On September 23, Shiji (Hong Kong) Ltd. ("Acquirer"), an investment company, entered into an agreement to purchase all outstanding shares of eFuture (NASDAQ:EFUT), a software and solutions provider to the retail and consumer goods industry in China, for $6.42 per share in cash. All that remains for the consummation is approval by two-thirds of all outstanding shares at the extraordinary meeting on December 19. The deal is expected to close by year-end. Currently, the spread between the consideration price and market price is 5.2%, or 84% annualized. This makes for a fantastic arbitrage, but there are certain risks that must be assessed before making an investment.
1. Financing the "Going-Private" Transaction
The transaction is not contingent upon financing, as the approximately $20 million needed to close will be covered by equity capital from the "Buyer Group". Buyer Group consists of the Acquirer, Beijing Shiji Information Technology Co., Ltd., and Mr. Zhongchu Li. As it stands, the Acquirer is wholly owned by Beijing Shiji, and Beijing Shiji is directly controlled by Zhongchu Li, who owns 54.77% of the firm's shares. Per Duff & Phelps, the financial advisor to EFUT, Beijing Shiji has adequate equity capital to complete the transaction. Furthermore, Zhongchu Li is one of China's richest businessmen with a net worth over $2 billion.
Therefore, the risk that the deal does not close because of financing is low.
2. Termination and Payment of Consideration
The agreement provides a $2.2 million termination fee, or 6% of EFUT's equity value, paid to EFUT if the transaction does not close but all conditions are met. This is considerably more than the average 3% break-up fee for failed mergers. However, a $1.1 million fee goes to the Acquirer if, among other conditions, the deal does not close by May 23, 2017. This puts the onerous to finalize the deal on EFUT, which would not be worth mentioning except for the fact that China is currently instituting higher scrutiny on capital outflows from the country. Because Buyer Group's operations are primarily in China, it appears that the consideration will be a capital outflow.
With that said, because this is such a small amount of capital, only $20 million, that is leaving the country, I do not suspect getting capital out of the country to be a problem. Moreover, the merger agreement does not mention NDRC or SAFE approval for this deal.
Therefore, the risk that the deal does not close by long-stop date is low.
3. Shareholder Vote
A condition of the merger, per Cayman Island corporate law, is two-thirds of all outstanding shareholders must approve the going-private transaction. The vote is scheduled for 10 PM on December 19, New York Time. Currently, the Acquirer owns 51.9% of EFUT's 5,284,215 shares outstanding. Thus, only 30.6% of the remaining 2,539,358 shares not owned by the Acquirer must vote for the approval. Also, EFUT's board proposes shareholders vote FOR the merger.
Therefore, the risk that the deal does not close because it lacks shareholder approval is low.
4. Other Conditions and Considerations
Because the merger value is minimal, there are not any other regulatory approvals aside from the shareholder vote needed to consummate the transaction, which is good. On the other hand, because the transaction is so small, trading volume is low. This means there is less opportunity to build a large position, and therefore, makes this potential arbitrage play prohibited to only those approximately $200,000 or less.
Currently, there is no litigation pending against this transaction. As to fiduciary duty, Cayman Islands is less stringent than Delaware law, and even though there are some obvious red flags with the process of this deal, I do not foresee litigation being a factor.
The deal is expected to close by year-end, but has a long stop of May 23, 2017. I expect the deal to close shortly after the shareholder vote on December 19.
Once the merger closes, each share of EFUT's stock will be converted into the right to receive $6.42. If the deal closes by year-end, an investor can expect an annualized return of 84% based on EFUT's current trading price. If the deal fails, there is downside risk of EFUT's shares declining to the pre-merger news trading price of $5.45. Thus, investing could lose 11% or greater if the deal is not consummated.
After all considerations, I believe the merger goes through and that it closes by year-end. Please, share your thoughts below.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in EFUT over the next 72 hours.
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.
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