New Frontier Health merger arbitrage

A corner of the special situations market that has had my attention almost since starting this blog are going private transactions with Chinese companies. A decade ago investors got a strong reminder that investing in China isn’t without risks after a massive wave of fraud was discovered. And more recently, the for-profit education sector showed how businesses can be wiped out at the whim of the Chinese government. But where there is risk, there is also opportunity. And because of that I do think that Chinese going private transactions offer in general a fertile hunting ground for special situation investors. Spreads are usually a lot bigger than for similar transactions in the US or Europe, and since insiders are usually taking the company private at a cheap price they are plenty motivated to complete the transaction. Once a definitive agreement is signed almost all deals get completed.

New Frontier Health (NYSE:NFH), an operator of hospitals in China, became public at the end of 2019 through a combination with a SPAC. Now, less than two years later, insiders are trying to take the company private again for $12/share. Not the worst possible outcome for shareholders, given that most should expect to lose money if you don’t redeem your SPAC shares for trust value. At the same time, it does not make this transaction an obvious great deal for insiders. You take the company public at $10/share (effectively less since a bunch of warrants are given away as well) and then you buy it back less than two years later for $12/share. I have no doubt that insiders are getting a good deal. It is just not as obvious as IPO’ing your company for $10/share and buying it back for half price. New Frontier Health seems like a reasonable decent business and in their latest investor presentation they estimate a SOTP valuation of $15/share and a growth scenario that could get to $45/share.

New Frontier – Potential transaction value creation slide

Insiders own 39.3% of the company and the definitive merger agreement was signed less than a week ago. So we don’t have to worry that for example recent changes in the Chinese/US regulatory landscape have given insiders second thoughts about completing this deal. At the moment the stock is trading at $11.19, offering a 7.2% spread to the merger consideration. With an expected deal closing in the fourth quarter of this year I think this is a pretty decent opportunity. There are Chinese going private transactions with bigger spreads, but for a Chinese deal without any visible hair on it, I’ll take it.

Disclosure

Author is long New Frontier Health

11 thoughts on “New Frontier Health merger arbitrage

      1. Frank

        Wouldn’t the risk be “that the aggregate amount of Dissenting Shares shall be no more than 10% of the total outstanding Shares immediately prior to the Effective Time”? You might get majority approval but also 10%+ disapproval

        Reply
        1. Alpha Vulture Post author

          That’s indeed a risk, although if I remember correctly a Chinese deal where this was a real issue got completed with some delays anyway. People going for the dissenting trade have of course no interest in the deal failing, so if that becomes an issue there is probably some room for negotiating. But in this case, the going private transaction doesn’t look like an obvious steal to me, so doubt that people will massively go for the dissenting trade.

          Reply
  1. tthaar

    I really like this idea, the risk-reward ratio looks very nice here, especially in the current market environment. Wish you’d post more frequently!

    Reply
  2. Blades

    AV, thanks very much for this idea. What do you think about the trading in the warrants? The PR indicates holders will get $2.70 plus $.30 if they consent to amendment of the warrant agreement. This is interesting on its own because intrinsic value to the $12 common price is only $.50. Maybe this is a way the insiders can get a kicker?

    Anyway, trading on the warrants is curious, spread to $3.00 Is only 1.4% to the last sale price of 41.96 versus 6.5% to the common spread.

    Reply
    1. Alpha Vulture Post author

      The warrants have a provision that in case of a merger the exercise price gets adjusted based on the Black-Scholes warrant value, so effectively the intrinsic value is higher than $0.50.

      But yeah, the small spread of the warrants seems to be a bit curious to me. You might be able to setup a nice hedge by shorting some of the warrants.

      Reply

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