Recommendation: Long Asiainfo-Linkage (ASIA) at $11.77
Target Price: $12.00
Asiainfo's go-private deal is likely to close before end of 2013. The anti-trust approval has already been granted, which removes the biggest uncertainty in the deal. Moreover, the deal is likely to receive the approval from shareholders. Last but not least, the assumptions that Goldman Sachs used in the fairness opinion result in conservative fair value estimations. As the result of all these favorable factors, we believe Asiainfo is a relatively safe investment with a 1.9% gross/39.8% annualized return.
Background of the Merger
The existence of Asiainfo-Linkage is the result of a merger between Asiainfo and Linkage in December 2009. On January 12, 2012, CITIC Capital submitted a proposal to acquire all of the outstanding shares not already own by CITIC. The special committee engaged Goldman Sachs to start a sale process. Goldman Sachs contacted 48 potential bidders. 15 potential bidders, including 2 potential strategic bidders and 13 potential financial bidders, entered into confidentiality agreements with the company. By July 2012, only CITIC and another financial buyer (Bidder A) remained in the process after conducting due diligence. Libin Sun, the ex-CEO of Linkage owning 17.2% shares, decides to join Bidder A. Suning Tian, the founder of Asiainfo, teamed with CITIC. In September 2012, Bidder A withdrew from the bidding process because it could not offer a winning bid. The buyer group led by CITIC submitted a bid at $12.00 and signed a definitive merger agreement with the company in May 2013.
Financing of the Merger
The deal consideration is $887 million. Rollover shareholders will contribute their shares valued at $134 million. Buyers will contribute $415 million of equity financing. The buyer group will also take out $330 million of debt financing from a syndicate led by Normura, ICBC, Bank of Taiwan, Cathay United Bank and Maybank. The interest rate on the loan is up to 4.75% and can be terminated on March 7, 2014 if the merger has not closed by that time.
The merger consideration of $12.00 represents a 52.3% premium over the closing price on the last trading day before the initial announcement of the CITIC proposal.
The financial advisor of the go-private offer, Goldman Sachs, conducted a public traded comparables analysis. Goldman Sachs chose iSoftStone and Pactera, which are Chinese IT services companies listed in the US, as comparable companies. The peers trade at 3.8x FY2013 EV/EBITDA and 2.8x FY2014 EV/EBITDA. According to the analysis, ASIA's deal value represents 6.5x FY2013 EBITDA and 4.7x FY2014 EBITDA. We see a similar pattern with the earnings multiples comparison as well. Hence, shareholders are adequately compensated based on the comparison with peers. However, we are not very comfortable with the forecasted numbers used by Goldman Sachs. For example, iSoftStone currently trades at 6.0x LTM EV/EBITDA and Pactera trades at 6.3x 2013 EV/EBITDA. Based on this comparison, the takeout multiple of 6.5x is not so generous.
Goldman Sachs also conducted a precedent transaction analysis. The median LTM EV/EBITDA of comparable transactions is 7.9x. We noticed that the precedent transaction comparables are selected from cash acquisitions in the IT Services industry between late 2007 and 2012, when the economy hardly recovered from the Great Recession. Compared with the already depressed precedent transaction valuation, ASIA's EBITDA multiple of 6.5x at deal price does not look very generous.
Last but not least, Goldman Sachs conducted a discounted cash flow analysis. Goldman used the management projections for 2013-2016, where the growth remains over 10% until 2016. The analysis assumed a perpetual growth rate of 0%-4%, and a discount rate of 16.3%-18.3%. There is not any justification for these two assumptions. According to the DCF model presented by Goldman Sachs, the company should be worth about $10.61-$12.91 per share. Thus, Goldman Sachs concluded that the deal value of $12.00 per share is very generous. We think the assumption that the terminal growth period begins in 2016 can be validly challenged as Goldman Sachs admitted that they simply had no vision on the business beyond 2016 and had to use the terminal growth model. The discount rate could be challenged too. If Goldman Sachs had used the global telecommunication IT services companies as the peer group, the median beta of the peer group would be 0.99, which is much lower than iSoftStone and Pactera's average beta of 1.72. Another piece of evidence we see is the analyst at UBS used a 9.9% WACC to discount the free cash flow.
Conditions of the Deal
We will discuss the following two significant conditions for the deal to close.
- The merger requires approval from more than 50% of shares. Based on the proxy statement, the buyer group owns 15.3% of shares as of the record date of the special meeting. Mr. Sun, who holds 17.2 % is likely to vote against the deal since his request for CITIC to raise the deal price to $13.00 was rejected in August. Another shareholder, Brandes Investment Partners, filed a 13D in August to push for a higher deal value, but the attempt has largely failed. Other significant shareholders are insurance companies and mutual funds. It is unlikely that they will vote against the deal. Talking to the deal's financial advisor, we do not think they are concerned about receiving the shareholder approval.
2. The merger requires the approval from Ministry of Commerce (MOFCOM) in China. As expected, the application went to the second phase of the MOFCOM review and was cleared by the end of second phase. This condition is fulfilled now.
Expected closing time
According to the proxy statement, the merger is expected to close before the end date, which is February 12, 2014. Since the parent is required to close the merger within three days after all conditions are fulfilled, we target the closing date to be December 26, or 3 weeks later. We used the target closing date to calculate the annualized return.
The merger can be terminated by either party, if
- The deal does not close by February 12, 2014
- Shareholders do no approve the deal
- Any government entities prevent the deal from happening
The merger can also be terminated by the Company if
- The Parent has breached the contract or has inaccurate representations and warranties which cannot be cured
- The company receives a superior proposal prior to the shareholder approval
- The Parent fails to close the merger within three days after all conditions are fulfilled.
The merger can be terminated by the Parent if
- The Company breaches the contract or has inaccurate representations and warranties which cannot be cured
- The board of directors changes recommendations or supports a competing offer
The Company termination fee is $18 million, which is quite low at 2% of the deal value. The company pays the termination fee if the merger is terminated due to Company's inaccurate representations, a failure for shareholders to approve the merger, a failure to close the deal by February 12, 2014, a change of recommendation by the board or the adoption of a superior proposal by the company.
The reverse termination fee is $36 million. The parent pays the termination fee if the merger is terminated because the parent willfully breaches the agreement or the parent fails to close the merger within three business days after all conditions are fulfilled.
At $11.77, ASIA may provide shareholders with a 39.8% annualized return if the merger closes. The only remaining condition for the deal to close is likely to be satisfied on December 19, 2013. Therefore, we recommend a long position in the stock.