American DG Energy merger: attractive with an 19% spread!

American DG Energy Inc. (NYSEMKT:ADGE) is being acquired by Tecogen Inc. (NASDAQ:TGEN) in an all stock transaction. Tecogen is offering 0.092 shares for every ADGE share. What is very surprising is that when the deal was announced the stock price of ADGE barely reacted. ADGE closed just 6.8% higher on negligible volume while Tecogen was offering a premium of approximately 35%. Since then the stock prices of both companies have barely moved and as a result the spread is still an extremely juicy 19%. Note that, because both stocks are fairly illiquid and can have a wide bid/ask spread putting an exact number on the spread is hard, and entering a position at this price might be even harder. I decided to pay up for my ADGE shares.

With a spread this big your reaction is probably “there must be something serious wrong here”, at least that was what I thought. But after reading the preliminary proxy statement there isn’t a whole lot that I can find that would worry me. What is unusual is that both companies are already very closely related. They are already located at the same address, the have the same two co-CEOs, the same big shareholders and they are sharing board members. From the S-4:

Senior Leadership Overlap

  • John Hatsopoulos is the co-Chief Executive Officer of both Tecogen and ADGE.
  • Benjamin Locke is the co-Chief Executive Officer of both Tecogen and ADGE.
  • Robert Panora is the President and Chief Operation Officer of Tecogen and General Manager of ADGE.

Board Overlap

  • John Hatsopoulos is a member of the Board of Directors for both Tecogen and ADGE
  • Charles Maxwell is a member of the Board of Directors for Tecogen and Chairman of the Board of Directors of ADGE.

Ownership Overlap

  • John Hatsopoulos together with his family beneficially owns more than 22% of Tecogen and 20% of ADGE.
  • George Hatsopoulos together with his family beneficially owns more than 21% of Tecogen and 19% of ADGE.

But I don’t see that as a negative in this case, this just means that it makes a ton of sense to merge the two companies. They are active in adjacent businesses and since ADGE has a market cap of just ~$17 million and Tecogen has a market cap of ~$85 million maintaining two separate stock listings is just too expensive. The two companies expect that they will be able to eliminate approximately $1 million in costs annually by merging, which is significant. What I think is perhaps the biggest worry of people interested in playing the merger arb is this:

No Deal Protection Devices; Termination of the Merger Agreement
The Merger Agreement does not contain any so-called “deal protection devices” such as a no-shop provision or a termination fee. Prior to obtaining ADGE stockholder approval, ADGE may withdraw or modify its recommendation to ADGE stockholders with respect to the Merger, terminate the Merger Agreement and enter into an agreement with respect to a competing acquisition proposal with a third party. In addition, Tecogen and ADGE may mutually agree to terminate the Merger Agreement at any time prior to the Merger effective date, regardless of whether Tecogen or ADGE stockholder approval has been obtained. See “The Merger Agreement – Termination of the Merger Agreement by Either Tecogen or ADGE.”

This obviously makes it easy for both companies to change their mind, and cancel the deal, but I don’t think that is a significant risk-factor in this case. There is really just one party here, and that partly must be interested in pursuing the current deal. Why? Because just getting a merger agreement signed and getting a preliminary proxy statement on the SEC site is an expensive process. You’re not going to spend a solid six figure dollar amount, or perhaps even a seven figure amount, if you aren’t serious. Especially if you are also a shareholder in both companies.

So I think that this deal will probably be completed, and I also think it will be completed soon. It doesn’t require any regulatory approvals, and both companies expect to complete the deal by approximately March 21, 2017. Getting shareholder approval should also not be problematic considering the inside ownership in both companies. Insiders own 24.8% of Tecogen and 18.0% of ADGE (and family members related to the insiders own a bit more). They will require some support from outside shareholders, but it is a deal that makes sense and as an ADGE shareholder you get a nice premium, so I don’t see why it shouldn’t happen. The Tecogen Q3 conference call contains a couple of interesting tidbits (not all on the slide) that further demonstrates how closely related the two companies are, and why a merger makes sense.

To me it seems that ADGE is just a stock that is being ignored by the market. Since the deal was announced on the 2nd of November total trading volume in the stock was a bit less than 2 million shares for a total value of roughly $600,000. That’s absolutely nothing for a company with more than 50 million outstanding shares when a big corporate action is announced. If it would be a controversial deal you would at least expect to see some trading action, or a high short interest. In this case, just nothing is happening. Another hint that owners of ADGE and Tecogen might not be keeping track of what their stock is doing comes from the S-4:

After due consideration, the Board of Directors of each of Tecogen and ADGE determined not to require approval of a “majority of the minority” of stockholders of each company as a condition to closing of the Merger due to a number of factors, including but not limited to: (a) a historical pattern of a significant percentage of stockholders of each of Tecogen and ADGE not voting in prior annual meetings, making it difficult to achieve a majority of the minority of all eligible shares for each such company, particularly in light of the significant equity ownership of officers and directors and their families of each company;

Conclusion

Perhaps that I’m missing something here, but I don’t see what… I bought a decent position, and in case I’m somehow missing something I guess the downside is limited. ADGE is barely up compared to the price before the transaction was announced so it also shouldn’t drop a lot in case the deal doesn’t go through. It’s a bit of a weird situation, but I think it’s extremely attractive at current prices. Investors love calling random stuff an asymmetric risk/reward opportunity, but this is really one of those deals. And not in the usual merger arbitrage way with a little upside and a lot of downside! 🙂

Disclosure

Author is long ADGE, no position in TGEN

59 thoughts on “American DG Energy merger: attractive with an 19% spread!

    1. Alpha Vulture Post author

      Thanks, some nice (and positive) background info. So far his plan of making money through share price appreciation instead of a salary hasn’t really worked out though. ADGE down 90% since that article was published…

      Reply
    1. Alpha Vulture Post author

      I almost never hedge. It’s usually quite expensive to hedge in these micro caps, it takes up a ton of margin space, and in the long run the stocks that go up should offset the stocks that go down.

      Reply
      1. Don

        What are your thoughts/experience on mergers where both companies are losing money? According to John Paulson one should avoid these.

        Reply
  1. Matt Jones

    What is your method to finding these? Do you just open up all the 425 filings and start going through them? Do you use google alerts? RSS? Thanks

    Reply
      1. Matt Jones

        I’m just trying to figure out how to automate it. I have an rss feed for sec filing companies. I’m wondering more about the stuff that doesn’t show up there. For example otc companies. Do you just look through otcmarkets press releases every day?

        Reply
    1. Alpha Vulture Post author

      Not that far away from the price it was trading at yesterday. Small trade yesterday at the end of the day at the bid price made todays move look a lot bigger than it really is.

      Reply
  2. Eridon

    Take a look at these news:http: //www.prnewswire.com/news-releases/american-dg-energy-buyout-alert—national-securities-law-firm-seeks-higher-price-for-american-dg-energy-shareholders-in-connection-with-proposed-buyout-and-encourages-shareholders-to-contact-law-firm-for-more-information-300384946.html

    Are these news covered by the historical pattern of shareholders not voting in previous annual meetings that you mentioned in your article??
    Any IDEAS on how you source all these mergers, tender offers?Any website or blog you recommend!!

    Reply
  3. Dror

    Nice idea.
    Unfortunately I couldn’t even read your post fully before the stock took off. Maybe I’ll have more luck the next time.
    Thanks for writing!

    Reply
  4. Arma Virumque Cano

    This is wonderful. I thought I was alone in thinking excessive hedging is sometimes silly. Folks always ask hedge with S&P puts, hedge everything etc. But they hardly talk about the expense of hedging. Limited downside in itself — as you have mentioned — is an implicit hedge with merger workouts.

    Another example — so many folks love to talk about hedging DVMT (that’s the VMWare majority shares held under Michael Dell & Silver Lake’s vehicle) by shorting VMW and so being long contraction in the discount (similar to BEXIMCO). Well what’s silly is there’s no reason why spread can’t just as easily widen and if Michael Dell screws up, VMW isn’t ringfenced from the creditor fallout, so the hedge would have been an added cost, including opportunity cost of tying up cash. So just a lot of over-hedging and underthinking in general.

    Thanks mate — your blog’s an inspiration.

    Reply
    1. Alpha Vulture Post author

      Thanks, good to hear :). And I think that If you can hedge something super cheap it’s a good idea. In this case I have an opinion on the spread, not on the underlying business. In a perfect world I would be short TGEN. Unfortunately it’s not cheap. 9% borrow annualized and 100%+ margin requirement.

      Reply
  5. Zcaprd7

    I make 0.092 times Tgen price of $3.96 = 0.36432 – current ADGE price is 0.3410 – so I guess I’m too late?

    Reply
  6. Connor

    This was on my radar as well, but I passed given how sketchy the deal looked to me.
    I have less experience in merger arb and am trying to improve over the next couple of years so would love your take:

    Yes, both companies are clearly connected at the hip, but I couldn’t get comfortable with the myriad of related party transactions and consistently negative FCF for both companies. Neither has ever generated any real FCF (ever!).

    To me, in such a small unhedged deal with two very sketchy companies, I just couldn’t get comfortable with the liquidity risk if something were to go wrong. From my perspective, the value of both companies could potentially be zero, I don’t 100% know the motivations of each management team to have these two separate entities in the first place and there is enough to make me concerned, and there is not much liquidity if something goes wrong.

    My question to you I guess is: how, if at all, does this kind of sketchy situation with consistently negative FCF from both companies affect your view on the proper spread? I guess one answer is “who cares if they go through with the cash offer,” but would be curious on your take.

    Thanks in advance.

    Also, was surprised you did not write up the APOL merger! That seemed like a very interesting one I would have guessed you would be attracted to given the potential for a rerate higher if the deal fell through– obviously very unusual. Curious if you looked at it and just decided to past?

    Connor

    Reply
    1. Alpha Vulture Post author

      I don’t think this deal looks particular sketchy. Sure, both companies haven’t had the best financial results since they became listed, but it’s also not absolutely horrible (right now not that far away from break-even). They are for sure real businesses, it’s not some kind of stock promotion or something like that. And I think it’s unlikely (but of course possible) that something changes in such a drastic way in the few months that it will take to complete this merger that the deal will be cancelled. And since this is a stock deal you don’t have to worry whether or not Tecogen has enough cash to complete it.

      It’s really not that much different than any other merger arbitrage. Sure, it’s not the lowest risk deal possible, but then again: the super low risk deals usually have a spread close to zero. Here something around 5% or something like that sounds more reasonable to me. There is some risk, but it’s not insane.

      And I don’t think liquidity risk is a big deal, especially for a PA. Very simplistic, but if you can manage to buy something you can probably also manage to sell it if you want. And when things go wrong you are usually screwed; doesn’t really matter if it’s a highly liquid stock or an illiquid one. Liquidity isn’t going to save you if a stock gaps down with, for example, 50%.

      PS. Most merger arbs I participate in I don’t write about. At some point I had a tiny tiny position in APOL, but sold it before most of the upside materialized. But usually don’t like merger arbs in large cap stocks, way harder to get an edge. You can be sure that plenty of merger arb professionals have looked at that deal, while I doubt that a single one looked at this one. This is just too small for a fund to spend time on.

      Reply
    2. Don

      I think a large portion of the spread is due to the bankruptcy risk for ADGE. However, a 19% spread is extreme.

      From the Form S-4

      “Critical negative factors in evaluating the prospects for ADGE as a stand-alone company were ADGE’s uninterrupted history of major operating losses and the overhang of its debt obligations for borrowed money. Without significant additional financing, which is likely not to be feasible, ADGE would be unable to repay this debt and either would be forced to seek relief under the bankruptcy laws or negotiate the conversion of the debt into ADGE common stock at an unfavorable conversion ratio. The first alternative would likely wipe out the value of the equity of ADGE, and the second alternative would likely significantly dilute the interests of the other ADGE stockholders and largely destroy the value of their equity.”

      Reply
      1. Alpha Vulture Post author

        I don’t think this risk should impact the spread, as long the risk of the bankruptcy isn’t within the time frame of the merger. It should impact the share price of ADGE, and that’s of course why the stock is down 90% since 2010. But according to the latest financials the company’s only debt was a $3 million senior convertible note while there was a bit more than $3 million in cash. Sure, if they are going to continue to lose money they will need additional financing, but it’s not like they are going to run out of money any moment.

        Reply
  7. Miki

    based on the proxy https://www.sec.gov/Archives/edgar/data/1537435/000153743516000187/tgenadges-4.htm the 0.092 for every TGEN stock should be calculated against TGEN closing price at Nov 1st which is 4.03$. That means 0.37$ for every ADGE stock.
    But what I don’t understand is this (from the proxy statement): “Based on the closing price of Tecogen common stock on the Nasdaq Capital Market of $3.84 on December 19, 2016, the last practicable date before the date of this joint proxy statement/prospectus, the exchange represented approximately $0.35 in Tecogen common stock for each share of ADGE common stock.”
    So which is the amount paid for ADGE shares? 0.37$ or 0.35$?

    Reply
      1. Thomas Bachrach

        These stocks aren’t liquid enough for too many TGEN holders to sell while at the same time buying ADGE without collapsing the spread.

        AV, thanks for another very interesting idea. You are on a roll lately. I think (hope) much of the spread here is due to market inefficiency related to ADGE’s illiquidity and sub $1 stock price (great stuff if you are a small investor!).

        Reply
  8. fa

    Can you please stop publicizing these? It would benefit you and others to be able to buy more of these stocks at low prices without publicizing these and driving up the price. I don’t know how big your PA is but a decent sized PA likely means it takes weeks to acquire a position that moves the needle given the liquidity.

    Reply
    1. Alpha Vulture Post author

      Don’t worry about what benefits me, I’m definitely not publishing them when I’m still acquiring myself 😉 And I guess luckily for you I don’t write about most deals I participate in.

      Reply
  9. Tamas

    I’ve been contemplating this play, but it makes me really uncomfortable, I will have to pass on it.

    Basically it’s an option to buy TGEN at around 3.3-3.8 USD without knowing when you can start to exercise this option. Would I buy TGEN today for 3.3? No.

    Perhaps after the merger what with all the synergies and efficiency improvements? No, I don’t believe the management can pull that off.

    So it’s a no-go on a value basis.

    What about pricing? I can’t see how a 20% diluted TGEN with post-merger sellers abound would trade at anywhere near it’s current price. (Of course I can’t see how it even trades at it’s current price…)

    The only way I can see this is a viable play is by applying the greater fool theory.

    Reply
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  11. JJ

    So the merger completed last Friday? Any reason why ADGE has been slowly slipping lower lately? There is still a spread based on Mar 17 closing prices.

    Reply
  12. pietje

    ADGE will declare earnings tomorrow. Maybe some news is coming, we’ll see. Completed by March, 21 seems a bit of a stretch now.

    Reply
  13. Anuj Kumar

    They mentioned several options other than TGEN on the call and the press release said timing would be later this year. It sounds like a shareholder vote is in the next 30-60 days (CEO was surprisingly confused about what the timing would be). If not approved they would have to look to go another direction.

    Reply
  14. Anuj Kumar

    I’m assuming people are more and more worried the deal is falling apart as the price continues to drop for ADGE. Any thoughts would be much appreciated!

    Reply
    1. Alpha Vulture Post author

      I guess some of the comments of the CEO hint a little bit in this direction; that they have more strategic options besides TGEN, that he is a bit fed-up with the whole process (SEC making things difficult, getting sued for bullshit reasons)

      Reply
    1. Alpha Vulture Post author

      Yeah, think it most likely will still happen. I’m pretty sure they want to do this deal. But as two small companies with limited financial and legal resources that might in the end not be able to successfully navigate this to a conclusion…

      Reply
      1. Anuj Kumar

        I have a feeling it’ll still get done. They may have to change the voting to majority of the minority though?

        Reply
        1. Alpha Vulture Post author

          I don’t know about that. I think something like that depends mainly on the state laws of where the company is incorporated. They are either legally required to do it, or they don’t.

          Reply
  15. Vincent

    Thanks for sharing again. Do you know what happens if the minority shareholders are so passive to not vote, is this seen as a no vote? Also, do you expect a drop in share price of TGEN after the merger by people just playing the merger arbitrage?

    Reply
  16. Vincent

    On april 12 the registration form was declared affective by the SEC, so the only requirment now is shareholder approvement. I did some further research on the shareholder approval requirement. From the proxy statements it can be found that for the TGEN shareholder meeting, only a majority of the votes cast is needed. For the ADGE shareholder meeting however, a majority is needed of all the issued and outstanding common shares. Given the large amount of shareholders of ADGE not being active investors, do you see this as a material risk of not obtaining a majority approval?

    Reply
  17. Stan Grundy

    Thanks, you did great work on this one.

    So if you were one of the lucky few to sell your TGEN shares on Monday, you made a nice little spread. However, based on recent TGEN trading prices (with thin volume) the spread is actually closer to zero. Did you sell your shares on Monday, or are you holding on waiting for a rebound after the initial post-deal selling abates? Suppose one did not get a chance to sell their shares yet—would you recommend holding? Thanks

    Reply
    1. Anuj Kumar

      I think the volume has actually been enormous for tgen and I’m guessing all the additional shares are creating selling pressure (especially when the float isn’t that high).

      I’m hoping / assuming it’ll recover to the high 3s versus setting new 52 week lows every day. It’s a bit of a vicious cycle in that decreased selling pressure will improve pricing but likely reduce volume moved and I’m guessing many of us have a multiple of average daily trading volume (~12k shares) so you will likely want to leg out.

      Reply

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