Pendrell (PCO) – Going Private – Potential for 18% upside

Current Price – $6.36

Expected Cash-out – $6.55-$7.5

Upside – 18%

Expiration Date – expected by June 30, 2017

 

In the base case this trade has only $20 upside, but there is an embedded free option which might or might not materialize. It is definitely an interesting case from educational perspective.

Pendrell is $150m market cap company that trades below cash balance. The company intends to go private via 1-for-100 reverse share split. The board of director has already approved the transaction, and the vote will be put forward to shareholders during the next meeting (expected in mid June). Company plans to finalize the reverse split by the end of June (if approved by shareholders).

The cash-out price for the fractional shares has not been determined yet, but I expect it to be at least $6.55 and potentially up to $7.5 (my reasoning below). Downside is well protected by the cash on the balance sheet.

The trade here is either to buy 99 shares and have a guaranteed cash-out upon reverse split, or buy larger amount with expectation that shares will pop-up upon announcement of larger than $6.55 cash-out price.

 

Company Background

Pendrell owns and licenses patents in memory and storage technologies, digital media, digital cinemas and wireless technologies. Current licensees include many blue chip names (Sony, Toshiba. Amazon, DTV and etc). Licensing fees seem to be settled in one-off lump sum payments, so there is no continuous income stream (e.g. in Q3 2016 no revenues were generated). Company has also filed claims or started litigation against a number of other blue-chip names which infringe its patents. It has also lost cases against Google and Apple (both cases currently in appeal).

Further financial performance depends on success of signing new licensing agreements or winning court cases. As my thesis is more short term oriented, new agreements are not that relevant and I assume company will burn through $6m of cash in the next two quarters (which seems to be the latest run-rate assuming zero revenues).

Eagle River controls 67% of the voting power and has 33% economic ownership.

 

Reasons for $6.55+ cash-out price

I expect the cash-out price for the fractional shares (those owning less than 100 pre-reverse split) to be at least $6.55/share and potentially more:

- On March 9, 2017 the company agreed to buy $2.4m (10% of total) shares from one of the larger shareholders at $6.55. I think this sets the bottom price at which fractional shares might be cashed out.

- Additionally, the above share purchase agreement has a clause that $6.55 might be adjusted upwards if Pendrell buys or sells substantial number of shares for a higher price. I take it as a sign that further upside has been considered and therefore probability of it is not zero.

- Pendrell’s book value per share is $7.85 (excluding value of patents), which is comprised of cash ($7.05 per share) and net working capital ($0.8 per share). Expected cash-burn during upcoming two quarters would reduce BV to $7.5. Anything below these book values would be a steal from minority shareholders. However, the largest shareholder has 65% of the votes and thus low cash-out price (i.e. $6.55/share) is certainly possible and likely.

- What gives a bit of hope is that the reverse split transaction has been recommended by the Special Committee, which is comprised of independent directors, who are supposed to be unaffiliated with the largest shareholder. And this is the main reason why I consider it likely for the the cash-out price to be fair and closer to current BV per share (or at least closer to Cash balance per share).

 

Risks

The main risk here is that the reverse split is done by cashing-out fractional shares at $6.55. I consider this to be the most likely scenario and this would result in only minimal upside relative to current share price.

Another factor is that the company might incur significant litigation expenses related to patent infringements during the upcoming quarter, which would reduce cash balance as well as BV per share. Litigation expenses have been limited over the last few quarters, but due to new cases and appeals these might be higher in Q1.

Also the company might cancel the intended reverse split for any other reasons. In this case the share price might actually increase due to cash + NWC being significantly above the current market cap and no pending delisting over the next few months.

Stock has been volatile over the last month and there might be better opportunities to enter this position (e.g. under $6/share, where it traded just a week ago).

6 COMMENTS

  1. over2u

    I guess idea is on hold:
    “the Board determined that the consummation of the Reverse Stock Split should be deferred until no earlier than the fourth quarter of this year”

    1. dt

      Very interesting development.
      Company announces reverse split, potential delisting and buyback and then two weeks later cancels all of that with no explanation provided. Something must have happened in the meantime.

  2. dt

    After the reverse split got cancelled, I have closed my position in PCO. As expected the share price did not drop upon the announcement and I have exited the position with a tiny gain. Currently, there is no imminent catalyst that might close the gap between current share price and book value (mostly comprised of cash) and at the same time I am not comfortable holding PCO as longer term investment as its cash flow is fully driven by lump sum payments from litigation settlement, which I am not able to predict with any reasonable accuracy.

    Having said that, i might be missing out on some short term positive developments – the reverse split, buyback and delisting were cancelled just two weeks after announcement. The company could easily be in potential take-over talks, on the verge of winning a large settlement or anything else that would force management to change course. But I have no other facts (besides unexpected cancellation) to support this, thus my exit of the position.

  3. dt

    The reverse split seems to be back on the table again (still scheduled for Q4). Shareholders are set to vote on reverse split on 14th of June – 65% of the voting power is controlled by Eagle River which supports the transaction.

    https://www.sec.gov/Archives/edgar/data/1359555/000119312517124709/d290561dpre14a.htm#toc290561_11

    The fractional share cashout price deliberations have a new twist:

    “Payment for Fractional Shares. If approved and implemented, the Reverse Stock Split will reduce all issued and outstanding shares of Common Stock into one hundredth (1/100) of the pre-split number of shares of Common Stock. In lieu of any fractional shares that would otherwise result from the Reverse Stock Split, the Company will pay each holder of a fractional share cash equal to such fraction multiplied by the greater of $6.55 or the average closing price of Class A Stock for the twenty trading days immediately preceding the effective date of the Reverse Stock Split”

    Thus the likelihood of $6.55/share cash out price has increased – I was expecting the cash-out price to be higher (closer to BV). No position currently – upside is too small currently and waiting for quarterly results.

    1. FM

      Now the price is 6.14, 6.67% to 6.55. A perfect odd lot tender offer opportunity? Can I just buy 99 shares now at $6.14/share and wait for the reverse split and get $6.55/share?

      1. dt

        The reverse split can still be cancelled. Also it will likely take till Q4 2017 for the reverse split to happen. I Imagine there will be better buying opportunities to participate in this odd-lot.

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