2013 has started off with an absolute blast for me. I know I’m not alone in this, as it seems across the board microcap and illiquid stocks are finally starting to get some love. Does this have me worried? Absolutely- but that’s the subject of another post. Today’s post is on one of the few “dregs” of my portfolio so far this year- ALJJ (this may sound like deja vu, as ALJJ was a dreg of my portfolio last year too!).
As a brief recap, ALJJ entered into is basically a pure arb play. They are selling their sub to Optima, and then using part of that cash to repurchase a huge chunk of their shares. With the rest of their cash, they will go hunting for an acquisition to make use of their NOLs. I thought the deal was a slam dunk, but the company announced a delay in the deal as Optima tried to secure financing.
So I’ve been a bit frustrated with the holding, especially as the rest of my portfolio took off.
As a practice, whenever I’m frustrated with a holding, I re-review my thesis, re-read the relevant docs, and just generally re-assess the investment. I find this a great way to hold onto stocks as the crater and keep a cool head. In fact, it’s one of the reasons I started the blog- I can just go back to my write up and quickly realize how cheap a stock is after it falls.
Anyway, I was doing the same and reviewing ALJJ’s merger agreement when I noticed this line on p. 31 in the section talking about when the parties could terminate the agreement
upon written notice to Optima, at any time after the date that is 14 business days after KES delivers its audited financial statements at and for the fiscal year ended September 30, 2012 and certain other materials to Optima (the “Financing Confirmation Date”), but no later than December 31, 2012, if the Note Offering shall not have been consummated for $50 million in gross proceeds to Optima on or prior to the Financing Confirmation Date; unless within 48 hours of the Financing Confirmation Date, ALJ notifies Optima (1) that it will agree to receive the difference between (i) the aggregate gross proceeds that Optima has received in the Note Offering and (ii) $50 million (the “Financing Shortfall”) in notes (at par) in lieu of cash (subject to ALJ’s determination that receipt of notes would be in compliance with applicable corporate and securities laws) or (2) one or more designees of ALJ notify Optima that they will purchase notes in an amount equal to the Financing Shortfall in the Note OfferingNow, I could be reading this wrong (it wouldn’t be the first time). But to me, it looks like ALJJ has the option of financing the transaction for Optima if Optima can’t come up with the money.
I think this would be incredibly attractive for ALJJ (in fact, I even recommended they do it when they announced a financing delay). The high interest rate would be shielded by their NOLs, and if Optima ended up defaulting, ALJJ may just end up getting their business back! Of course, that’s impossible to tell without seeing the balance sheet, but I think ALJJ would do fine in a default with their bonds.
But I don’t think a default is likely absent a pretty significant downturn in the economy. I believe there are significant synergies between Optima and ALJJ, and those should prove enough to weather most storms.
It is true that if they pursued this route and had to finance all of the bonds they’d have to call off the tender. But if ALJJ had to finance only half of the bonds, they could do the tender and provide the financing. While that would be somewhat of an ideal situation, I think there’s a chance it happens.
The other thing that I hadn’t previously mentioned but thought worth bringing to light is the default fee. Optima did not have to pay one if they cancelled the merger in December because they couldn’t find financing. Optima didn’t find financing in December, but they kept the merger on. Now they would have to pay the break up fee (over $3m). Why wouldn’t they just cancel the merger if they didn’t think funding was coming?
So I think the deal goes through. I think the tender happens. And I think shareholders at today’s prices make pretty attractive returns.
Either way, it’ll be interesting to see how it plays out!
Disclosure- Long ALJJ