China Customer Relations Centers: A Nice Spread In 60 Days
Summary
- China Customer Relations Centers is going private at $6.5 per share.
- The gross spread is 5.7%, but the annualized spread is 34%.
- The merger is closing in 60 days.
Investing in China Customer Relations Centers (NASDAQ:CCRC) at current levels presents the opportunity to park money in a situation where the odds are on our side. Odds that will pay 5.7% in 60 days or 34% annualized.
China Customer Relations Centers is incorporated in the BVI, but the company's operations are in mainland China, and it provides business process outsourcing services for the transportation, e-commerce, financial and telecom companies in China. It offers voice and online customer support and care services. The company is listed since 2016, and while financial performance has been steadily improving and growing year after year, the stock performance has been chaotic, especially since the covid outbreak from which the stock price never really recovered and hence the actual opportunity.
The offer
The current offer is already an improved one. The first offer was made in November 2020, but the Buyer Group had to increase it, and increase they did. In March 2020, an additional $1.13 per share was offered to get to the actual $6.5 per share, which represents a bump of 21% from the November offer of $5.37. The offer represents a gross spread of 5.7% from the actual CCRC share price of $6.15 and an annualized spread of 34%. The merger, since the parent will buy the outstanding shares and merge the company with one of its wholly-owned subsidiaries which will be the remaining entity, is expected to close in the second quarter of 2021.
Taiying Group and other affiliated shareholders are the buyer group and own approximately 71% of the company, so the voting outcome is almost certain since they only need majority for the resolution to pass on the extraordinary general meeting of shareholders, according to BVI legislation. Additionally, the company has also secured financing for the transaction, with a debt commitment letter from China Merchants Bank for a facility of $42 million. The parent expects the deal to cost around $34.5 million, which is more than covered by the debt facility.
Is it fair?
The current offer values the company at around $119 million. From every possible metric, it is a highway robbery, and that is why the parent company, the CEO and chairman, the CFO and all other insiders all want to snatch the company from shareholders' hands.
In 2019, the company made $13.2 million in net income, so the buyer group is paying 9x CCRC earnings, which is laughable for a profitable company with a net cash position, $29 million in cash and only $2 million in debt. In fact, when adjusted for the cash position, the parent is paying 7x the company's 2019 net income and that is not all. If we consider the growth factor, the mispricing is even more apparent. Revenues have grown from $59 million in 2015 to $173 million in 2019, or around 48% annually. The last 12 months' revenues stood at $198 million. In the same period earnings have grown 177%, from $4.8 million to $13.2 million. But again, in the last 12 months, the company generated $18.5 million in earnings. The real PE ratio of the offer may be a lot lower than 7x. Even when we look through a price approach, the offer seems a very lowball one. Before covid, the price was rarely below $10 per share and sales and earnings were lower.
Does it matter?
The buyer group is basically taking advantage of its minority shareholders, but they have more than 70% of the voting rights by their side so they can do almost pretty much anything. And in the current situation their greed is our opportunity.
If we consider the unaffected price, the $5.22 per share, or the price before the second announcement, we can extrapolate that the market implied probability for the deal to close is 73%, while I believe it is much higher than that. First, the offer has already been revised with a 21% bump, and that indicates that there is some commitment from the buyer group. Secondly, financing is guaranteed since they have a commitment letter from a bank to finance the acquisition and it is not a condition for the merger to close. Thirdly, there are no regulatory conditions imposed on the merger and for last they control the voting outcome with 71% of the votes. Meanwhile, the company's financial position is another good risk mitigator since the $27 million in net cash becomes available for the parent as soon as the merger is effective. Actually, the company can almost pay for the entire deal with cash that will be available as soon as the merger closes.
What is the catch?
The big risk to avoid in these situations is the failed deal kind of situation. In this case, I believe the deal will close in the timeline provided by the merger agreement, and at current prices, the spread is attractive enough to compensate for the risks. The spread is wider than usual because the situation involves a small-cap Chinese company with few shares outstanding and incorporated in the BVI. Additionally, the buyer is also incorporated in the BVI and not publicly traded which adds a layer of complexity since the financial situation of the buyer is not known. All these factors add uncertainty to the situation and make their perceived risk higher than it really is and that is why this kind of spread exists. The real risk is a sudden change of heart from the buyer group, but since the merger agreement is signed, it would be difficult for the parent to get out and the company's financial performance has been very good in the latest quarters.
All in all, I believe that deal is safe and that we will get our money back and some in less than 60 days. It is a situation where the odds are on our side!
This article was written by
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