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.
"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).
- 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:
Is there any potential regulatory pushback either here or in China with this deal? Any of you?
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.