OCB Bancorp (OJCB) – Merger Arbitrage – 10% uspide

Current Price – $12.75

Acquisition Price – $14

Upside – 10%

Expiration Date –  Q4 2017

This is straight forward merger arbitrage opportunity in nanocap land. Liquidity is very low – thus limit orders and lots of patience are needed to accumulate the position. I consider current spread (10%) to be attractive as I see limited risks of this deal falling apart. Low liquidity is likely the main reason for the spread to exists.

Merger Agreement


Background

OCB Bancorp is being acquired by Sierra Bancorp (BSRR) at $14/share in stock. Both banks are based in Southern California with BSRR having 33 branches and OCB only 4. Merger is conditioned on OCB shareholder approval and receipts of government agency approvals. The acquisition price is also subject to certain potential adjustments (more below).

At acquisition price OCB is valued at 1.83x TBV and 22x TTM earnings, which looks reasonable valuation for a bank that seems to be on strong growth trajectory over the last few years (loans have grown at 29% CAGR, deposits at 15% CAGR). Also, on top of that there should be material cost synergies from personnel reductions, which will disproportionally affect the acquired OCB’s profitability – net income during 2016 amounted to only $1.3m, thus even if only a few top level execs are let go, net income boost will be material. Factoring in the potential synergies the acquisition looks even cheaper from earnings perspective. Sierra Bancorp itself trades at similar earnings valuation and only slightly cheaper  (1.74x) with respect to TBV.

All of this suggests that Sierra Bancorp is unlikely to walk away from the transaction – in the presentation the company is indicating less 4 years TBV payback period and 20% IRR on this acquisition (not exactly sure how did Sierra’s management arrive at those figures).

While I have limited understanding in what kind of hurdles might surface from regulatory approvals, at least from geographical location perspective merger seems a natural fit (see slide 3 of the presentation) and is unlikely to cause any market concentration concerns.

This leaves us with OCB shareholder approval. Ownership structure is not disclosed (not SEC registered) but as OCB is a combination of 4 community banks, I would expect share ownership to be rather concentrated locally, potentially among insiders. All insiders have signed agreements to vote their shares for the merger. Also, during the last few years OCB stock traded in the range of $5-$6/share with very low liquidity, thus any other shareholders not related to management seem to be well rewarded and would probably support the merger (just speculation from my side).


Potential price adjustments

Merger agreement contains two potential price adjustments:

1) If OCB’s transaction related expenses are over $2.6m, then acquisition price will be adjusted by the amount above this threshold;

2) If OCB’s book value is below $16.6m, then acquisition price will be adjusted by the amount below this threshold;

I do not think any of these thresholds will be triggered. The BV continues to grow and as of Q1 2017 stood at $17.1m. With regards to transaction related expenses $2.6m is almost 10% of the market cap and this amount seems to offer plenty of leeway (albeit I am less confident on the expense threshold vs book value threshold).

Also worth noting that even-though the per share consideration is fixed at $14/share, this will be paid in Sierra Bancorp shares and the number of shares one gets will be determined by the volume-weighted average price of the common stock of Sierra over the 20 trading days immediately preceding, but not including, the 5 business days before the anticipated closing date. Thus, hedging might be required during the last month before the merger consummation. However, I would expect the spread to close before that – catalysts will be OCB shareholder approval (meeting expected in Q3 or Q4 2017) and any approvals from federal agencies.


Downside

If the transaction is cancelled, there will clearly be some short term pressure on the share price from arbitrageurs unwinding their positions. But I would expect the shares to settle above the unaffected share price of $8/share (although due to almost no trading before the announcement, it is hard to judge what the true unaffected price is). The OCB Bancorp is clearly for sale and valuation even at $14/share is not very demanding, especially after taking into account the potential cost synergies (which are very real for tiny community bank acquisitions). In the era of bank consolidation there should be more than one interested party.

14 COMMENTS

  1. Matteo Galullo

    “Thus, hedging might be required during the last month before the merger consummation.” so you mean start a short position on Sierra Bancorp?

    1. dt

      Yes, when the exchange ratio will already be known. This will happen only in the last month before the merger.

  2. FM

    I’m confused here. If the consideration price is fixed at $14, then why is there a need to hedge in the last month? Even if the VWAP for BSRR dropped in the last month, you use $14 divide by the VWAP, you get more shares of BSRR. And what is the exchange ratio gonna do with this? I thought the exchange ratio is already known (0.5143) written in the presentation?

    1. dt

      The exchange ratio in the presentation is just an indication based on share prices at the time (check footnote on the slide). Regarding hedging, here is an example:
      - Assume, BSRR price during the 20 day valuation period averages $26/share;
      - This would mean that for each share of OCB investors would get 0.538 shares of BSRR ($14/$26). At this point in time the exchange ratio get’s fixed and $14 becomes irrelevant.
      - If afterwards during the last five days before the merger or right after the merger BSRR share price starts dropping, then previous OCB shareholders would receive less than $14/share.
      - Thus hedging is required for those not willing to have exposure to BSRR share price movements when the exchange ratio is known (or approximately known).

      Hope this clarifies the situation.

      1. FM

        I see. So we are actually hedging for the last five days only right? If that’s the case I can hedge as soon as the exchange ratio is fixed, no need to do it from the first day of the 20 days period. Am I right? Thank you.

        1. dt

          you might be able to approximately guess the exchange ratio even before it is fully fixed, so hedging might be initiated also earlier.

  3. Paul Lee

    Sierra filed an S-4 which lays out insider ownership of OCB. The directors collectively own 23.54% of the stock

    1. dt

      Insider ownership is slightly lower than I expected and it seems that remaining ownership is rather dispersed (no other holders of >5%). Still I would expect management to have close relationships with at least some of the other larger shareholders (these were are community banks) – thus the actual secured wove is likely higher than 23.5%. And even if only 23.5% of the shares are currently secured for approval, merger is still likely to go through as only 1/3 of the remaining shares need to vote for the merger.

      What is more concerning from the recent proxy, is that the price is no longer fixed at $14 – if BSRR share drops below $25.22 then consideration paid per OJCB share might be as low as $11.67. This is new and not mentioned in the previously disclosed merger agreement. From the recent S4 filling:

      “The formula in the merger agreement will result in the following per share merger consideration, all subject to possible downward adjustment as described immediately following the below bullets:
      - If the Sierra closing price is between $25.22 and $30.82 per share, then the per share merger consideration will be $14.00 worth of Sierra’s common stock for each share of OCB common stock and the exchange ratio will be between 0.45425 and 0.55511.
      - If the Sierra closing price is between $30.82 and $35.03 per share, then the value of the per share merger consideration will be between $14.00 and $15.91 and the exchange ratio will be fixed at 0.45425.
      - If the Sierra closing price is between $21.02 and $25.22 per share, then the value of the per share merger consideration will be between $11.67 and $14.00 and the exchange ratio will be fixed at 0.55511.
      - If the Sierra closing price is more than $35.03 per share, Sierra will have the right to terminate the merger agreement unless OCB agrees to adjust the exchange ratio as necessary to fix the price at $15.91 per share.
      - If the Sierra closing price is less than $21.02 per share, OCB will have the right to terminate the merger agreement unless Sierra agrees to adjust the exchange ratio or add cash as necessary to fix the price at $11.67 per share.”

  4. dt

    OJCB shareholder vote is set for 21st of September and latest proxy can be found here:
    https://www.sec.gov/Archives/edgar/data/1130144/000114420417044185/v473604_424b3.htm

    I still have an unhedged position in OJCB. There will be no further earning announcements before the shareholder vote, so would not expect material movement in BSRR shares (which in turn also affects likely payout for OJCB if BSRR drops below $25.22).

    Voting results (if positive) should push the OCJB share price closer to merger consideration to be paid (i.e. $14/share).

  5. greg lia

    Deal approved. Anyone happen to keep a spreadsheet of the 20 day measurement period? I am thinking yesterday or today is the last day of the period as final 5 days before closing are not part of the computation? eyeballing a chart looks like it could be low 25′s? ( understanding below 25.22 is not protected) If so would make OJCB worth an additional 4 or 5% or so, (based on current BSRR 26.28) maybe 4.16 or 4.20 perhaps a second arb opportunity? Looks like BSSR readily shortable, question is how much ojcb can you get, always a wide spread.

  6. Noah

    Shareholder approval, trading above 14. Nice one!

    PORTERVILLE, Calif., Sept. 22, 2017 /PRNewswire/ – Sierra Bancorp
    (NASDAQ:BSRR), the holding company of Bank of the Sierra and OCB Bancorp (OTC:
    OJCB), the parent company of Ojai Community Bank, announced today that all
    necessary approvals were received for the acquisition of OCB Bancorp,
    following the OCB Bancorp shareholder vote on September 21, 2017. Subject to
    satisfaction of customary closing conditions, Ojai Community Bank will close
    its doors on September 29, 2017 and re-open on October 2, 2017 as Bank of the
    Sierra.

    1. dt

      The press release is somewhat ambiguous in that sense, but my understand is that conversion will take place on the 2nd of October. This means that we are already in the last 5 days of trading before the merger closure and that the exchange ratio has already been set. If this is really the case, I would expect BSRR to come with the press release announcing the exchange ration today.

      Based on my calculations the exchange ratio should be c. 0.555 (the weighted average share price of BSRR during the last 20 days is around the $25.2). At current BSRR price each share of OJCB is worth c. $14.3.

  7. dt

    As expected OJCB share price shot up right after shareholder approval – this merger arbitrage trade resulted in 10% return over three months.

    If market liquidity allows, I intend to close out my OJCB position this week. Otherwise I will wait until I receive BSRR shares.

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