Last week, one of my “undervalued merger” plays, AUTO, closed at a price that I believe stole the company. I don’t think I’ve ever been so disappointed by an investment despite the fact I basically broke even.
Intermedia’s bid values the equity at $9.15, or about 4.5% above KES’s bid of $8.75 and over 14% above the $8 price Intermedia would have purchased Outdoor for before KES came along.
So with the topping bid in, the question now becomes: what does KES do? Is there a higher bid coming?
Obviously, I’m no prophet, and you’d need a crystal ball to 100% know whether a higher bid was coming or not. And it’s hard to predict without seeing the full terms of the Intermedia offer and the benefit of a proxy statement with merger background. However, at the same time, the KES deal was set to go through next week, and since both Intermedia and KES know where the other party stands, I think it’s likely that the two sides quickly get their best bids in quickly so both sides can figure out their plans going forward and they include OUTD or not.
So is a higher bid coming. I think yes. I’m no investment banker, but the first rule in bidding in an auction is don’t put your best bid on the table first. The reasoning is simple: put in a lower bid. If you get the company at that price, great. If not, you force the other party to “tip” their hand, and then you can come in with your best bid.
There’s reason to think both parties are following that playbook.
Let’s start with KES- as I’ve covered before, their bid was clearly designed to be topped. Again, I don’t think KES necessarily wants the company, but I think they want to make sure they receive fair value. And I don’t think $9.15 is fair value. While this is admittedly speculative, I would bet KES was ready for a competitive bidding situation and had always had a higher bid ready in the back of their pockets. I would bet they’d be happy to own the company standalone for $9.50 or so a share, and that they won’t let Intermedia take the company private for anything lower.
Now let’s move on to Intermedia. Why do I think they’re ready to bid higher? Well, aside from the “don’t put your highest bid out first” rule, there’s also the fact that Intermedia has already said they think Outdoor is worth more than $9.15 to them.
That line may make you do a double take. Why would Intermedia tell everyone that they think Outdoor is worth more than $9.15 a share? Isn’t that terrible negotiating?
The answer: yes, it is. But it doesn’t change the fact that they have. First, remember that Intermedia responded the KES’s topping bid with a bid that had a headline value of $9.25 including $0.50 of preferred shares. I can’t imagine Kroenke let’s them off for less than that.
More importantly, think back to Intermedia’s letter refuting KES’s bid. Specifically, this line
Thus, utilizing current multiples, the allocation of synergies to the segment with respect to which they are applicable and the most recent estimates of achievable synergies, it is clear that the KSE Proposal falls below the bottom end of the range of the pending transaction with IMOH and is nearly $2.00 below the high end of the range. Furthermore, the KSE Proposal deprives the OUTD stockholders of the significant equity upside which the combined integrated company can deliver in the future.,
Doing some rough math, that means Intermedia thinks OUTD is worth between $8.80 to $10.70 per share (and multiples have risen even further since then). Think KES can’t do that math? Think again; they know what Intermedia thinks OUTD is worth and they’re going to make them hit that bid.
There’s another reason to think Intermedia is willing to raise their bid: the financing. As I’ve noted before, media mergers tend to have high synergies. Because of these synergies, they tend to be done with some portion of stock so that selling shareholders can capture some of the upside while the bidders don’t need to lever themselves to the hilt to give sellers full value for their company plus synergy / take over premium.
Notice what Intermedia’s bid doesn’t include? If you guessed “an equity component,” give yourself a cookie. Why would Intermedia be willing to lever themselves to the hilt and not use any equity? It doesn’t make much sense… unless you think Intermedia’s prepping for a bidding war and feels like they need to be able to raise their bid quickly. Then it makes sense to settle all of their debt financing first, and then use equity for any incremental raises.
Consider if they had done a 50/50 split of debt and equity to start. Then 1) it could be argued that they didn’t have a superior proposal, as KES could argue the surety of $8.75 cash is better than a mix of cash and equity and 2) Intermedia couldn’t quickly raise their bid, as each bid raise would require an increase in debt that would require them to raise more debt from banks.
But by putting all of their debt / cash bid up front, Intermedia doesn’t need to worry about either of those scenarios. Their bid is undoubtedly superior to KES’s (more cash = better), and if they need to quickly raise their bid, Intermedia can just throw in equity now. KES bid $9.50? No problem, Intermedia throws in a dollar of equity and blows KES out of the water. KES comes back at $10.25? Add another $0.50 of equity and Intermedia takes the prize again.
In other words, no matter what KES bids, Intermedia can now quickly top them (assuming, of course, they choose to).
Overall, I think it’s more likely than not that the final bid comes in early next week closer to $10 than $9. It looks like shares are set to open around $9.50 (I’m writing this Tuesday night, April 30th, so I haven’t seen where shares will open), which seems a bit low but more or less fairly valued on the risk reward scale. I might sell 10% or so of my position tmr simply because this is a really big position for me right now, but overall I’ll hold on to the bulk of it and wait to see what comes. For those of you who aren’t involved in the name currently, I’d recommend paying close attention to the stock tomorrow: these small caps can be very volatile on bids, and it wouldn’t surprise me if a few shares trade hands close to the $9.15 bid price in the next day or two.
Disclosure: Long OUTD.
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