Recommendation: Long Camelot Information Systems (NYSE:CIS) at $1.94
Target Price: $2.05
Camelot's go-private deal is likely to close in late January/early February in 2014. We believe the company will announce the exact date of the special shareholder meeting in two weeks. Following the shareholder approval in late January, the go-private deal will close as the merger does not require MOFCOM approval in China. The investment is likely to generate 5.6% return within 1.5 months with an optionality to receive a higher offer. We think the opportunity exists because the stock has no analyst coverage. The downside is limited as there was a legitimate potential buyer bidding at 17 cents above the deal price in the bidding process. As the result of all these favorable factors, we believe Camelot is a great investment.
Background of the Merger
Camelot has been beaten down after the Longtop Financial fraud was exposed in 2011. In early 2013, a co-founder of the company, Mr. Ma, started to consider a go-private proposal to cash out unaffiliated shareholders. Later, Mr. Ma's wife and another board member joined the buyer group. On March 12, the buyer group offered unaffiliated shareholders $1.85 per ADS. The independent committee retained Duff & Phelps as its financial advisor. Duff & Phelps solicited interests to 71 parties. Only Beyondsoft (002649: Shenzhen), a listed Chinese company, expressed interest and the rest 70 parties expressed no interests to acquire Camelot. On May 7, Beyondsoft Corporation expressed interest and subsequently offered $2.04 per share. On July 26, Beyondsoft increased the offer to $2.224 per share. However, the combination of Beyondsoft and Camelot will be subject to MOFCOM approvals, which brings uncertainty to the deal. Moreover, Beyondsoft was in the process of finishing another acquisition, hence the financial resources and the staff resources were constrained back in July. Consequently, Beyondsoft was informed in early September that its bid was not selected because Beyondsoft failed to provide enough information on the regulatory application and evidence that Beyondsoft has obtained financing for the deal. On July 5, a Party D expressed interests to acquire the company for $2.00-$2.40 per share. However, after approaching Camelot's division managers on August 27, Party D viewed the company to be a "people business" and was unsure if Party D will receive support from division managers. As a result, Party D withdrew from the process. On September 13, the buyer group increased their offer to $2.05 per share, and their offer was subsequently accepted by the independent committee.
Financing of the Merger
The total amount of funds required to complete the merger is $64.31 million. On September 18, 2013, the Parent obtained a debt commitment letter from China Development Industrial Bank for $70 million. The interest rate of Camelot's debt financing is 2.00% plus LIBOR, which is lower than Asiainfo's debt financing which requires ASIA to pay 3.25% minimum interest rate and Pactera's debt financing which requires Pacter to pay 3.50% plus LIBOR. The Parent also obtained a convertible debt commitment letter from Zoyi Management Consulting ltd for $20 million convertible notes. Zoyi was also granted an option to increase the investment by $10 million. Both China Development Industrial Bank and Zoyi are reputable players in private equity in the Greater China region. Therefore, we believe the financing of the deal is reliable.
The merger consideration of $2.05 per share represents a 36.7% premium over the unaffected price and 41.4% premium over 30-day average price prior to announcement of go-private proposal. According to Duff & Phelps, the 36.7% one-day premium is higher than the 25.0% premium in IT company mergers and 28.6% premium in Chinese go-private transactions during the past three years.
The financial advisor of the independent committee, Duff & Phelps, conducted a public company comparable analysis. In aggregate, the public trading comparables trade at 12.5x LTM P/E and 6.9x LTM EV/EBITDA while the Camelot go-private deal values the company at 16.3x FY2013 EV/EBITDA. Furthermore, The EBITDA multiple is also higher than the 7.9 EV/EBITDA of comparable Chinese IT Services company merger deals since 2012. From the comparison, we can see the deal valuation is quite generous.
Expected closing time
According to the preliminary proxy statement, the merger is expected to close in early 2014. Talking to the CFO of the company, we have the impression that the company is incentivized to close the deal as soon as possible, as the buyer group wanted to start a full fiscal year as a private company. Based on our research, it usually takes Chinese companies 2-2.5 months before SEC clears the definitive proxy statement. Camelot filed its first Schedule 13E3 on October 18th, so we believe the definitive proxy statement will be filed within two weeks. Assuming that the shareholder meeting happens a month after the announcement, we are looking at late January for target closing date.
Conditions of the Deal
The following are the most important conditions to be fulfilled before the deal can close.
- The merger requires approval from more than 50% of shares. The rollover shareholders hold 34.04% of shares. Hence, the deal only requires approval from another 15.96% shares, which we feel is very likely given the 36.7% premium over the unaffected price and the generous valuation multiples. In addition, institutional shareholders own over 47% of shares. Since the deal value is above the recent 52-week high, it is likely to be in the best interest of institution investors to accept the offer.
- No government or court prohibits the deal from closing.
- There is no material adverse effect in the business.
The merger can be terminated by either party, if
- The deal does not close by June 18, 2014 (the "End Date")
- 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 provided inaccurate representations and warranties which cannot be cured within 30 days
- The company receives a superior proposal prior to the shareholder approval
- The Parent fails to close the merger within 10 days after all conditions are fulfilled.
The merger can be terminated by the Parent if
- The cmpany has provided inaccurate representations and warranties which cannot be cured within 30 days
- The board of directors changes recommendations or supports an alternative offer
The company termination fee is $3 million, representing 3.1% of the deal value. The company pays the termination fee if the board adopts an alternative offer, the deal does not close by the End Date, or shareholders fail to approve the merger agreement.
The reverse termination fee is $3 million. The parent pays the termination fee if the merger is terminated because the parent willfully breaches the covenant or the parent fails to close the merger within 10 business days after all conditions are fulfilled.
On December 17, a well-respected hedge fund, Pine River Capital Management, filed an amendment of schedule 13D and disclosed an ownership of 7.2%. Their activist ownership gives us a potential optionality since they might be successful in negotiating a higher offer for shareholders.
At $1.94, Camelot may provide shareholders with a 5.6% gross return if the merger closes. We believe the deal is likely to receive shareholder approval based on our analysis, which is the only significant remaining condition. The downside is relatively small because of the competing offer at $2.224. Therefore, we recommend a long position in the stock.
Disclosure: I am long CIS. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.