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Summary

  • Going long on RDA Microelectronics could generate a decent annualized return given the 8.76% premium and the estimated closing time of 2 months.
  • The acquisition is highly likely to go through since it's part of government's efforts to consolidate the fabless semiconductor industry. A competing bid further reduces the downside risk.
  • A market multiples analysis indicates the stand-alone stock is undervalued even after the price jumps since the acquisition talk.

Going long on RDA Microelectronics (NASDAQ:RDA) at its current market price represents a unique merger arbitrage opportunity with great upside potential and limited downside risk. The SEC filing could be found here.

Tsinghua Unigroup's Acquisition of RDA Microelectronics

On November 11, 2013, RDA Microelectronics and Tsinghua Unigroup jointly announced that they have entered into a definitive merger agreement under which Tsinghua Unigroup will acquire all of the outstanding ordinary shares of RDA for $18.50 per American Depositary Share. The merger values RDA's equity at approximately $910 million, on a fully-diluted basis. The purchase price represents a premium of approximately 33.3% over the closing price of RDA's American Depositary Shares on September 26, 2013, the last trading day prior to the announcement by RDA of the receipt of a non-binding acquisition proposal letter from a third party, China's state-owned Shanghai Pudong Science and Technology Investment Company (see the company's news release). According to the original merger agreement, the transaction was expected to close in the first half of 2014 but it was until May 5th 2014 that RDA issued an update on the pending merger, putting off the transaction closing date to the second half of 2014 with a long-stop date of August 8, 2014. In the update, RDA reconfirmed that Tsinghua Unigroup is taking concrete actions to close the transaction within the framework of the merger agreement.

The Risk Arbitrage Opportunity with Great Annualized Return Potential

At the current price of $17.01 as of June 16, 2014, the buyout price of $18.50 represents an impressive 8.76% premium to the market. The transaction is subject to approval by the shareholders of RDA, and antitrust and other regulatory approvals, and is not subject to any financing condition. The market is either pricing in a significant chance that the deal will not close or failing to operate efficiently. I believe risk arbitrageurs who buy RDA would profit from the spread within 1 to 5 months. The differential represents a 176% annualized return if the deal executes in 1 month; 66% if the deal executes in 2 months, and 22% if the deal executes in 5 months. The deal will very likely be closed in less than 2 months, before the long-stop date of August 8, 2014.

Company Background

RDA Microelectronics, Inc.

RDA is a fabless semiconductor company that designs, develops and markets wireless system-on-chip and radio-frequency semiconductors for cellular, connectivity and broadcast applications. The company's product portfolio currently includes baseband, radio-frequency front-end modules, power amplifiers, transceivers, Bluetooth system-on-chip, Wi-Fi, Bluetooth and FM combo chips, FM radio receivers, set-top box tuners, analog mobile television receivers, CMMB mobile television receivers, walkie-talkie transceivers and LNB satellite down converters.

Headquartered in Shanghai, China, RDA went IPO in 2010 and listed its ADS on Nasdaq. RDA has a diversified blue-chip customer base, including the top 10 branded handset manufacturers in China, including ZTE, Huawei, Tianyu, and TCL, and the top design houses in China, including Longcheer, Huiye, Tinno and Wingtech.

Tsinghua Unigroup Ltd.

Tsinghua Unigroup Ltd. is an operating subsidiary of Tsinghua Holdings Co., Ltd., a solely state-owned limited liability corporation funded by Tsinghua University in China. Tsinghua Unigroup's business lines include high-technology, bio-technology, science park development, and urban infrastructure construction. In late 2013 it made two acquisitions (the completed Spreadtrum (NASDAQ:SPRD) acquisition and the attempted RDA Microelectronics acquisition). Like RDA, Spreadtrum is a fabless semiconductor company that develops mobile chipset platforms for smartphones, feature phones and other consumer electronics products. This move is widely believed to be part of a Chinese-government attempt to consolidate the fabless semiconductor sector. Combining these two Shanghai-based fabless companies through two separate acquisitions executed by Tsinghua Unigroup is expected to deliver a new, state-owned, consolidated entity that might become powerful enough to compete with Taiwan's MediaTek.

Risk & Reward

I believe the merger is highly likely to be completed. As mentioned above, Tsinghua Unigroup's successful acquisition of Spreadtrum in December, 2013 and attempted acquisition of RDA was believed to be a Chinese-government attempt to consolidate the fabless semiconductor sector, thus it would be very absurd that the Central government and the National Development and Reform Commission of China would not pass the deal.

The deal was already passed by the shareholders, the acquirer's parent Tsinghua Holdings is well-funded, and there were no material changes to both companies' operations since the merger bid last year. That is to say, the regulatory approval, shareholder approval and financing concerns were pretty much cleared.

However, the reason that the deal was prolonged is that over the last few months, the proposed deal has triggered negative emotions among RDA employees. Chairman and CEO Vincent Tai, who reportedly resisted the Tsinghua Unigroup's acquisition plan, was fired by the RDA board late last year. The objections are mostly due to cultural differences. According to a blog on EETimes, compared to the more agile and free-spirited RDA, Spreadtrum is a much bigger corporation where engineers are known to be highly regimented, working in a modern "feeding" machine-like environment.

Given that Shanghai Pudong Science and Technology Investment Co., Ltd. Lost the bid war with a $15.5 target price (12% premium), we can believe the stock price had a buffer of at least $15.5. Now we present the results of the sensitivity analysis behind the estimates of the annualized returns through the merger arbitrage. In the best case, the deal would be completed within a month and generate a whopping annualized return of 176%.

Stand-alone Company Valuation

I present a comps analysis below to justify that even if the acquisition did not fall through, at the current market price, RDA would still be significantly undervalued. The company is currently trading at an EV/EBITDA multiple of 9.97x, significantly lower than the industry median of 12.35x, so do its EV/Sales and EV/EBIT multiples. RDA's P/E and PEG ratio are also much lower compared to its close competitors. Looking forward into the next year, RDA's revenue growth rate is expected to be around 21%, a little bit higher than the 3-year trailing rate. Gross margin and EBITDA margin are also expected to rise back to pre-2013 levels as the semiconductor industry becomes more profitable than last year.

(click to enlarge)

Conclusion

Risk-arbitraging on an under-covered and undervalued high-tech business with a growing market, improving margins, and a high-quality customer base for an upside potential of great return potential and limited downside risk is too good an opportunity to miss.

Disclosure: The author has no positions in any stocks mentioned, but may initiate a long position in RDA over the next 72 hours. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.

Source: RDA: A Unique Merger Arbitrage Opportunity With Great Return Potential