap a 8x multiple on last years operating earnings we get a very similar value of $3.18/share. So right now Deswell isn’t expensive, but probably fairly valued, and after more than six years I think it’s time to move on to something else. I have always been a bit hesitant to sell this stock because of the years of continues insider buying which at some point in time will probably culminate in a going private transaction. But I don’t have unlimited patience…

Deswell Industries went up 53% in the more than six years that I held the position, and while that is not bad, you would expect a mediocre annualized return. But thanks to all the dividends ($1.04/share in total!) that the company paid in the meantime the internal rate of return was actually a pretty satisfactory 15.10%. Better than I expected before I did the math for this post.

Disclosure

No position in Deswell Industries anymore

Comtrex Systems merger arbitrage

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Thanks to a blogpost of NoNameStocks I was alerted to the fact that Comtrex Systems (OTCMKTS:COMX) is being acquired by Zonal Hospitality Systems in an all-cash transaction for approximately GBP 7.46/share (~US$9.88 at the time of writing). With the stock trading at $9.43 there is a spread of 4.8% remaining which seems pretty high considering that this sounds like a low-risk deal that should close pretty fast.

    1. There are no regulatory hurdles to take.
    2. More than 50% of Comtrex shareholders have already entered in voting agreements, so stockholder approval is a formality.
    3. There shouldn’t be financing issues since Comtrex is a tiny company (~US$16 million market cap) with a significant cash balance.
    4. Comtrex is being acquired at a ~60% premium, so no crazy downside risk if the deal fails.
    5. And to top it all off: it’s a deal that at first glance seems to make sense for both companies since they are in the same business (point-of-sale stuff for the hospitality sector).

The only question mark is that the merger consideration is subject to certain adjustments, but without a merger agreement publicly available it remains a guess what those are. My guess is, and I think this is the most likely scenario, some kind of adjustment based on net working capital and net cash balance at the time of the merger. This is very common, and usually this adjustment is just as likely to result in a higher price as in a lower price. Especially since Comtrex is a solidly profitable business this is unlikely to be a large risk. It’s not some kind of melting ice cube that gets smaller and smaller while waiting for the merger to be completed. But we will have to wait for the proxy statement, which is expected to be send to shareholders in a couple of weeks, to be sure what the deal exactly is.

Disclaimer

Long COMX

Willbros Group merger completed

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Yesterday the merger of Willbros Group with Primoris Services was successfully completed. When I wrote about the merger I thought that there was little that could derail the deal, and that it would close fast, and that proved to be the case. Making a 9.1% return in two months time is as good as it gets in the merger arbitrage game.

However, just because that this deal was completed successfully doesn’t really mean that it was a good bet. I think it was, but last week I got a not so nice reminder that deals with companies that aren’t in the best financial position (like Willbros) can quickly get very ugly when things don’t go as planned. I had a position in Rosetta Genomics, a company that was flirting with bankruptcy as well before Genoptix agreed to take it over. After it (finally) managed to secure shareholder approval for the deal I thought that there was also little that could derail it, until Genoptix claimed the existence of a “Material Adverse Effect” (no details were given).

The stock has cratered since that announcement because it’s unlikely that there will be anything left for equity holders in a bankruptcy scenario. Looking back at it in hindsight I don’t think I made an error in betting on this merger, but the unfortunate reality is that there is always a small possibility of a deal failing for some unexpected reason. As long as you size your positions accordingly it shouldn’t be a problem, although it’s of course never going to be nice…

Disclamer

Long Willbros Group (since the cash payment hasn’t been received yet by my broker)