Global Eagle Entertainment (ENT) – Expected Tender Offer – 80% upside

Current Price –$6.2

Offer Price - $11

Upside – 80%

Expiration Date - TBD (likely H2 2017)

 

Global Eagle Entertainment provides satellite based entertainment and connectivity services for aviation and maritime industries (think wifi on the plane or Gogo). Company presentation is here. Its systems are installed in 750 aircraft currently and the company has contracts for further expansion. Revenues are growing at 30%+ annually, but ENT is still loss making and burning cash. I am no expert in technology investments and find these extremely difficult to value, but recent events caught my attention.

In Nov ENT entered into rather complicated investment agreement with Shareco, a subsidiary of Chinese conglomerate HNA group. From the press release:

“Entered into agreement with Shareco and HNA Group to make major investment in GEE and plan to form a JV to provide IFEC hardware and services in China:

  • Deal extends relationship between HNA, Shareco and GEE, industry leaders already working together on providing inflight connectivity and passenger entertainment to Chinese airlines
  • GEE and Shareco plan to form a joint venture in China to provide connectivity to 320 aircraft initially and potentially grow the service to over 500 aircraft in the future
  • Shareco plans to invest up to an expected aggregate of $416 million in GEE stock through a combination of primary and secondary share purchases at $11.00 per share, for up to a 34.9% stake in GEE”

One of the key items here is that Shareco will spend $416m for 34.9% of the company when the current market cap of 100% of ENT is at $505m. Strategic investor seems to be valueing the company far higher than the market.

Structure of Transaction

This investment will be done in couple of stages:

1. Shareco will purchase newly issued shares of ENT for $11/share resulting in 9.9% ownership in the company. So Shareco will invest a total of $103m in this stage and existing ENT shareholders will be diluted by c. 10%, but this dilution will take place above market prices, so likely a positive. This stage is expected to close during the first half of 2017

2. After the initial investment is finalized, Shareco will purchase a further $150 of newly issued ENT stock at $11/share. ENT will contribute these fund towards JV with Shareco which will be 49% owned by ENT and will provide in-flight entertainment and connectivity in China and exclusively service aircraft operated by NHA Group entities (which comprises over 320 aircraft today). ENT shareholders will again be diluted, but still above market prices.

3. Also after the finalization of the initial investment, Shareco will launch tender offer and purchase $163m of stock at $11/share from public shareholders so that the final ownership by Shareco would be 34.9%.

My game here is that the gap between current share price ($6.2) and $11 at which strategic investor is buying the shares from the company and later from shareholders should be narrowing the closer we get to the actual transaction (likely in H1 2017). Announcement of the tender offer will be the final catalyst (likely in H2 2017).

Risks

- The closing of the initial investment is subject to regulatory approval including Committee on Foreign Investment in the United States and Department of Defense. I am fully ignorant on how likely this approval is, but management seems to be optimistic. From Q3 conf call:

Andrew DeGasperi

Is there any potential regulatory pushback either here or in China with this deal? Any of you?

Dave Davis

So, this – yes, that’s a good question. So this is what – this is how we intend to do this. Now that we signed the agreement we’re going to apply for ESS and CTS approval, which are the government approvals that are required. We don’t expect there to be significant issues and the reason is this, the amount of classified business that we do is very, very small; well under $500,000 a year in revenue.

So to the extent that we would need to mitigate any issues from a confidentiality or classified information standpoint, it’s relatively straightforward to mitigate. It’s particularly true with stage one, but we had extensive consultations with turnings on our side, Shareco had expensive converse – consultations with turnings on their side, and I think we’re all fairly confident – very confident actually that there’s not going to be any significant regulatory hurdles in front of us.”

- Subsequent Investment as well as tender offer are currently in ‘Letter Agreement’ form. So a strict binding agreement on these subsequent investment has not been reached yet and might potentially change.

- ENT is levered with $441 of debt and does not generate sufficient cash for interest payments at the moment – this is partly due to large legal bills and settlement related to one legal case. Going forward profitability will likely be much better.

- And the biggest risk is that Shareco simply cancels the transaction. In that case ENT would get only $10m termination fee.

Why ENT share price is drifting lower?

I do not have crystal ball answer to this, but Q3 results have been below expectation and guidance was lowered. The transaction described above was announced on the same day as earnings so this might have have overshadowed the strategic investment and upcoming tender offer (both of which I view as very positive). Currently the company trades at all time lows. Another possibility is that market does not believe the Shareco investments will take place either due to stop by regulators or due to Shareco bailing from the deal.

On a relative basis GOGO (main competitor) trades 50% higher than ENT  (comparing EV/Revenue and EV/ad. EBITDA metrics for 2016), so ENT is not expensive on relative basis. Also a bit of speculation - yesterday saw large increase in volume and trading activity when prices approached $6, so we might be nearing the bottom.

In any case I find it really strange that company trades at $6 when another party expressed interest to buy 35% of it for $11. This makes me think I am missing something important - and due to that ENT is a small position for me at the moment.

29 COMMENTS

  1. ep

    Looks interesting. By the way, are there some words missing after “Strategic investor values the company” ?

  2. Chaim Gewirtz

    Where’s the beef?

    If I am reading this correctly, the stage 3 tender offer is for 14.8m shares, which is about 17% of the 85.3m shares currently outstanding. Who do you expect to sell the remaining 83% of your position too? Are you counting on the market price to go up for this to work?

    1. dt

      Yes, I am counting on the market price to go up as the transaction progresses. As I said in the write-up:

      “My game here is that the gap between current share price ($6.2) and $11 at which strategic investor is buying the shares from the company and later from shareholders should be narrowing the closer we get to the actual transaction (likely in H1 2017). Announcement of the tender offer will be the final catalyst (likely in H2 2017).”

      I simply do not see how the shares can continue trading at current levels if transaction progresses as described. Also, the final sharecount by the time the tender is announced will be 108m (after two issues for Shareco), so the tender offer will be for 13.7% of the outstanding shares. But I expect to liquidate the position

      See recent example of FVE (http://www.specialsituationinvestments.com/2016/10/five-star-quality-care-fve-tender-offer-competing-bids-25-upside/) on how tender announcement for portion of the shares (20%) affected the tender price prior and after expiration of the offer. I expect a a somewhat similar market reaction in here. Over the last few years I have not seen a situation where the tender is announced at 80% premium and shares continue trading at the same level.

      Hope this clarifies my thinking with regards to this special situation.

  3. dt

    ENT announced contract extension with South West Airlines today and shares are trading higher on the back of it. South West Airlines is the largest customer (22% of revenue and 65% of connectivity revenue) this extension is a big deal, as there was a risk that SWA would go with another provider instead. Contract details are not revealed so it is hard to judge whether this new contract will boost performance. But at least this contract extension validates ENT’s business model and proves it serves the needs of its customers well. Also revenue will be smoother going forward.

    https://www.sec.gov/Archives/edgar/data/1512077/000119312516792032/d314001dex991.htm

  4. dt

    I closed my position at $8/share. 30% gain in two weeks. At the moment it looks like I accidentally managed to get the peak. The shares settled at a round $7.7/share or 24% gain.

    My main thesis was obviously about the tender offer and investment in the company by the third party at $11/share vs $6 trading price at the time of the write-up. Upcoming tender offer provided a good downside protection as it did not look reasonable for the shares to continue trading almost 50% below the valuation at which strategic investor is buying the shares. This contract extension simply served as a catalyst to validate the business and propel the shares upwards.

    If the shares trade lower again (around $6), I might reenter the position. With tender offer at $11/share in mid 2017 still pending, it is worth to continue tracking the position.

  5. Joe Hill

    Any of you guys taking another look at ENT here below $6.50? I’m not smart enough on them to understand why they are back to trading at pre-Southwest-Contract-Extension levels less than a month after the announcement, so curious what you guys think. I haven’t seen any news on ENT to justify the move but I did come across this from earlier today and I believe they have another sell-side investor conference later this month: http://spacenews.com/global-eagle-buying-out-inclined-satellites-entire-capacity/

  6. Blake Peterson

    Interesting that HNA group is also the company buying Skybridge from Scarramucci…should be approved no problem

    1. dt

      I do not think this has any implications for ENT transaction. Do you view this differently?

      1. Blake Peterson

        I just think it means they have friends in high places now

  7. LEYI ZHANG

    Hi Dt,

    do you think it is realistic to buy May call option, and sell it while price goes up to $11 ?

    The maximum loss will be the option cost, if price stays low.

    1. dt

      Leyi, I think you answered the question yourself. If the share price does not go up by then, you loose the premium. Why do you expect share price to go up till May? It is likely to drift upwards when the initial investment of HNA is finalized – this is expected by the end of H1 2017, but might not happen till the option expiration in May.

      I am tempted to wait for annual results before reentering the position.

  8. Makarid

    Hi dt,

    i am trying to find the logic behind the HNA Group of $11 price offer to by 35% of the company even if they can buy ENT much less with this price in the market place.Do you know if there are any legal barriers behind that(change of control barriers)?Thanks a lot!

    1. dt

      I think there are certain fundamental reasons for HNA to be willing to pay premium for ENT:
      - HNA is not only buying shares, but also provides ENT with new funds to help grow the company (buying shares in the open market would not have this effect);
      - Fund raised in the second step of HNA funding will be put into JV, where the other 50% will be owned by HNA – so HNA is kind of funding their own venture with that;
      - HNA will likely gain quite a bit of know-how from JV with ENT;
      - It’s usually quite hard to acquire 35% stake in a company without affecting the market price;
      - The tender offer was likely the requirement from ENT in order to lower dilution for shareholders to get their approval.

      Also, as you suggest, there might be some regulatory issues, but I am not aware on any details on those.

  9. Alex Chu

    Hi dt,

    Any idea how HNA is funding this deal? Internally generated funds or debt?

  10. jsl zc

    Hi, dt. The price dropped significantly. How do you evaluate the current situation? Is it a good time to take a shot?

    1. dt

      Before there is any clarity on what happened and why CEO and CFO resigned, I am not reentering the position.

  11. Daniel Trynoski

    The CEO resigned. I wonder why?

    Global Eagle Entertainment CEO Dave Davis Resigns, Jeff Leddy Names New CEO
    8:22 AM ET, 02/21/2017 – MT Newswires
    08:22 AM EST, 02/21/2017 (MT Newswires) — Global Eagle Entertainment (ENT) has appointed Jeff Leddy as chief executive officer, effective immediately.

    Leddy, who has served on the company’s board of directors since 2013 replaces Dave Davis, who resigned as a board director and as CEO effective Feb. 20. Davis will continue to support the company as a consultant during a transition period.

    1. dt

      No idea really. Something might be potentially very wrong (maybe terrible Q4 and client losses) and HNA investment might be put on the question mark. Q4 results and conference call should shed some light onto this.

  12. Kevin Cox

    Lotsa lawyers. The last time I had that happen the security went to 0.

    1. dt

      Kevin, which lawyers are you referring to? If you mean standard PR announcements by lawyers chasing new clients after any bigger drop in share prices, then I would not pay to much attention to these.

      Having said that, unexpected CEO resignation is a real and big concern.

  13. Kevin Cox

    Etrade news shows a continuing stream of Law Firms announcing class action lawsuits. Anyway I had forgotten earlier that I followed you and sold for a 15% gain in 6 days so……”nevermind”

  14. dt

    Looks like problems at ENT continue to pile in. Last week saw resignation of Chief Accounting Officer (now all top officers have resigned) and then two days later the company disclosed additional internal control weaknesses regarding financial reporting.
    Really not sure where does all this put the planned HNA Group investment.

  15. fernando oliveira

    When Chinese firms are involved its ALWAYS tricky. Looks like they were just ‘putting a play’ on longs

  16. dt

    ENT issued an update with regards to recent business performance as well as Shareco investment.
    Presentation and transcript can be found here – http://investors.geemedia.com/events.cfm?eType=Upcoming&eType=Featured

    The key section:
    “Now let me turn to a few minutes for — to our Shareco HNA transaction. If you remember, we entered into an agreement to create a joint venture with Shareco to supply content and connectivity services to over 500 of the HNA Group’s aircraft as well as take an equity investment from Shareco. Upon the signing of the transaction in the fall, we made significant progress in formalizing the joint venture. Under our proposed terms, the JV will purchase equipment and services from Global Eagle to exclusively service aircraft owned by HNA. In addition, we submitted an application to the Committee on Foreign Investment in the United States, known as CFIUS, for U.S. government approval for an equity investment from a foreign entity into Global Eagle.
    Recently, CFIUS completed the initial evaluation and concluded that the deal, as originally constructed, presented unresolved national security concerns. Both parties agreed to withdraw the application with the intent to refile and exercised our CFIUS extension option under the terms of the original agreement. With the new application that we tend to file shortly, we’re exploring mitigation alternatives to address the national security issues raised by the committee. In parallel, we’re also evaluating modifications to the investment structure that may enable us to alleviate the CFIUS concerns.”

    So it seems that equity investment (including the expected tender offer) is of the table at the moment due to ‘national security concerns’. Investment structure is now likely to be modified.

    No position currently and quite happy to have closed it out after the initial price run up and 30% gain in two weeks.

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