On June 28, 2019, Highpower International, Inc. (Nasdaq: HPJ) entered into an Agreement and Plan of Merger (the “Merger Agreement”) with Mr. Dang Yu Pan, Chairman of the Board and CEO of HPJ, Mr. Wen Liang Li, a director of HPJ, Mr. Wen Wei Ma, a stockholder of HPJ, and Essence International Capital Limited (collectively, the “Acquirers”) where the Acquirers will buy all outstanding shares of HPJ not currently owned by the group for $4.80 per share in cash. The “going-private transaction” is expected to close by the end of the third quarter and is currently trading at an approximately 7 percent discount to the closing price, or 32 percent on an annualized basis. Therefore, this may make for a fantastic arbitrage, but there are certain risks that must be assessed before making an investment.
The transaction is conditioned on the adoption of the Merger Agreement by a majority of both all outstanding shares of HPJ’s common stock as well as all outstanding shares not directly or indirectly owned by Acquirers, their affiliates or officers and directors of the company. As of June 27, there were 15,642,704 common shares outstanding, inclusive of shares issuable within a 60 day window. The Acquirers control 5,394,967 shares, or 34.5 percent of shares outstanding. The only other shareholder with more than 5 percent voting power is Renaissance Technologies, LLC, which currently holds 6.8 percent, or 1,062,599 shares. Therefore, to adopt the merger, a total of 5,123,869 shares will need to vote in favor of the transaction ((total shares outstanding – Acquirers’ shares) / 2 ). Renaissance Technologies, a quantitative investment management company, will likely vote in favor of the merger; leaving only 4,061,270 needed in favor of the merger for approval. It is highly likely Acquirers will get the votes needed to close the transaction.
The total value of the transaction is approximately $51 million. Acquirers entered into an equity commitment letter with Essence International Capital Limited (“Essence”) where Essence will contribute the entire amount of cash needed to close the transaction. Essence is a private equity firm based in Hong Kong and subsidiary of Essence International Financial Holdings Ltd. Although there is very little public information regarding the parent, the firm’s website provides adequate legitimacy to support its ability to fund the transaction. Moreover, the Merger Agreement provides adequate assurances that Essence will perform as well as legal recourse in the event it fails to perform. Therefore, the transaction is not subject to a financing condition and there is de minimis risk Essence fails to perform.
State Administration of Foreign Exchange (“SAFE”) currency conversion
SAFE functions as the gatekeeper of China’s capital controls, and must approve the exchange of RMB for U.S. dollars to pay out to existing HPJ shareholders. In 2015, China “instituted tighter capital control as well as curbs on ‘“irrational outbound investment”’ after the stock market rout of [that] caused huge capital outflows and a shar depreciation of yuan against the US dollar.” See here. Recently, however, has softened restrictions on outbound funds used to “repurchase or delist shares” of offshore companies. See here (Circular 37). For example, eHi Car Services Limited was recently taken private and that deal was approximately $1 billion. This transaction, on the other hand, is only $51 million. Therefore, it is unlikely that SAFE will stifle this deal beyond ordinary closing procedure.
It is anticipated that this deal closes by the end of the third quarter of 2019. This gives HPJ and the Acquirers over 80 calendar days to close the transaction. A concern, however, is that the deal may drag on past the end of the third quarter. This, in part, is because Acquirers’ took over one year to turn their non-binding proposal into a contractual agreement. Furthermore, the parties negotiated an "End Date" of December 31, 2019 with a potential extension to March 31, 2020. Despite these facts, the risk that this deal does not close during the anticipated closing window is slight given the Merger Agreement carries liquidated damages. To be certain, however, it may be prudent to wait until the parties provide the Definitive Proxy Statement to shareholders entailing the date of the special shareholder meeting before entering into an arbitrage position.
Article 9 of the Merger Agreement provides the terms for termination by the parties if certain events occur including, but not limited to, a superior proposal or failure to fund the closing of the transaction. HPJ is required to pay Acquirers a $2.4 million fee, or 4.7 percent of the transaction value, in the event it breaches its obligations under the Merger Agreement. Acquirers is required to pay a $4.7 million, or 9.3 percent, in the event of a breach. The main concern with this deal is whether Acquirers will perform their obligations under the Merger Agreement. The reverse termination fee provides adequate assurances that Acquirers want to see this deal close.
This deal was originally announced in June of 2018 but was recently made official at the signing of the Merger Agreement on June 28, 2019. As such, the market had ample time to digest and discount the $4.80 per share offer price in the event that the deal does not close. Between the non-binding proposal and the signing of the Merger Agreement the stock traded from a low of $2.07 per share to a high of $3.84 per share. Over that time, HPJ has experienced over 20 percent revenue growth and operating margin expansion. The company has a debt-to-equity (book value) ratio of 1.02 and an 8.3x interest coverage ratio. If the deal fails, it is expected the shares return to their pre-Merger Agreement price range between $3 to $3.40 per share.
Probability of transaction closing
In light of the foregoing analysis, it is the Author's opinion that, because the Definitive Proxy Statement has yet to be provided for shareholders, there is an 85 percent chance this deal will close. If and when, however, the proxy statement is furnished, the Author believes the chances increase to 95 percent. Accordingly, the Author believes the transaction has an expected value of $4.53 per share with an expected .67 percent arbitrage spread, or 2.93 percent annualized.
To summarize, the Author believes this deal is expected to close within the next 80 calendar days, providing a 7 percent real return, or 32 precent annualized. There is the slight chance the deal is stifled by SAFE and an even smaller chance Acquirers do not close as defined in the Merger Agreement. Because, however, the parties took over a year to sign the Merger Agreement, it is prudent to wait for the definitive Proxy Statement before opening an arbitrage position.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in HPJ 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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