Recommendation: Long Charm Communications (NASDAQ:CHRM) at $4.47
Target Price: $4.65
We believe Charm Communications is likely to close the go-private deal by late September. The buyer consortium owns shares representing 68.7% of total votes, enabling the buyer consortium to obtain the requisite shareholder approval. The go-private deal values Charm Communication at a deep discount compared with public-traded comparables and precedent transactions, so the downside is limited. Dissatisfied with the offer price, the second largest shareholder may negotiate a higher offer price for minority shareholders, providing optionality in this situation. As a result of these factors, we recommend a long position in the stock.
Charm Communications is a leading advertising agency group in China that offers integrated advertising services with particular focus on television and the internet. Charm Communications completed its initial public offering in 2010 and raised $74 million. The company has two segments: Advertising Agency and Media Investment Management.
In the Advertising Agency segment, Charm Communications places advertisements on behalf of its clients on China Central Television (CCTV), satellite, and regional TV channels. Charm collects commissions as a percentage of the total advertising spending from clients. From 2004 to 2013, Charm Communications ranked #1 measured by the total value advertisement spending on behalf of clients on CCTV.
In the Media Investment Management segment, Charm Communications buys a portion of advertising time from a TV channel and sells the pieces of the advertising time to its clients. In2013, Charm Communications had exclusive agreements with regional TV stations such as Tianjin Satellite TV and Beijing Sports TV as well as a few programs on CCTV.
Background Information of the Merger
On May 19th, 2014, Charm Communications announced that it has reached a definitive merger agreement with He Dang (Chairman of the Board) and China Media Capital. According to the merger agreement, shareholders of Charm Communications will receive $4.70 per share in cash (less 0.05 ADS cancellation fee). The merger consideration remains unchanged from the offer price in the non-binding proposal from September 30, 2013, which we think undervalues the company. During the 30-day go-shop period following the execution of the merger agreement, the company did not receive any superior proposal. The merger is expected to close no later than 3 business days after all conditions have been satisfied.
China Media Capital is a state-owned private equity fund with a focus in the media industry. Its previous investments included IMAX China, Oriental DreamWorks (a joint venture with DreamWorks), Fortune Star film library and three STAR China TV channels previously owned by News Corp and a financial website Caixin Media. Based on the information, we feel confident that the acquirer is a reputable and serious buyer that is willing to close the deal.
Premium Paid Analysis
The merger consideration represents a 17.2% premium over the unaffected price and 17.5% over the 30-day average price before the announcement of the non-binding proposal. In comparison, the median premium over one-day closing price and 30-day VWAP of announced Chinese go-private deals are 24.0% and 34.3%, respectively.
Trading Comparable Analysis
The deal values the company at 11.3x FY 2013 EBITDA and 10.3x FY 2014 EBITDA. We chose three direct competitors of the company, SinoMedia Holdings (HK: 00623), Guangdong Advertising (SZ: 002400) and BlueFocus Communication Group (SZ: 300058). The median valuation is 24.7x FY 2013 EBITDA and 16.07x FY 2014 EBITDA. In fact, if the company completes the go-private deal and relist in Mainland China, the valuation of the company could increase by 60% to 120%.
Precedent Transaction Analysis
We compiled the statistics of all the completed M&A deals within the Chinese advertising industry with transaction value above $50 million in the last 4 years. The precedent deals valued the targets at 13.4x LTM EBITDA on average, which is 18.5% above Charm's deal valuation of 11.3x LTM EBITDA.
All three measurements support our belief that Charm Communications is undervalued in the go-private deal.
Financing of the Merger
The total amount of fund required to buy out minority shareholders is roughly $81.5 million. Bank of China will provide $60.0 million of credit facility at the interest rate of LIBOR plus 2.3% per year. Utilization of the $60 million credit facility is conditional on Charm and its affiliated company pledging $37 million of deposit onshore and $13 million of deposit offshore. Charm has $121 million cash on hand, so this requirement should not be an impediment to the deal. The buyer consortium will provide $28.0 million of equity financing.
Expected closing time
In the proxy statement, the acquirer expects that the go-private deal will close in the third quarter of 2014. Based on the current progress in the SEC proxy review, we set September 30th, 2014 as our target closing date.
Conditions of the Deal
The conditions need to be satisfied or waived before the deal could close.
1. The company obtained the shareholder approval for the merger agreement. The merger requires approval from 2/3 of shares voted in person or by proxy in the extraordinary shareholder meeting. In addition, the deal requires that no more than 10% of shareholders exercise their dissenting rights. Since the buyout consortium already own 68.7% votes attached to the total outstanding shares, the buyer consortium will be sure to obtain the requisite shareholder approval.
The only significant shareholder that with more than 10% share ownership is Dentsu Aegis Network (Aegis), a wholly-owned subsidiary of Dentsu Inc. Aegis was a pre-IPO strategic investor of Charm Communications with 15.2% ownership. In addition, Charm and Aegis started a joint venture back in 2010 called Vizeum China. The CEO of Dentsu Aegis Asia Pacific Network shared our view and argued that the offer price was insufficient at the board meeting. According to the merger agreement, however, even if Aegis exercises the dissenting rights, buyers can still choose to waive the condition and close the deal. Therefore, the opposition from Aegis is unlikely to cause the deal to fall through. Instead, the opposition brings optionality to the deal as Charm may raise its offer price for minority shareholders to save legal costs.
2. No government entity or court blocks the deal. Since the deal does not require any regulatory approvals from China, the only approval that the deal requires is SEC approval of the proxy statement. There is a shareholder lawsuit in the US, but it is unlikely to pose a threat to the deal.
The merger can be terminated by mutual consent. In addition, the merger can be terminated by
a) either the Company or the parent if
- The merger does not close by November 19, 2014 (outside date).
- Any final and non-appealable injunction from government entity is in place.
- The requisite shareholder approval is not obtained.
b) the Parent if
- The Company breaches the merger agreement.
- The board changes its recommendation prior to the shareholder meeting.
c) the Company if
- The Parent breaches the merger agreement.
- The Parent fails to close the transaction within 3 business days after all conditions have been satisfied.
- The board decides to enter into an alternative superior proposal.
The company termination fee is $2.9 million, or 1.5% of total equity value. The company will pay the termination fee if the company enters into a superior proposal or the company breached the merger agreement. The Parent termination fee is $2.9 million. The Parent will pay the Parent termination fee if Parent breaches the merger agreement or fails to close the merger after all conditions have been fulfilled.
We think it is likely that the deal will close by September 30, 2014. The current market price implies a 76% chance of deal completion, which we think underestimates the probability to close the deal. In addition, we see limited downside risks even if the deal falls through due to the low valuation compared with public-traded comparables and precedent transactions. Therefore, we recommend a long position in the stock.
Disclosure: The author is long CHRM. 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.