Diageo/Sichuan Swellfun Tender Offer Looks Risky, But Might Provide An Interesting Shorting Opportunity

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Includes: DEO
by: Special Situation Investor
Summary

Thalassa-LSR deal offers 31% spread.

After the tender, a considerable drop in THAL is expected.

Diageo wants to increase their stake in Sichuan Swellfun via a tender offer, and although the participation is risky, the situation might provide a good opportunity for shorting.

Diageo (NYSE:DEO) - Sichuan Swellfun (600779.SS) Tender offer

Spread: 8% (no possibility to execute on IB)

UK alcoholic drinks company Diageo wants to increase their stake in their Chinese peer Sichuan Swellfun from the current 60% to 70%. Consideration stands at 45 CNY/share (19% premium to undisturbed price, but 27% discount to the previous tender). I expect the participation to be high (maybe not as high as in the previous tender, but still), and a price fall after is very likely as well. So, overall, this trade is quite risky, and I would probably be even more interested in the shorting Swellfun instead of participating in the tender.

In 2018 summer, Diageo has also done a tender offer for 20% of the shares at 62 CNY (23% premium to undisturbed price). The buyer had 39.71% at that time, so the free float was about 294m shares, out of which 247m (about 50% of the shares outstanding) have participated in the tender. After that, the shares fell sharply (over 30% in a month), and it seems like everyone who participated above 50 CNY ended up with a loss. In order to have a better picture and guesses on the current tender, it would be very helpful to check the company's performance. However, I haven't been able to find any recent report so far.

Short Background:

Diageo bought about 20% of Sichuan Swellfun in 2007 and has slightly increased their stake in 2011. In 2013, they have bought another 18% and ended up with 39.71%, which was increased in the last tender in the summer of 2018

Local Shopping REIT (LSR.L) - Thalassa Holdings (THAL.L)

Spread: 31%

A month after the initial announcement of a possible offer, LSR has received a binding proposal to acquire the remaining shares from their largest shareholder - THAL (owns 25%). The deal will go in a form of a tender offer, and the consideration is 9m GBP + 16m THAL shares, which, if we assume 100% participation, translates into 14.64p + 0.26 THAL per LSR share. The offer document is expected to be released by the 6th of March. Although the spread on this deal is very attractive, the profitability of this deal is largely dependent on the amount by which THAL is going to fall after the tender.

THAL is an illiquid company that apparently does not really care much about shareholders' value, and so far, this merger looks like one more attempt to raise the funds by acquiring and liquidating LSR assets, so I believe that LSR shareholders are going to choose a full cash option.

Change in THAL

THAL value

Cash Portion

Total Value

Profit/Loss

0%

0.213

0.1464

0.360

29.35%

−10%

0.19188

0.1464

0.33828

21.68%

−20%

0.17056

0.1464

0.31696

14.01%

−30%

0.14924

0.1464

0.29564

6.35%

−40%

0.12792

0.1464

0.27432

−1.32%

−50%

0.1066

0.1464

0.253

−8.99%

According to the table, if shares drop about 38%, the upside will be gone.

Last reported book value of THAL is 21m GBP with the NAV of 1.07/share.

THAL currently trades at about 23% discount to NAV, and here is the historical data.

THAL

NAV/share

Price

Discount to NAV

2018 JUNE 30

1.16

0.845

−27.16%

2017

0.96

0.98

2.08%

2016

1.01

0.49

−51.49%

2015

0.79

0.395

−50.00%

2014

1.11

0.42

−62.16%

The structure of the deal does not look beneficial to THAL, to say the least, as after the completion, its NAV is going to drop to 0.9/share (due to the share issuing and cash spending), but anyway, if we take that the discount to NAV is going to remain the same, THAL shares will therefore have to drop by 22%, and we would end up in sweet 10%+ profit. However, it seems that, historically, THAL is used to trading at much higher discounts.

Given that there is obviously going to be some additional selling pressure from LSR shareholders, I believe that, all in all, this is a quite risky trade as 38% fall is quite likely.

Some additional info on the companies:

Thalassa is an investment company mostly involved with manufacturing and testing of flying node autonomous underwater vehicle (AUV) for offshore seismic surveys.

Local Shopping REIT is a small-cap property investment firm, which has sold off almost all its properties. It is used to operate at a huge discount to NAV as well. Given that the current price of the deal offers a slight premium to NAV, I expect the participation to be high.

LSR

BV

NAV/share

Price

2018

20

0,336

0,3

−10,71%

2017

26.4

0,425

0,31

−27,06%

2016

27

0,43

0,296

−31,16%

2015

28

0,42

0,263

−37,38%

Takeaway

So, all in all, in my opinion, both deals are quite risky, and you should be careful about participating straightforwardly. As I've said before, I would probably be more interested in actually shorting Swellfun (if you have a broker that allows trading this stock). In regards to the second deal, a considerable drop is expected after the tender, and actually one might think that it might be interesting to jump in for a rebound. However, so far, I don't see any strong arguments for that to happen as well.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.