Parametric Sound's (PAMT) reverse merger with Turtle Beach is not likely to be positive for shareholders, and barring the market awarding a significant premium to the resulting company, it might even be disastrous.
Now, we have precious little information on this merger. What we know is:
- Parametric Sound will merge with Turtle Beach, with Parametric Sound's shareholders ending up with 20% of the interest in the new company, and Turtle Beach shareholders holding 80%;
- Turtle Beach is profitable and had revenues of $205 million in 2012;
- $12 million in Turtle Beach preferred stock will remain outstanding along with accrued dividends;
- Parametric Sound shareholders will have to approve the deal;
- Parametric Sound will have to issue $5 million in debt or equity prior to the deal;
- Parametric Sound will be managed by Turtle Beach officials, including the CEO. This is a reverse merger after all;
- If the merger fails under certain conditions, Parametric Sound might have to pay $1 million to Turtle Beach and/or enter into a licensing agreement for its technology. This licensing would be exclusive for console products and non-exclusive for computer products;
- Turtle Beach might have to pay $1 million to Parametric Sound if the merger fails.
I believe this deal will be negative for Parametric Sound shareholders
The reason is simple. Parametric Sound trades on hope and thus at a huge premium to its inexistent business activity. Once the merger goes through, however, the resulting company is likely to be valued according to its present fundamentals and prospects.
And what prospects will those be? They will be the prospects of a company making gaming headsets whose website didn't even work in 2 different computers of mine. Gaming headsets, and headsets in general, are deeply competitive. Gaming is not expanding much, and the available choice is large.
Comparable companies such as Skullcandy (SKUL) or Logitech (LOGI), while profitable, trade at deeply discounted valuations. Since all we know about Turtle Beach are its revenues, the one metric that concerns us is price/sales. Skullcandy trades at a price/sales of 0.56, and Logitech trades at a price/sales of 0.53.
Implications for Turtle Beach and Parametric Sound
The main way that Turtle Beach would earn a higher valuation multiple, would be for it to be much more profitable than either Skullcandy or Logitech. But that's not likely - Turtle Beach is even accruing dividends on its preferred, and that's not the move of a hugely profitable enterprise.
So we can reasonably expect Turtle Beach to trade at a valuation that's close to its comparables. Something between 0.50 times sales and, to be generous, 1.00 times sale.
That would mean that the new Parametric Sound would trade with a market capitalization of somewhere between $102.5 million and $205 million. But remember, present PAMT shareholders will have just 20% of this new company. This would give them a value of between $20.5 and $41 million. And therein lies the problem - PAMT presently trades with a market capitalization of $118.1 million, so if Turtle Beach happens to converge to the valuation of its comparables, then the downside for present PAMT shareholders will be somewhere between 65% and 82%.
In short, this merger has the potential to be disastrous for PAMT shareholders.
The only hope would be for the shares to trade at a huge premium, which would be a bonanza for Turtle Beach shareholders - the shares would have to trade at a market capitalization of $590.5 million for PAMT shareholders not to lose, and this would value Turtle Beach shares at $472.4 million for a price/sales on the deal of 2.3 times (for Turtle Beach shareholders only). This is unlikely to happen given what we saw regarding comparable companies.
So the one thing that's likely to happen is for PAMT shareholders to lose and lose big.