ZAIS Financial (ZFC) – Tender Offer – 12% upside

Current Price –$14.06;

Offer price – at least $15.36 + $0.4 in dividends, a total of $15.76;

Upside – 12%

The tender offer is expected to be announced at the beginning of Q4 2016 and completed by the end of the quarter. Dividends will be distributed for record holders as of 30th of September 2016.

SEC filling

Caution: The below listed idea is more complicated and risky than the usual ideas posted on this site. Please due your own due diligence before investing.

 

Background:

In the proposed transaction ZAIS Financial (ZFC) is merging with Sutherland Asset Management (currently private company) – in a way this is a reverse merger for Sutherland, which is 4 times larger than ZFC and which failed to get public on its own. The transaction itself seems to be structured quite unfavorably for ZFC shareholders as the assets are being sold at significant discount to book value. So in order to raise chances of shareholder approval a tender offer for the existing ZFC shareholders was proposed. After giving effect to the mergers, continuing ZFC common stockholders will own between approximately 14% and 24% of the diluted common equity of the combined company, and former Sutherland stockholders will own between approximately 86% and 76% of the diluted common equity of the combined company.

ZFC will commence a tender offer to purchase a number of outstanding shares of ZFC common stock having an aggregate value of up to $64.3 million. The tender offer will be made at a price that will be not less than $15.36 per share, which is equivalent to purchasing 4.19m shares or 47% of fully diluted ZFC shares.

 

Considerations and Risks:

- The whole transaction, including tender offer is subject to shareholder vote on the 27th of September. Largest shareholder (8% owner) is opposing the merger and argues for liquidation instead. Arguments can be found in the 13D filling. ZFC’s rebuttal is in management’s presentation. While I do not have a very strong opinion on how the vote is going to turn out eventually, ZFC shares already trade at 25% discount to book (with majority of book value comprised of cash holdings), so downside seems to be quite protected even if the deal gets voted down. Also ZFC sold down majority of its assets, so if the transaction is voted down, liquidation is really the only option to go and might result in even higher payouts for shareholders.

- The tender offer is likely to be oversubscribed and it is not clear whether there will be any odd lot provisions (most likely not). If all of the current ZFC shareholders tender, only 47% of the shares will be accepted for cash and the rest will be returned in the shares of the merged company. There might be possibilities to hedge this risk right after the tender expiration.

- ZFC share count will increase c. 4x after the merger and at least part of new shareholders (current investors in Sutherland) might want to cash-out right away creating short term price pressure for the shares of the merged company. However, in the longer term the downside also seems to be well protected by the BV of the merged company (commercial mortgage REITS tend to trade around BV), which is expected to be c. $16.3 after deducting all transaction related fees and etc. For unhedged position to start loosing money the shares of the combined company need to drop to c. $12, which would be 25% discount to book – quite extreme for relatively liquid mostly commercial mortgage REIT (ZFC if residential mortgage REIT, which tend to trade slightly cheaper relative to book value).

- The bottom line is that even-though there is uncertainty with regards to the shareholder vote as well as proration, the downside seems to be well protected even for unhedged scenario. Nevertheless high short term volatility after voting results as well as on the first days of trading of the combined company is very likely.

None of the items expressed above should be considered an investment advice. Please do your own due diligence before investing.

 

 

15 COMMENTS

    1. dt

      It probably depends on your broker, so you have to check with them. I use IB, and on previous occasions I had no problems tendering the shares that I bought on margin. Just beware of potential margin calls.

    1. dt

      Yes I have. The merger has been approved and tender offer for 47% of the outstanding shares has been launched. All as expected.

  1. Z A

    If you are non-US resident there may be a withholding tax. I am not sure if that is on the gross cash proceeds or just on the gain. Any ideas?

    What are the federal income tax consequences of participating in the Offer?

    If you are a Non-U.S. Stockholder (as defined in Section 13), the payment of cash you receive for your tendered Shares may be subject to U.S. federal income tax withholding. See Section 13.

    1. dt

      As far as I understand it will be exactly the same treatment as with any other US tender offer. Tendered shares will be considered as sales transaction and no withholding tax will be deducted. Non-Us holders will have to pay capital gains tax on profits earned in their home country.

  2. dt

    Below table shows the expected pay-offs from the tender if the ZFC shares are acquired today for different proration factors (columns) and discount to BV of combine company (rows).
    I am unable to properly copy in the table in the comment, but hopefully it is still possible to read.

    http://www.specialsituationinvestments.com/?attachment_id=844

    I consider proration of 60% and discount to BV of 15% to be most likely, resulting in 3% gain for the trade at current prices (ZFC at $14.33 per share). I liquidated part of the position as the likely upside has been considerably reduced after dividend payout.

    1. dt

      I fully closed the position yesterday when prices reached $14.9 per share. The remaining upside from the tender is only 3% and that would be only for part of the shares due to proration. So not worth participating in the tender any longer.

      Over the month this trade resulted in gain of 9%.

  3. dt

    Tender results have been announced. Proration factor is 69%, so only 31% of the tendered shares will not be accepted. As per above I did not participate in the tender, but that was only because the price increased a lot before the tender expiration.

    But had I participated in the tender, the overall return would be quite similar – 69% of the shares tendered at $15.37 and 31% of the shares sold at $13.5 after tender expiration results in overall return of 8% (including dividend).

    So this would have been a great trade even if the ZFC price had not increased that much before the tender.

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