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Buy-Out and Tender Offer - A Look at ALJ Regional Holdings

November 27, 2012 | About:
On Nov. 18, ALJ Regional Holdings (ALJJ) announced the sale of its majority-owned steel subsidiary, KES, to Optima Specialty Steel (Optima) for $112.5 million cash. ALJJ also announced it would commence a tender offer for approximately 50% of shares outstanding conditioned on the closing of the sale of KES.

Before I go into detail, I want to acknowledge some bloggers who have followed the stock for longer than I have. Each has written about the transaction and are worth a read: Alpha Vulture, Whopper Investments and OTC Adventures. You can also find the two deal documents by clicking on the merger agreement and tender offer.

The Deal

The tender: If the merger closes, ALJJ will use approximately 50% of the cash generated ($25.8 million) to purchase approximately 50% of the shares outstanding, up to 30 million shares, with an option to purchase up to an additional 2% of outstanding shares. The number of shares purchased may be reduced if it’s determined that it will negatively affect the company’s NOLs. If more than 30 million shares are tendered, odd lots under 100 will have priority and the rest will be pro-rated.

It will be structured as a modified Dutch Auction for a price per share between 84 cents and 86 cents. I believe we’ll be on the upper end of the range and I don’t expect pro-ration because of large insider ownership and other shareholders who I expect to want to hold on to their shares. It’s expected that the tender offer will expire on Dec. 24, so even at today’s price you’re looking at a very attractive ROI.

Chairman Jess Ravich owns 19.5% of the outstanding shares and an option to acquire an additional 2 million shares. He will not be tendering his shares. The directors collectively own 24.9% of shares.

The merger: ALJJ owns about 85% of KES Acquisition Company. KES owns Kentucky Steel, a mini-mill based in Kentucky. Optima has agreed to purchase KES Acquisition Company for $112.5 million. After ALJJ pays off its debt, there will be approximately $51 million of cash left, equal to 86 cents per share.

Optima is financing about $50 million of the deal. The merger is contingent on their ability to gain financing, and on regulatory approval.

ALJJ will hold the special meeting for the transaction on Dec. 21. There’s no reason to believe shareholders won’t approve it.

The termination fee information is as follows:

The Merger Agreement contains certain termination rights for ALJ, KES and Optima, including, without limitation, if the Merger is not consummated on or before February 28, 2013 and if the approval of the stockholders of ALJ or KES is not obtained. The Merger Agreement further provides that, upon termination of the Merger Agreement under specified circumstances, including certain terminations in connection with an alternative business combination transaction as permitted by the terms of the Merger Agreement, KES may be required to pay Optima a termination fee of $3,375,000. The Merger Agreement also provides that the Merger Agreement may be terminated, without payment of any termination fee, by ALJ or KES at any time prior to December 31, 2012, if Optima is not able to complete the Acquisition Financing by approximately December 20, 2012. Further, the Merger Agreement may be terminated by ALJ, KES or Optima if the Acquisition Financing is not completed by February 28, 2013. If the Merger Agreement is not terminated by December 31, 2012 and is later terminated because the Acquisition Financing is not completed by February 28, 2013, Optima must pay KES a termination fee of $3,375,000.
Brief ALJJ History

ALJJ is an interesting company. It actually only has two employees. ALJJ pays Pinnacle Steel to operate the steel mill, which produces 2,600 variations of bar flats and are sold to niche markets. The chairman of ALJ, Jess Ravich, is a managing director at Houlihan Lokey, an investment bank. Previously, he was at Jefferies and Drexel Burnham. He’s also the chairman of the board for Cherokee (CHKE), a company that manufactures, markets and sells fashion brands. He holds a JD from Harvard and was the editor of the law review, so he’s obviously a smart guy.

When the current board members joined the company in 2005, it had less than $1 million in cash, $14 million in liabilities, and an accumulated deficit of over $340 million. With this transaction they’ve turned that into $50 million in cash and no debt. An impressive result.

ALJJ stayed profitable even through the difficult periods of 2008 and 2009. While their gross margin shrunk considerably those years, as would be expected, they continue to generate cash, only going cash flow negative in 2010. Ravich was originally able to take control of the company by levering it up significantly. They continued to be able to make debt payments and exchanged equity for debt in some cases, significantly reducing the debt load through the years. As a demonstration of their financial strength, earlier this year they initiated a share repurchase program for shares below 50 cents.

Ravich’s stated intention is to use the leftover cash to pursue another acquisition. This transaction and tender offer will allow him to have majority control of ALJJ and, with that, a considerable amount of freedom. For investors who elect not to tender, I think patience should be the key word. The company has considerable NOLs and, it appears, the ability to finance future transactions. I would be surprised if they were not able to find an attractive acquisition over the next 18 months.

On the negative side, the company announced poor fourth quarter results on Oct. 15. If this deal fell through, the big revenue drop may be a concern.

Brief Optima Specialty Steel History

It’s always important to examine the acquiring company and the deal structure to gauge the likelihood of the deal going through. Optima knows KES well as KES is a supplier to Optima. Optima also has been doing a variety of deals lately. They acquired Niagara LaSalle, North America's largest independent manufacturer of high quality engineered cold finished steel bars, late last year. Niagara’s CEO, Kevin Stevick, then became Optima’s CEO. Optima also owns Michigan Seamless Tube, a specialty steel processor focused on cold drawn seamless tubes.

Niagara had also bought two other steelmakers over the 18 months before they were acquired by Optima. These transactions all appeared to have gone smoothly. They sold $175 million in notes to finance the Niagara deal last year. A financing concern may be that for that deal they originally planned to sell $200 million, and had to decrease it to $175 million.

Risks

There are a few risks:

The merger could fall apart. I think this is unlikely, as described above, but if it did you could expect shares to drop closer to where it traded at before the merger announcement. The biggest risk here would be Optima’s ability to secure financing for the deal.

The tender offer may be withdrawn. If the merger goes through, I think the tender being withdrawn would be very, very unlikely. If somehow it would be withdrawn, you’d still have a net-net situation, though trust in management would be severely damaged.

The merger and/or tender offer is delayed. If you’re considering tendering shares as opposed to holding them, then the additional time to close will have a negative effect on your ROI.

If you decide to not tender shares and it goes through as planned, Jess Ravich’s ownership percentage will increase significantly. This would have to be something in which you’d be comfortable.
Investment Options

On first glance it would appear the obvious investment would be to simply tender shares. At a purchase price of 77 cents, you have a return between 9.1% and 11.7% over a likely period of no more than two months.

However, I think a case can also be made to hold on to shares and expect management to make another accretive transaction. The board seems to have treated shareholders fairly through the years. Their compensation is low, as is the compensation for the two employees. This should ensure that cash burn is low during the period while they’re looking for a new acquisition.

ALJJ had $259 million in NOLs at the holding company level end of fiscal year 2011. This is a tremendous asset for the company. Because of this, the stock should (but who knows if it will) trade for more than its cash level. Couple that with the expectation that Jess Ravich will be able to find another attractive acquisition, and I think if investors are looking for a stock that will be uncorrelated to the overall markets for at least the next few years, ALJJ may be one to hold onto. Of course, patience would be key considering Ravich does not know when he will find the next acquisition. If he does, though, ALJJ could see considerable gains.

The company has previously explored listing the stock on a national exchange. That is on hold for now, but if they find an attractive acquisition with the cash, I’m sure they will once again look to do that. That exposure should be helpful to the stock price.

Disclosure: Long ALJJ

About the author:

Steven Kiel
Steven Kiel is the president and chief investment officer for Arquitos Capital Management, a Virginia-based investment management firm. He is a graduate of George Mason School of Law and a captain in the Army Reserves. He manages two spoke funds, The Freedom Fund, a value-oriented portfolio, and The Hayek Fund, a portfolio dedicated to free market principles. He can be contacted at steven.kiel@arquitos.com or through the firm's website at www.arquitos.com.

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Comments

Adib Motiwala
Adib Motiwala - 1 year ago
Nice work Steve. I can see why the spread would be so large. A tender that depends on a merger closing, which depends on partial financing to close the deal.

Question: If the tender goes through, would the company have any cash left over?

Are you considering not tendering?

thanks

adib
slkiel
Slkiel - 1 year ago
Thanks Adib- Yes, they are using half of the cash generated by the sale for the tender and will have half of the cash left over at the holding company level. This is also where the NOLs are, so it will be an attractive cash shell with about 86 cents of cash per share after the tender is complete.

Initially I was planning on tendering, but after doing the research for this article I have become impressed with management and the value of the NOLs. I believe they'll be able to find a company to purchase within a year. They should be able to borrow a considerable amount as well if necessary. I think that will cause the value of the stock to rise considerably, depending on what they can find. At the very least, this will be a stock uncorrelated to the overall markets at least for the next year.

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