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Global Education & Technology (GEDU) – A Chinese Merger Breakup Arbitrage

December 16, 2011 | About:
Global Education & Technology Group (GEDU) is a Chinese ADR that offers English language training in China. It has become embroiled in an insider trading scandal surrounding its pending acquisition by Pearson (PSO), the large British media and education company. Pearson announced on November 21 that they would acquire GEDU for $11.006 in cash per ADR. That represented a 105% premium to the prior closing price and a whopping 214% to the 30-days prior average trading price.

On December 5 the SEC filed an emergency court order to freeze the U.S. brokerage accounts of four Chinese citizens accused of engaging in trading in GEDU on material non-public information in the days leading up to the announcement of the transaction. One of those accused had her brokerage account funded by an entity controlled by GEDU’s chairwoman (and wife of the CEO). On December 14th the SEC filed an amended complaint which also implicated Yonghui Zhang, an employee of GEDU and the brother of GEDU’s CEO.

The question now is whether Pearson will call off or at least postpone the closing of the deal in light of the accusations. GEDU closed at $5.29 the day before the deal announcement and at $3.62 just two days prior. With the stock trading at $10.40, if it falls back to $4 that would be a 62% gain. Even an announced delay in the transaction, which Pearson has said would close in fourth quarter, would probably send GEDU stock tumbling. The potential downside is that the deal closes and the stock trades to $11 — a 6% loss. It doesn’t seem anybody is interested in outbidding Pearson for GEDU.

An extensive presentation of the short thesis and links to the SEC complaints can be found atAbsaroka Capital’s website. After Absaroka came out with their short report at 1:30 p.m. on December 8, GEDU stock dipped from $10.85 to $9.55. At 2:35 p.m. that day, Fly on the Wall reported that Pearson had told Bloomberg the GEDU transaction was proceeding as planned despite the allegations. However, Bloomberg never published anything about Pearson’s response, so that rumor remains a rumor. In any event, after the Fly on the Wall report the stock recovered to the $10.30-10.40 range where it is still trading. The market clearly seems to think Pearson will close the deal with GEDU stock trading at just 5% below the buyout price.

My guess based on the information that has come out so far is that Pearson still goes through with the deal. The merger proxy discloses that Pearson has been angling to acquire GEDU since September 2010, having made no less than eight offers since that time. As Absaroka notes, Pearson is almost certainly overpaying for GEDU and it is probably not a good deal for PSO shareholders on its own merits, but I think that is irrelevant to the short thesis. The question at hand is whether Pearson will go through with the deal, and clearly setting the scandal aside they think GEDU is worth buying at $11.00.

As this securities lawyer notes, the central difficulty in the SEC’s case is establishing the source of the inside information. The only hard link proposed to GEDU insiders is the funding of one of the trader’s accounts by wire transfers from an entity whose sole director is the GEDU chairwoman. That certainly looks terrible, but I am not sure it will be enough for Pearson to call off the deal if they really think it is a good one on its business merits. The chairwoman might have to resign, and Absaroka thinks that Pearson would perceive that as a huge negative because of how critical Chinese government relations are to businesses in China.

It is difficult to tell how much the chairwoman matters to the business in this case. I am not sure her resignation what would be enough for PSO to back out of a deal they want to do so badly. That said the trade is perhaps still tempting as a mispriced option given you are risking 6% to the downside for 50%+ upside.

Disclosure: No position in stocks mentioned.

Elie Rosenberg runs a value investing research website at valueslant.com. Sign up here to get his free value investing ideas and analysis by email and get his free ebook, "16 Ways to Find Undervalued Stocks."

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