Global BPO Services: Betting on Shareholder Approval

Jul.22.08 | About: Stream Global (OOO)

The warrants on Global BPO Services (OOO) are a good bet over the very short-term. The warrants have a strike price of $6 and Global BPO is trading at $7.80, allowing the warrants to have an intrinsic value of $1.80 and time value of another $1.50 for a total of $3.30. However, the warrants only trade for $0.67. There are two main reasons they trade for such a low value, which we’ll get to later, but more importantly, there is a good chance that one of these reasons will no longer be a factor when shareholders approve the pending merger with Stream Holdings on July 29th.

The shareholder vote is important because warrant holders can’t exercise the warrants until shareholders approve an acquisition. Global BPO is a special purpose acquisition company, or “SPAC,” created to find an acquisition in the outsourcing arena. Earlier this year, Global BPO’s management announced a deal to acquire Stream Holdings. The deal looks like it is priced attractively, plus the CEO of Global BPO, Scott Murray, used to run Stream Holdings from 2000-2002 until he sold it to Solectron. Shareholders have a choice to approve the attractively priced acquisition and own shares in the ongoing company or vote against the deal and receive $7.93 in proceeds from the Global BPO’s IPO trust fund.

The recent history of SPAC stock performances after acquisition approval is horrendous, so it had seemed likely that shareholders would vote against the deal and warrant holders would have worthless warrants. However, in early June, Global BPO’s management increased the likelihood of shareholder approval by announcing an interesting deal with Ares Capital, a private equity firm. The deal would have Ares Capital pay $150 million for convertible preferred stock at $8. Global BPO would use the money from Ares to tender for 70% of its publicly-held shares. This event significantly increased the probability that shareholders would approve the deal, but it didn’t make the vote a foregone conclusion.

At this point, Shareholders had a choice to vote against the deal and get their $7.93 from the IPO trust or vote against the deal with just under 30% of their shares and get $7.93 for those shares and tender the remaining 70% of their shares to get $8.00. The problem was if not every shareholder voted against the deal with just under 30% of their shares but every remaining share was tendered, not all of the tendered shares would be accepted. For all of the shares not accepted in the tender offer, the shareholders faced the prospect of getting less than $7.93. The safest route for shareholders was still voting against the deal with all of their shares and assuring themselves of $7.93.

This all changed on Friday, July 18th when Global BPO’s management again increased the chances of the shareholders voting for the deal. They announced that the tender offer at $8 will be increased to 100% of publicly held shares minus the shares that vote against the deal to receive the $7.93 from the trust fund if not deal is completed by October 2009. This makes the vote a lot simpler for shareholders. They can either vote for the deal and get their $8 at the end of August in the tender offer or they can vote against the deal and wait around until October 2009 to see if Global BPO’s management can come up with another deal. With these new terms, I believe it is likely they will vote for the deal.

If shareholders do vote for the deal, the warrants seem cheap for two main reasons: 1) the warrants are worthless unless management completes an acquisition by October 2009 and 2) SPAC shares have been performing poorly once deals get completed and the warrants don’t become exercisable until October 2008. At 70 cents, they are trading below their $1.80 intrinsic value. Plus, there is more than 4 years until the warrants expire, so there is about a $1.30 time value attached to them assuming a low 20% volatility on the underlying stock.

The first major risk to SPAC warrants is if the management team doesn’t make an acquisition, which makes the warrants worthless. However, as I discussed above, I believe this risk will decrease considerably for Global BPOS’s warrants after shareholders vote on July 29th.

The second major risk to the warrants is the lack of exercisability until the one year anniversary of the IPO. Global BPO warrants reflect the risk of stock performing poorly once the tender offer is completed. Reviewing some the SPAC deals to get completed in 2008, the shares have performed poorly after the deals have been completed. Stocks like BTC, SMCG and IGC have all dropped more than 40% after completing their acquisitions, so the Global BPO warrants seem to be pricing in a decline in the underlying stock once the tender offer gets completed.

It will be interesting to see what happens to the stock after the tender offer is completed. I believe all of the publicly held stock should be tendered, so all the natural sellers of a SPAC deal will have already left the stock. So, there may be less selling pressure than a normal SPAC deal. The only remaining shares will be the 9 million held by insiders. However, I think there will still be selling pressure from warrant holders trying to hedge their positions if they are able to borrow the stock to short it against their warrant positions.

Stepping back from the Global BPO warrants to the stock, the Stream Holdings acquisition seems like a good bet, especially after having a private equity firm make such a major investment. The price of 6.3x 2008 EBITDA on a business with depressed margins seems average, but the projections for 2009 are for 90% EBITDA growth due to both continued revenue growth and margin expansion. Management appears to have a focused plan for improving Stream Holdings’ business. Plus, unlike other acquisitions, this management team will be focused on one business because they don’t have an existing business to worry about.

Overall, I think there is a short-term opportunity in Global BPO’s warrants because I expect the deal to get approved by shareholders on July 29th. Beyond that, I think the warrants will end up being a good deal as the Stream Holdings acquisition performs well. However, the stock will probably sell-off once the tender offer is completed towards the end of August. If the stock trades down to $6, the warrants should still trade up to $1.20, which assumes a low 20% implied volatility. The move from 70 cents to $1.20 is worthy of investor consideration.