This is just a quick follow up to my previous post on the merger arbitrage / tender arbitrage opportunity created in ALJJ, but I just can’t understand why the market is offering the company at this price.
Let’s do a quick review. The company is selling their steel sub for $110m+. Upon closing, the company will do an tender at $0.84 to $0.86 per share (representing net cash per share the company will have) for ~50% of their shares outstanding, which their chair (who owns 20% of shares) has agreed NOT to participate in. They will then become a complete cash shell searching for an attractive acquisition to take advantage of their huge NOLs. If they can’t find one within the next two or three years, they’ll likely liquidate.
The deal has already passed regulatory clearance.
So the one big risk here is financing risk. I don’t think it’s a big one.
First (and this is actually the weakest measure), reread the press release from when Optima bought Niagara. Doesn’t this quote really pop out-
Niagara LaSalle will benefit from Optima Acquisition’s strong record of success acquiring and growing companies in the steel sector
Or how bout this one
Optima Acquisitions, LLC is a U.S.-based investment firm with affiliated holdings in steel, ferroalloys, mining, real-estate and other industries. Current affiliated companies in the steel and metals industry include Michigan Seamless Tube, LCC, Warren Steel Holdings, LLC, Steel Rolling Holdings, Inc., CC Metals & Alloys, LLC, Felman Production, Inc. and Felman Trading, Inc
Keep all those subs in mind.
Per the proxy, Optima intends to finance the deal by issuing more of their 12.5% senior secured notes due in 2016. Optima first issued $175m of these when they acquired Niagara late last year. The offering was rated single B by Moody’s, and was priced at 96 for a yield to maturity of over 13%.
Hmmmm. Look at that press release by Moody’s. This is an interesting line
An upgrade in the near-term is not likely given that Optima’s scale remains a limitation. However, once fully integrated, we believe that Optima’s leading niche market position and potential growth in end markets should translate into better credit metrics. EBITA-to-interest expense nearing 3.5 times while debt-to-EBITDA remaining near 3.0 times (all ratios incorporate Moody’s standard adjustments) would imply a potential for positive rating pressure.
A downgrade could ensue if Optima is not benefiting from operating efficiencies or financial performance is negatively impacted by a decline in the company’s end markets. EBITA-to-interest expense trending below 1.5 times or debt-to-EBITDA nearing 4.5 times (all ratios incorporate Moody’s standard adjustments) or deterioration in its liquidity profile could pressure the ratings. Also, an increase in the commitment of the secured revolving credit facility could negatively impact the ratings of the Notes due 2017.
Now, we all know the market for high yield debt is, to put it mildly, on fire right now. Investors have an insatiable thirst for yield. So I looked the bonds up on Bloomberg, and- guess what- they’re trading at 110 right now. I’m doing the math in my head, but I believe that puts the YTM at under 10% currently.
So either investors are CRAVING these bonds, or the synergies Moody’s talked about in rating the bonds are coming through. Probably a bit of both. Either way, I bet investors would easily snap up $110m or so more of the bonds. But they don’t even need to snap that much up- per the proxy (p. 52), Optima already has more than half of the financing lined up. They only need to issue $50m of new notes.
And now the coup de gras- check out this interview w/ the CEO of Optima.
One interesting tid bit is the acquisition will take the company up to $700m in revenue. ALJJ’s piece of that will come out to well under $200m (around $160-175m), so I’m betting the $110m in bonds they need to borrow is pretty easy to come up with given the size of the operation.
But most important is the last few paragraphs
Optima said Nov. 19 it agreed to acquire KES Acquisition Co., which owns a mill producing special-bar quality steel. It will pay New York-based ALJ Regional Holdings Inc. (ALJJ) $112.5 million for KES. Optima’s Niagara Lasalle Corp. unit, which makes cold finished steel bars for auto markets, is KES’s largest customer, Stevick said.
The acquisition will increase Optima’s annual sales to about $700 million and improve its ability to fill orders quickly, the CEO said. The company’s mills have waiting times as long as 12 months, he said.
Two of the company’s major customers that drill for gas increased orders by 20 percent since 2011, Stevick said, declining to name them for competitive reasons.
WOAH! Largest customer? Wait times as long as twelve months? Improved ability to fill orders?
That sounds like some serious synergies between the two businesses.
And let’s not forget Optima is paying ~6.5x trailing EBITDA for the business. Alternatively, see p. 52 of proxy for projections. The price works out to ~7x projected “steel operating profit” for each of the next five years. Either way, it’s not like it takes a lot of synergies for the merger to make sense here.
So I think the deal goes through without a hitch, and you make at least 10% plus on the shares accepted in the tender (and my math says you’re guaranteed of getting at least 62% of the shares tendered accepted).
And as for the shares that aren’t accepted in the tender?
Well, let’s just say there are worse things in the world than owning a company trading for a discount to net cash w/ a management team holding a huge ownership stake (total mgmt team + board will own ~50% of shares after tender), a history of value creation through deal making, and tons and tons of NOLs.
I’ll be happy to own those for a long, long time.
Disclosure- Long ALJJ
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Jess Ravich just accepted a position as Group Managing Director and Heald of Alternative Products with TCW. I wonder if he will be allowed to continue in his role with ALJJ?
I think it is a very small company, arbs probably not focused on it since it is so small and there is uncertainty as to what they will do with the cash afterwards.
Yes, and there’s already a line forming to tender shares – “A stockholder holding substantially in excess of 5% of the Company’s common stock has agreed to tender his shares in the tender offer”
So it’s unknown how many shares left that can be tendered. No financing secured, not known if you can tender 100% of your shares, unknowns with the new company – too many unknowns.
I think buying the Optima bonds might be a better proposition !!
All the shares can be tendered, besides Jess’ shares since he agreed to to tender. The big unknown is how many of the tendered shares gets accepted if the financing comes through. Considering how hot this HY market is and the fact that the Optima bonds moved from just over par at the end of November to 109 today, I am hoping that the financing won’t be an issue.
I’m long too and a bit surprised by the lack of shrinking discount. Not willing to buy any more though. Kind of funny how I like these situations because I don’t think the market prices the situation correctly, but then when it continues to not price it correctly, I get nervous…
Downside risk.
This was a $0.40 stock before the news, so if the deal falls through its going back there and then some. Remember liquidity isn’t going to be there for some microcap when everyone heads for the exits at all once. I’d say you’re looking at over a 50% loss in the bad case, and maybe a 10% gain in the good one.
So sure it’s “likely” to go through, but is it 5:1 to go through? That’s just breakeven. The vol is huge on this, so you’re going to want much better odds than that to make it attractive. 90% to go through is only a 4% expected return and a 30% standard deviation. You get better odds on a risk adjusted basis long the whole market than even the 9:1 case.
So you tell me – what is your estimate for the probability the deal goes through?
Any idea if there is a record date for either the merger vote or tender offer?
Down 12% and counting. Merger is on hold pending failure to find financing. Might still go through, but it’s sure not easy money.