Current Price – $8.10
Tender Price - $8.05 - $9.00
Upside from Tender – 11% or $90 (if tender is priced at the upper limit)
Upside from Shorting - 30% (if share price reverts to unaffected levels)
Expiration Date – 16th of April 2018
No proration for odd lot holders
Tender Offer with Odd Lot Provision
This is standard odd-lot dutch tender by micro-cap company. Shares currently trade close to the lower limit. Pay-off depends on how many shareholders tender and at what price points they do it. My expectation is that this tender will end up being priced close to or at the lower limit due to reasons outlined in the shorting section. Couple arguments in favour of higher tender prices:
- Tender is for c. 10% of all outstanding shares (tender size $12.7m -$14.2m);
- Insiders own another 10% of shares and have agreed not to participate in the tender.
Case for Shorting CTG
CTG share price has increased from $5.29 to current $8+ (50% jump) after tender intentions have been announced. I believe this was driven by pure technical buying in expectations of the tender being priced at premium to the newly established market price. Therefore significant share price correction is likely after the tender expires.
The only material announcements that might have caused the share price run-up are: (1) intention to launch the tender offer, (2) acquisition of Soft Company, (3) Q4 results and (4) guidance for 2018.
Soft Company Acquisition
Acquisition of Soft Company is unlikely to have had such an effect on the share price as acquisition amounts to less than 10% of the parent in terms of revenues and employee count. Profitability levels were not disclosed. Soft Company revenues are growing at 5% annually, but workforce has increased by 15% annually. There might be cross selling possibilities for a combined company, but judging by the provided guidance management, these are not expected to be material.
Q4 results showed continuation revenue decline observed over the last few years, albeit the decline has somewhat slowed down and margins have improved (see slide 19). Results were in the mid-point of the guidance, so no positive surprises that would warrant 50% share price jump.
Based on management's figures organic revenue growth is expected to be 3%-10% and non-GAAP EPS is expected to improve by 50% (heavily weighted towards the second half of the year). However, CTG management has tendency to miss the guidance - e.g. the very first 2017 guidance indicated flat revenues, however the eventual result was revenue drop of 7%. Therefore, I doubt market is giving much credibility to the new guidance.
Also, quite similar revenue guidance was issued for 2016 (which was also missed), but stock traded at $4.81 after the announcement. The only difference today is that CTG is finally forecasting growth (most of which acquisition driven), but even that was already partially baked in their 3-year plan announced in the beginning of 2017 (see Slide 4), so no positive surprises here either.
This leaves us with the tender offer as the only likely explanation for the sharp share price increase. Worth noting that this increase has been gradual over couple of weeks rather than instant jump as would happen if there was a positive surprise from earnings, guidance or acquisition.
So my theory here is that some smart guys (sadly I was not one of them) with plenty of cash saw tender announcement and realized that if they push the share price upwards management will be forced to select tender pricing within the newly established price range. At which point the same smart guys will have a whole month to unload the acquired shares at significant premium to cost. Weekly trading volume increase up to 5x-10x since the tender announcement seems to be supportive of such view.
Is CTG Overvalued?
I am trying to base this trade mostly on technical aspects related to unjustified share price run-up after the tender offer announcement. For more detailed overview of the company from fundamental perspective (as well as bullish view) I suggest to read this VIC article. The main thesis is that CTG is a misunderstood turnaround situation where growth in higher margin Solutions segment will surpass the decline in lower margin Staffing segment. And also that downside is somewhat protected by $5 BV/share mostly comprised of cash, accounts receivables and cash value of life insurance policies.
After two years this turnaround story has not worked out so far - CEO was replaced after only 15 months in the office and revenues continue to decline across both segments. Dividend was cancelled and despite material share buybacks, the share count has decreased only slightly due to dilutive stock based compensation. Revenues are still heavily concentrated with two largest clients (IBM and Lenovo accounting for 37%), which continue to reduce their needs for CTG services every year.
I have no idea if we are on the edge of turnaround right now, but at least Q1 2018 guidance does not look very promising.
Assuming CTG achieves the targets set out in the 3 year plan and reaches EPS of $0.45-$0.55 by the end of 2019, then currently the company would be trading at PE of 14x-18x. Not overly expensive especially in the current market, but that is based on questionable earnings at least two years out. So I do not think I am risking too much by shorting CTG for a short term trade at current prices.
When to short?
Currently I have no position as there are still another three weeks until tender expiration and I doubt pricing will move below the lower limit till then. The possibilities are to short now and risk portion of position being bought in the tender or wait till after tender expiration, however opening prices the next day after expiration are likely to be lower.
Interested in hearing other views on this setup and opportunity.