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Comverse Technology (CMVT) - A Risk Arbitrage Opportunity (3 Times in 12 Months Potential Payoff)

April 04, 2012 | About:
george1357

george1357

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Situation Overview: In January of this year, Comverse Technology Inc. (CMVT), a global leader in BSS, mobile Internet and value-added services announced its intention to distribute 100% of the shares of its wholly owned subsidiary Comverse Inc. (Comverse Spin) to CMVT’s shareholders on a pro rata basis. CMVT is currently exploring, and expects to finalize and announce the structure that will result in the most efficient method of distribution, with the distribution expected to occur in the second half of 2012. In addition, CMVT is exploring alternatives to eliminate its holding company structure either simultaneous with or shortly after the distribution of the Comverse shares.

Comverse Technology (CMVT) is a holding company with three major assets:

- Comverse, a supplier of software and systems to telecommunications companies – comprised of two segments: Comverse BSS and Comverse VAS.

- 54% ownership of Verint (VRNT), a publicly traded defense software company that provides actionable intelligence solutions. CMVT owns both common stock and a preferred stock in Verint. Its stake is worth approximately $875 million at current market prices ($4/share).

- Majority ownership of Starhome, a small private company that provides roaming technology to telecommunication companies.

Valuation

Looking at CMVT on a sum-of-the-parts basis highlights a significant value opportunity.

Note: Since CMVT owns 54% of Verint, it consolidates the debt of Verint on its books, so essentially, in a sum-of-the-parts, Comverse Spin is debt free (with all the debt on the public Verint company). Netting out the debt would be double counting.

Comverse + Verint Valuations

Net cash - $380 million

Verint Stock

Common - $530 million

Preferred - $350

Verint Value $880 ($4/share)

Cash + Verint - 1,260 million

Com Shares Out. - 220 million

Cash + Verint/CMVT $5.70/CMVT share

CMVT = $6.45/share today, Comverse Spin implied value = $0.75/CMVTshare or $165 million

_______________________

What do you get for $0.75/share? – i.e., what is Comverse Spin comprised of?

It includes: Comverse (with cash) + Starhome + NOLs

Comverse:

Comverse has around $700 million of revenue and $70 million of estimated operating income. Depending on multiples applied, at 5-7x operating income, Comverse Spin is worth $350-$500 million of value (which seems very draconian, but conservative) amounts to at least $1.60-$2.30/CMVT share.

Starhome – 1x revenue implies about $35 million or $0.16/share

NOLs – NPV = $160 million or 0.75/share

So summing up the parts (adds up to $8.50/share):

- Verint = $4/share

- Comverse Spin in total = $4.50/share

o $1.87/share for Comverse (somewhere in the middle of the range)

o $1.72/share of cash

o $0.16/share for StarHome

o $0.75/share for NOLs

o $8.50 TOTAL

Thus, using very conservative estimates, upside is 30-40%. The downside would be just the cash on the balance sheet plus the shares in Verint valued at the current market price. Together this equals $5.70 per CMVTshare, assuming Comverse Spin is valued at nothing. Obviously, that is dependent on Verint’s current share price not collapsing. So downside of -12% and upside is 30-40%. This is a very attractive 2.5:1 reward:risk.

How to triple your money within 12 months:

If you want to just make real money (3-4x your money in 12 months) there is a synthetic way to make an investment in just the Comverse spin-off. Rather than buying the stock for $6.45 per share hoping the stock climbs to $8.50 per share, a respectable gain of $2 per share, an alternative is to hedge out the Verint stock and get exposure to just Comverse Spin + StarHome + Cash.

For every share of CMVT stock that you pay $6.45 per share for, you are essentially getting $4 per share of Verint (since CMVT owns 54% of Verint). Currently, Verint trades for $32 per share.

Thus, to isolate (i.e., hedge) just the Comverse Spin business, for every eight shares of CMVT long, go one share of Verint short.

1 share of CMVT = $4/share of Verint value

8 shares of CMVT = $32/share of Verint Value

1 Verint = $32/share

Long CMVT - 8 X $6.45 = $51.60 which = $32/share of Verint + $19.60/share in cash + Comverse Sub

Short VRNT - (1) X $32.00/share of Verint

Think of exposure as for every eight shares of CMVT you buy, you get $19.60/share of non-Verint ($13 of which is cash).

In the arbitrage scenario – shorting one share of Verint for every eight shares long of CMVT, an investor is essentially getting into Comverse spin-off at $0.75 per share or $165 million TEV for the spin. The $2 of “gain” if the stock rises from $6.45 per share to $8.50 per share becomes for the arbitrager a $0.75 per share net investment in the Comverse Spin worth $2.75 per share ($0.75 per share of isolated Comverse Spin-off + $2 per share of value accretion), 3.6x the net investment

Obviously, the gross exposure of the arbitrage scenario is greater than just buying the stock (i.e., the investor is leveraged). So for example, if you might be interested in just buying $10,000 of CMVT stock to play the upside of the stock going from $6.45 per share to $8.50 per share, then you’d have to buy $26,322 of CMVT and short $16,322 to get the same $10,000 of net exposure in the arbitrage scenario.

4,081 shares of CMVT - $26,322

(510) shares of VRNT (short) ($16,322)

Net Exposure - $10,000

Gross Exposure - $42,644

An investor is much more levered in the risk arbitrage scenario, but also has the chance of making 3x his/her money for the same $10,000 net investment. This is how the hedge funds make money in risk arbitrage. Here is a situation for the little guy. Good luck to all of you!

Disclosure: I’m in the arbitrage trade shown above

Relevant Segment Financials:

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Rating: 4.0/5 (9 votes)

Comments

jonmonsea
Jonmonsea premium member - 2 years ago
thank you for sharing the idea.
mscullen1
Mscullen1 - 2 years ago
George, Interesting article. Can you comment as to how you determined the net cash amount? Is it debt less cash (if you're calculating EV) or the other way around. Either way, I can't come up with the same figure on my own. Also, if it is EV you're using, why? The preferred, though convertible is a mezzanine capital component and this is not a private buyout. Including the preferred in the value is irrelevant to common shareholders in terms of value. I could make a case for using the conversion value, which is actually much higher, but management seems to keep increasing the conversion price (now set at 135% above original conversion price of $32.66) with intent of not converting. I ask all of this because it dramatically affects the value assigned to the rest of the business. Which is another issue I have. The spinoff is Comverse Inc. which consists of the BSS, VAS and Mobile segments. CTI will consist of the Verint, Starhome and "Other" post spinoff. That puts a wrench in the way you valued things. Not trying to beat you up, but my fund manager's took interest in your article and I'm trying to analyze things correctly. Thanks, MWS

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