Author Archives: Alpha Vulture

Merger arbitrage in the Coherent bidding war

On the 19th of January Coherent Inc. (NASDAQ:COHR) announced that it would be acquired by Lumentum Holdings Inc. (NASDAQ:LITE) for $100/share in cash and 1.1851 shares of Lumentum for a total consideration of $5.7 billion. A few weeks later MKS Instruments (NASDAQ:MKSI) kickstarted a bidding war with an unsolicited proposal only to be joined a few days later by II-VI Incorporated (NASDAQ:IIVI). Since then a multitude of improved proposals have been launched, all increasing the purchase price step-by-step while increasing the cash consideration and decreasing the equity consideration.

MKS Instruments dropped out of the bidding war some time ago. Yesterday Lumentum made its latest bid, valuing the company at $6.9 billion with a $220/share cash consideration and 0.61 shares of LITE for a total consideration of $274/share (using yesterday’s closing price). This morning II-VI upped the stakes with a bid of $220/share in cash and 0.91 shares of UUVI for a total consideration of $285/share (using the pre-market IIVI price). Coherent already declared the latest bid of II-VI a superior proposal and while this bidding war is probably reaching its final stages, there is certainly a decent chance we will see a couple more small price jumps.

So now that we have had a quick recap of the story so far, what would you expect the current price of Coherent to be? Surprisingly enough, the stock is in the pre-market trading at $265/share, at a decent discount to both the latest Lumentum bid (~3% spread) and the latest II-VI bid (~7.5% spread). During most bidding wars you see the target consistently trading above the latest bid price because people (almost) always expect that higher bids are a possibility.

In this case it is clear that a deal will be reached to sell the company above the current stock price, and it is certainly possible that both parties have some room left to bid more. So, apparently the market is pretty skeptical about the ability of the eventual acquirer to close the deal. Perhaps regulatory approval could be an issue, since it certainly will be a combination of two sizable companies in the same industry. But at the same time, as an outsider, it does not look too hard to me for this deal to get approved. MKS Instruments will remain as a very sizable competitor, and there multiple other sizable competitors such as IPG Photonics as well.

Perhaps I’m missing something crucial here, but to me it looks like that a bet on Coherent has pretty good odds. If there are no more bumps to the purchase price: fine. If there are more bumps: great.

Disclosure

Author is long Coherent

The curious case of the Garrett Motion rights offering

Garrett Motion entered bankruptcy last year, and is now on the cusp of coming out of it. The company filed an amended plan of reorganization last week that has the support of all major parties. The part of the plan that was strongly contested was the rights offering for convertible preferred shares that will shore up the balance sheet of the company. The COH group that owns 47% of all outstanding shares tried to keep this mostly to themselves, and only after some good work of the equity committee of unaffiliated shareholders the plan got adjusted to share the pie (a bit) more equally.

However, the COH group has pulled out all the stops in creating a structure in which unsuspecting shareholders lose their rights without getting anything in return. If you own Garrett Motion shares as of the record date you are eligible to participate in the rights offering, or tender your shares for $6.25/share in cash. The record date is today, so in order to be eligible for this you would have needed to buy the shares two days ago.

So to repeat: if you buy today, you are not getting anything besides the shares. You cannot tender them for $6.25/share and you will not be able to participate in the rights offering. But the tricky part is, if you sell today, you will also not be able to do that. According to the plan:

The 1145 Subscription Rights are not detachable or transferable separately from the Existing Common Stock held by 1145 Eligible Holders (the “1145 Eligible Shares”), other than those held by Equity Backstop Parties in accordance with the Equity Backstop Commitment Agreement or those held by Honeywell3, Centerbridge4 or Oaktree5 in accordance with the Plan Support Agreement. Rather, such 1145 Subscription Rights will trade together with the underlying 1145 Eligible Shares and be evidenced by the underlying 1145 Eligible Shares, until the Subscription Expiration Deadline.

The only way to keep your rights is to keep your stock till the expiration deadline. Everybody who sells today is throwing away these rights and giving them away to the COH group because they provide the backstop for the rights offering (and there are no oversubscription rights). If you don’t want the rights, you can just tender your shares for $6.25 at the end of the month. Selling your shares for less today is foolish, but nevertheless, the stock traded as low as $4.50/share just a few hours ago. Remember, nothing on the blog is investment advice. But really, do not sell your shares if you already owned them on the record date. In a rational world not a single share of this stock should trade between the record date and the expiration date. But we don’t live in that world, and of course, it does trade….

Garrett Motion Inc price graph

An additional complication is that the rights offering is for a part only for accredited investors. There are the “1145 subscription rights” that give every shareholder the opportunity to subscribe for one preferred share for every existing common share held as of the record date. Accredited investors have an additional opportunity to subscribe for 0.448951 shares for every existing share. It sounds like some law made it impossible for the company to offer more shares to regular investors, but at the same time, it is a very convenient feature for the group that is very motivated to get as much as the preferreds as they can get their hands on.

Disclosure

Author is long Garrett Motion

2020 end-of-year review, breaking the +1000% barrier

After a rocky start, 2020 turned out to be a pretty great year financially. My portfolio returned 19.31% which is more than the MSCI All Country World Index for the 9th year in a row and it also brings the cumulative return to 1015.82%. I think this is an absolutely amazing result, and I did not expect to achieve it when I started investing and I do not expect that I will be able to repeat it going forward. A more than 30% annualized return is just not realistic in the long-run. It helped of course that the past decade was a good one for investors in general, with the MSCI All Country World Index growing by 11.86% annualized. I am also doubtful that passive investors will be able to replicate that return in the next decade, but who knows? Probably more likely than me achieving more than 30% annualized again over such a long time span.

Year Return* Benchmark** Difference
2012 18.44% 14.34% 4.10%
2013 53.37% 17.49% 35.88%
2014 30.11% 18.61% 11.50%
2015 24.23% 8.76% 15.47%
2016 64.97% 11.09% 53.88%
2017 29.04% 8.89% 20.15%
2018 13.07% -4.85% 17.92%
2019 32.34% 28.93% 3.41%
2020 19.31% 6.65% 12.66%
Cumulative 1015.82% 174.27% 841.55%
CAGR 30.74% 11.86% 18.87%

* Return in euro’s after transaction costs, net 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 graph below, a driving force behind the performance of the portfolio was my bucket of special situations such as mergers, liquidations and bankruptcies. But it is somewhat arbitrary what I put in the bucket. My disastrous investment in the Bristol-Myers contingent value rights has its own separate spot, but it could easily have hidden away in that category as well. Somehow the rights are actually not the biggest loser of the year, that is my foreign currency exposure. I expect that most of my readers are located in the US, and probably did not notice it much, but because the dollar lost significant value versus the euro my portfolio was facing a strong headwind. In euros the ACWI was up 6.65%, but measured in dollars the index was up 16.25%. The impact on my own portfolio was comparable with a more than 8% currency translation loss. I usually own very few (if any) stocks that are part of the index, but because of its somewhat similar global equity exposure it is a surprisingly decent benchmark.


Besides the special situations bucket, a very strong contributor was my position in Xpel. It is quite amazing how much a single stock can do for your portfolio when it goes up more than 250% in a single year. I sold a few shares in December, but it remains one of my largest positions (it is only being beaten by my PDLI position). I own a lot of classic value stocks, but my performance for the last couple of years would have looked very differently if I would have owned nothing else. In the previous years HemaCare was a true high-flyer, and now Xpel. It just shows that there is quite a bit of luck involved in generating returns. Passing on a single idea, or making one bet that does not turn out as expected, and your results can look totally different.

To conclude this post, I want to wish my readers a happy and healthy 2021. May this year be better in every single aspect than last year!

Disclosure

Author is long most of the stuff in the performance attribution graph

Exited my position in the BMY-RT CVR

Almost exactly a year ago I wrote about the merger between Celgene and Bristol-Myers Squibb (NYSE:BMY). To make things interesting, the merger consideration included a contingent value right (NYSE:BMY-RT) that would payout $9/right if, and only if, three separate drugs would get approved by the FDA before their respective deadlines. I have not written about the CVR since, because I did not have much to add compared to all the information that was already out there.

Initially my position in the CVR was miniscule, since it was just a small part of the Celgene merger consideration. Over time I continued adding to my position, and earlier this month I hit the 5% mark, making this probably the highest amount of risk I have taken in a single name. I have frequently positions sized bigger, but most stocks don’t have (a realistic) potential to go to zero overnight on bad news. And because I don’t just want to share stories of success here, I felt obliged to post an update on this name since it is now probably my biggest loser.

Yesterday was the big day because liso-cel had it’s PDUFA date. Unfortunately, the news was bad. Because the FDA was unable to inspect a manufacturing facility in Texas due to corona travel restrictions it decided to defer action. The news did not came as a total surprise, since a week before Bristol-Myers Squibb already told the market that the FDA did not inspect the facility, and that it had told them previously that it would be required. Written like this you would probably question why I was still in the name, but the FDA did inspect the main facility in Bothell, Seattle. Maybe you should not try to ascribe too much logic to the actions of a bureaucratic organization, but I did not think it was far fetched to assume that the FDA had a plan to meet the PDUFA deadline.

Obviously that was not the case, and since the CVR has a deadline of 31 December 2020 for the approval of liso-cel I don’t see a realistic path forward for approval in time. The press release does contain a single line, that might have given people some hope:

The company is committed to working with the FDA to progress both applications to achieve the remaining regulatory milestones required by the CVR.

You could make a case that the company did not need to put this line in the press release, and if they would have thought that meeting the regulatory milestones would be completely impossible they would not have put it. At the same time, it is an empty statement. Bristol-Myers might be committed to do it, but the thing that matters: is the FDA committed? I think they would like to approve this as soon as possible, if they can, but they don’t give a s*ht about the CVR deadline. The biggest deadline they would care about would be the PDUFA deadline, and they missed it. The FDA also did not provide a new anticipated action date, which probably means that they don’t have a concrete plan with a clear timeline on how to do the final inspection.

Given that we are close to the end of the year with Thanksgiving and the Christmas holidays coming up as well I just don’t see how this remaining inspection can be done in time. The inspection would need to be scheduled, could take a few days to a week, the company would need a few weeks of time to be able to respond to the results of the inspection and then the FDA would need to make a decision. Theoretically it could be done, but it just seems very far fetched to me. Corona cases have been going up in Texas, so if they didn’t want to go in October, they certainly would not want to go now. If they would have thought a virtual inspection could be a viable option, they would probably have done that already so they could meet the PDUFA date. And with vaccines around the corner it seems that just waiting a few months could solve all issues.

Because of that I’m actually very surprised that the rights were yesterday still trading at $1. Assuming that the rights would trade between $5 and $7 if liso-cel gets approved (high-end might be a bit optimistic, since ide-cel approval is still pending) the market implied probability of approval before the end of the year is between ~15% and ~20%. I think that’s very optimistic, and would personally put it below 5%. I hope I’m wrong for the patients that need this treatment even though it would make me look double stupid for selling. But I am pretty happy with my decision to do so, and I am also still happy with my decision to buy as much as I did. Sometimes things just don’t work out, even if the odds are in your favour.

And yes, I know, if liso-cel does not get approved in time, there might still be some litigation value in the rights. But I highly doubt that is meaningful. Getting a decision to defer action from the FDA because they don’t inspect a facility because of corona is beyond any doubt not the fault of Bristol-Myers. And given the size of the CVR, with a potential $7 billion payout, Bristol-Myers can spend a lot of money on lawyers before a settlement would make financial sense.

Disclosure

No position in the rights anymore

XPEL: still not your classic value stock

A bit more than two years ago I wrote about my decision to take a position in XPEL, Inc. (NASDAQ:XPEL), calling it anything but a classic value stock. At the time it was trading at a 37.1 P/E ratio and a 10.0x P/B ratio, making some readers question if I was suffering from style drift. I don’t think these comments were particularly surprising given that I often blog about classic value stocks such as net-nets. But my style has always been one of being willing to buy anything at the right price. Sometimes that is one of the most ugliest stock you can imagine, while other times its a rapidly growing company that is just too cheap.

In my initial write-up I posted a simple valuation model, looking forward two years to see how the financials of the company could look like if it would continue its trajectory of high-growth. I should have made this post a couple of months ago when XPEL released its results for the second quarter, but didn’t think about it, so instead you will get a comparison to numbers that are actually moved two years and one quarter in the future. Putting the current numbers side-by-side with my model from two years ago looks like this:

XPEL 218 financial model compared to actual numbers

As should be expected, reality never fully matches a model, but I think it is actually pretty amazing how close this very simple model got. Revenue turned out to be a bit lower while gross margins turned out to be higher. But in the end, my expected earnings/share number is to the cent identical with the actual results. With the caveat of course that these results were achieved three months later than the model predicted, but also with the Corona crisis happening.

Of course, thanks to its continued growth, the stock is now even more expensive than it was two years ago. Instead of trading at a 37x P/E ratio it is now trading at a whopping 54x. So there has been some multiple expansion, but most of the gains that the stock made the past years are not because of that. The multiple went up 46% while the stock went up 400%, from $6.54/share to $33/share. Given that there are no signs of revenue and earnings growth slowing down, I think we can make a pretty similar model as two years ago that once again makes the stock look pretty decently priced. A bit more expensive than two years ago obviously, but not by a whole lot. I do expect that the multiple will contract in the future, but the growth in earnings should be able to counteract that and then some. But I don’t think the stock will be able to repeat the performance of the past two years. At least, that is not my base case.

Disclosure

Author is still long XPEL