Adesto Technologies Corporation (NASDAQ:IOTS) signed a merger agreement with Dialog Semiconductors (OTCPK:DLGNF). In my view, both companies will generate much more sales together than separately. The merger would also include cost synergies and will be EPS accretive. Besides, the conditions, the termination fees and Adesto's Board of Directors make me believe that the closure of the merger is likely. I may not buy shares of IOTS at the current share price, but will follow the company closely.
Adesto Technologies Corporation offers semiconductors and embedded systems that are essential building blocks of Internet of Things edge devices. It was founded in 2006, and is headquartered in Santa Clara, California.
There are two features that make this company a hidden gem. They include revenue growth and the large number of customers from different industries. In my view, the company is a perfect target for corporation willing to diversity its revenue sources:
Source: IR Presentation
Source: IR Presentation
Besides, from 2018 to 2022, the company's market opportunity is expected to increase at a CAGR of 25%. Again, Adesto is, due to this reason, an interesting target for large corporations willing to profit from the growing IoT market:
Source: IR Presentation
Adesto's balance sheet is very stable. As of September 30, 2019, cash in hand was equal to $37 million, accounts receivable was $33 million, and goodwill was equal to $38 million. In my view, both the goodwill and the accounts receivable are interesting for the buyer as they mean potential FCF. On the liability side, the company reports $20 million in accounts payable, and $55 million in convertible debt, which don't seem large amounts. Taking into account Adesto's cash in hand and accounts receivables, the amount of liabilities don't seem that large:
Source: Quarterly Report
In the next three years, Adesto is expecting to report revenue growth. From 2018 sales of $83 million, the company is expecting to hit $173 in 2021. That's more than 100% sales growth in less than three years.
Source: Market Screener
In my view, if the buyer acquires the company, sales growth may become larger. Adesto may be able to obtain a new list of clients from Dialog. Besides, it may also be able to sell its building blocks of Internet of Things edge devices to larger customers. When you have a market capitalization of more than $2 billion, like Dialog, more customers are willing to talk to you.
While assessing the words of the CEO to explain a transaction, I want to read about one or two reasons. In my view, if the management needs to offer 20 reasons to explain the rationale behind the transaction, they give excuses. I don't like that. It makes me think that the acquisition may be a solution for a difficult situation. In this case, the Dialog's CEO offered two very simple reasons. Dialog's list of products will increase, and the buyer will increase its exposure to the growing Industrial IoT market:
We are together expanding our presence in the attractive Industrial IoT market and strengthening our portfolio with highly complementary products - all of which make me incredibly excited about the future. Source: Jalal Bagherli, Chief Executive Officer, Dialog Semiconductor
Besides, I could also find what, I believe, is the most significant need of Dialog. The CEO did not mention it, but I figured it out in one of the presentations given by the management. The transaction with Adesto will reduce Apple concentration. Bear also in mind that the companies are expecting cost synergies and the merger is expected to be EPS accretive from 2021:
Source: Business Presentation
In 2018, Dialog's most relevant customers represented more than 83% of its revenue. Besides, Apple accounted for more than 10% of its revenue:
Customers with a significant contribution to revenue include Apple, Xiaomi, Huawei, Samsung and Panasonic. These top five customers represented 83% of Dialog revenue in 2018. Source: Dialog's 10-k
During each of the years ended 31 December 2018, 2017 and 2016, there was only one customer, Apple Inc. ("Apple"), that accounted for more than 10% of the Group's revenue. Source: Dialog's 10-k
Adesto does not report as much customer concentration as Dialog, which makes the transaction ideal. Dialog's CEO has not highlighted this fact, as it is one of the largest risks of its company. However, I do believe that I need to point it out for investors. Adesto's customer concentration is shown below:
Adesto is expected to close the acquisition in the third quarter of 2020, when shareholders will receive $12.55 in cash. Among the conditions, there is the HSR waiting period. Also, Adesto's shareholders will need to approve the deal. Finally, the Committee on Foreign Investment in the United States will need to accept the deal:
1. The adoption of the Merger Agreement by the holders of a majority of the Company's outstanding Shares
2. The expiration or termination of the waiting period under the Hart-Scott-Rodino Antitrust Improvements Act of 1976.
3. The clearance of the Merger by the Committee on Foreign Investment in the United States ("CFIUS Approval").
4. The absence of any order or other legal restraint or injunction preventing the consummation of the Merger and the absence of any law making the consummation of the Merger illegal, in any case, by any court or governmental entity having jurisdiction over the parties to the Merger Agreement. Source: Merger Agreement
In this case, I don't think the conditions will be an issue. The companies received the voting support of shareholders owning 3.1% of the total share count.
Source: Merger Agreement
Also, note that Adesto's market capitalization is less than $500 million, which is large. Thus, I don't expect that regulators will block the acquisition. Finally, Dialog Semiconductor is based in the UK, so I would expect that the companies will obtain the CFIUS Approval. Don't get me wrong, but if the buyer is not from China or Russia, I am not generally afraid of the CFIUS Approval condition.
Under certain circumstances, if the deal is not closed, Dialog or Adesto may have to pay the other party a termination fee of $15.76 million. I believe that buyers should have a termination fee larger than the target. It is not perfect. However, the Termination Fee/EV is close to 4%, which I believe is standard. I expect that investors would like this feature of the M&A contract:
The Merger Agreement contains customary termination rights for the parties, including the right to terminate the Merger Agreement if the Merger has not been consummated at or prior to 11:59 p.m. (California time) on August 20, 2020 (or, if so extended by either party in accordance with the terms of the Merger Agreement, November 20, 2020) (the "End Date"). Source: Press Release
The Merger Agreement provides that the Company will be required to pay Parent a termination fee of $15.76 million if the Merger Agreement is terminated under certain circumstances, including by the Company to accept a Superior Offer (as defined in the Merger Agreement) and enter into a definitive agreement providing for consummation of the transaction contemplated by such Superior Offer. The Merger Agreement also provides that Parent will be required to pay to the Company a termination fee of $15.76 million if the Merger is not consummated due to a failure to obtain CFIUS Approval prior to the End Date. Source: Press Release
I reviewed the Q&A session given by Adesto, but I could not find a lot of information regarding the post-merger integration planning. In my opinion, the following question regarding the future location of Adesto's Headquarters gives valuable information about the context of the negotiation. In my view, if Adesto's Headquarters is about to be in the United States, the management would have remarked it.
The parent's termination fee and the buyer's termination fee is the same. Taking into account this fact, I believe that Dialog's negotiation power was larger than that of Adesto. As per my experience, it increases the likelihood of successfully closing the deal. Dialog's enterprise value is more than 3x the target's enterprise value, which is also a good sign.
That's not all. I reviewed the Board Of Directors of the target. In August 2019, the company hired a director with a lot of M&A expertise. She did not announce that she was hired to sell the company, but mentioned that the company may proceed to its next level of growth:
I am excited to work closely with Adesto as it proceeds to its next level of growth Source: Press Release
Source: Company's Board Of Directors
The market understood well the appointment of new directors. After the announcement, the stock price increased from $8 to $10. Those shareholders who could read between the lines and bought at $8 made a profit of 50% in less than a year:
Source: Seeking Alpha
The company hired a director with M&A expertise more than seven months ago. It indicates, in my opinion, that the acquisition was proposed by Adesto. It also explains why Dialog had more negotiation power. Taking into account this fact, in my view, Adesto will most likely not walk away from the deal.
I reviewed the bonus multiplier of Adesto's Board of Directors in 2018, 2019, and 2020. The Co-Founder, President and CEO of Adesto increased its bonus target from 35% in 2018 to 85% in 2020:
In my opinion, most managers increase their bonus when they believe that they are close to selling the company. It is a clever strategy because they can ask for a larger salary when they work for the buyer.
After the announcement, Adesto`s shares traded at $12.1-$12.35, which is approximately 3.7%-1.6% below the offer price. I do believe that the merger will close. However, investors will need to wait for almost 10 months. If we take into account the time value of money and the current market conditions, I would not pay more than $11.60 for Adesto's shares. To sum up, I would recommend investors to wait a few months or weeks. The current value of the shares is too expensive. Don't get me wrong, I do believe that the deal will most likely close.
Investors need to understand the downside risk. If the deal terminates, Adesto's share price may decline back to $8, which would represent a loss of 50%. The downside risk is one of the reasons to claim that Adesto's share price should not trade at $12.1-$12.35.
Adesto Technologies Corporation is a hidden gem. In my opinion, the buyer appreciated the number of customers and its growing TAM. Dialog needs this acquisition to reduce its customer concentration risk. Taking into account this fact, I would expect the merger to close. Besides, the conditions and the termination fees are standard. Thus, I would not expect them to pose any problem. Regarding the target's share price, I would not buy at the current mark. I will be willing to buy at $11.60 because the merger is about to close in late 2020.
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Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in IOTS 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.