Ladbrokes Coral (LCL) – Free CVR – 25% upside

Current Price – £1.7

Merger Consideration - £1.68+CVR

Upside – CVR worth up to £0.428

Expiration Date – End of March or early April

Merger prospectusMerger presentationOffer document

This idea was shared by Alex.

 

On the 21st of December GVC and Ladbrokes (~£3bn. market cap) have agreed to merge. The enlarged group (both in the gaming industry) will be able to achieve recurring annual pre-tax cost synergies of not less than £100 million as a result of the merger.

 

Consideration and offer price

Under the terms of the acquisition, Ladbrokes Coral shareholders will be entitled to:

  • 32.7p in cash,
  • 0.141 ordinary GVC Shares and
  • a contingent entitlement of up to a further 42.8p in principal value of loan note plus an upward adjustment for the time value of money by way of a contingent value right (CVR).

Mix-and-match option: shareholders will be able to ask for more cash or for more GVC shares, and such requests will be met to the extent that they can be matched to requests in the opposite direction. There won’t however be any mix-and-match option between the CVR component and the cash/share components, so LCL shareholders will get no choice about receiving a CVR per LCL share. See Mix and Match Facility.

At current prices and using basic offer (no mix and match option) merger consideration is worth £1.69 + CVR. This is almost identical to the current share price of LCL (£1.7). Thus assuming no merger cancellation investors are getting the CVR for free.

Shorting GVC to hedge does not seem to be expensive (1.5$ annual on IB), but IB does not have any borrow availability currently.

 

Value of CVR

  • The CVR becomes a loan note worth between 0p and 42.8p, plus interest at 7% for the first 6 months and 1 day, then 9% until it matures (which it does on the later of 18 months after the effective date of the scheme of arrangement, and 6 months and 1 day after the loan notes are issued).
  • The amount that the loan notes will be worth will depend on the result of the government’s review of fixed-odds betting terminals (Triennial Review), in particular on whatever measures the government enacts limiting the maximum allowed stakes on them, how quickly they’re allowed to complete a game, and how many such terminals an operator may operate. See pages 6-9 for more details on CVR value calculation methodology.
  • Leaks from within the DCMS reported on 21-Jan in the news prompted sharp drop in LCL shares (under the rumored £2 maximum stakes, the value of CVR is 0). This selloff has created an opportunity with a payoff heavily skewed to the upside. The leaks might be just “politics”. The UK’s opposition parties are lined up against FOBTs, but actually have limited influence over the government’s final decision. Background information can be found here and here.
  • Currently market prices a high probability (>90%) that the Triennial Review results in the FOBT maximum stake being set at £2, which would result in CVR value being 0.
  • The consultation phase of the Triennial Review closes shortly but the final decision is unlikely to come for a few months.

 

Merger Risks

  • The UK Competition and Markets Authority is investigating the GVC and Ladbrokes Merger. A final decision by the CMA is expected to be released at the beginning of April. Donal McCabe, Ladbrokes Coral’s group communications director seems quite confident: “This is a process you have to go through on any deal and we’re not aware there would be any competition issues.”
  • The CMA also recommended that prior to the merger, the two separate entities should meet certain conditions to reduce any negative impact on the competition and customer choice. To comply with what was recommended, GVC Holdings and Ladbrokes Coral agreed to sell more than 400 retail shops and thus, to decrease its presence.
  • At this stage I consider the risks of merger getting derailed to be quite low (interested in hearing different opinions).

 

Conclusion

The merger would become effective no earlier than March 28. The new combined business will start trading joint shares immediately, on March 29. Delisting of Ladbrokes shares is scheduled for March 29.

There are conditions pending which could delay the closing but not derail the merger. Merger seems very likely to close and the market is valuing the CVR close to zero. I like those kind of CVR cases where you receive a free option.

13 COMMENTS

  1. Fa

    Could you please explain the mix and match option ?
    Is it more favorable to request all cash or all stocks than the regular offer ?

    Thanks

    1. Alex15

      Maximum Cash Option: For one Ladbrokes Coral share I will receive 1,55793 GBP in cash. Option 2 is designed to provide some sort of “soft floor”. At current share prices I doubt this option will be used much. Makes sense if you convinced that the CVR is worth more and you don’t want or can’t hedge.
      Maximum Stock Option: For one Ladbrokes Coral share I will receive 0,17845 GVC Holding shares. This roughly translates into an upside of 1% (assuming no proration), which makes oversubscription likely.
      Further information can be found here p.22-23

      https://www.ladbrokescoralplc.com/~/media/files/l/ladbrokes-coral-group/offerdocuments/ladbrokes-coral-scheme-document.pdf

    1. Alex15

      7% for the first 6 months and 1 day, then 9% until it matures (which it does on the later of 18 months after the effective date of the scheme of arrangement, and 6 months and 1 day after the loan notes are issued).

      1. Alex15

        A little bit of further thoughts on this.
        • There are two scenarios. In the first the base value will be determined by the table p.23 and the corresponding Envisaged Maximum Stake. The Base Value will then be converted into the Loan Note Principal Value by using the formula on page 22-23 (which also takes into account the time value of money between the Effective Date and the Loan Note Issue Date).
        • The second scenario is a bit more complicated. Generally, they calculate with estimated reduction in EBITDA.
        • Record date 6pm 27 Mar 2018
        • New GVC shares issued 8am 29 Mar 18
        • Cash consideration due within 14 days of the Effective Date.

  2. Eric Harwood

    What if there is no decision / Triennial Review outcome between now and maturity (which sounds like 18mos)? Would the CVR then be worth 0?

  3. Eldar Brodski

    Why is the probability of deal failure capped such that CVR has positive value under such cap? for instance, say deal failure probability is 5%, the CVR is not free…for LCL to be compelling, you have to show the prbability adjusted value of the CVR is positive

    5% chance of failure, for instance, means LCL falls to pre-deal level, say 135…implying a CVR price, if 5% is right, of 2…you then have to show why the CVR is worth more than 2

    1. Alex15

      There are different way to judge the risk here. If you “discount a deal failure” you might also calculate with an upside in case the merger goes through as planned (if unhedged). For those who entered earlier LCL dividend was return enhancing…
      I personally don’t have a problem with being long the merged company. The new company will be a cash machine and like they say it will take a brave man to bet against them.
      GVC prices debt finance package (http://www.iii.co.uk/alliance-news/1521447270711587500-3/gvc-prices-debt-financing-package-for-ladbrokes-coral-acquisition-alliss- )
      Interesting article about cutting stakes on betting terminals (https://www.telegraph.co.uk/business/2018/03/09/gvc-warns-ladbrokes-closures-betting-machine-stakes-slashed/ )

  4. dt

    I am struggling to understand which of the CVR valuation scenario’s will be in play and what will be the value of CVR if commissions review gets approved as it stands:
    - Scenario 1 (CVR value calculated based only on Maximum Stakes) – this should apply if “Maximum Stakes Measures are the only Triennial Measure” and if “such Maximum Stakes Measures stipulate only one maximum stake for all types of game available on a FOBT”
    - Scenario 2 (CVR value will be based on EBITDA impact) – all other cases.

    I am guessing it would be Scenario 2, as stakes for B2 machines will be limited to GBP2:
    http://www.gamblingcommission.gov.uk/news-action-and-statistics/news/2018/Gambling-Commission-publishes-advice-on-gaming-machines.aspx

    Has anyone worked out likely EBITDA impact and in turn CVR valuation?

  5. Alex15

    My understanding is that scenario 2 will apply. The EBITDA exact calculation will be difficult for outsiders, as the parties are taking into account, amongst other things, estimated customer lapse rates and staking down behaviour, and then reduce that gross estimated reduction in EBITDA by the estimated effect of any mitigating factors or circumstances. My understanding is that under scenario 2 the parties asses the EBITDA Impact Projection on the basis of the Ladbrokes Coral UK Business as represented in the financial models used by GVC and Ladbrokes Coral to calculate the Base Values set out in the table (p 6).

    The company has both B2 slots and B2 non-slots (predominately roulette). ~60% of LCL machines net revenue is derived from B2 non-slots, while only 7% of their machines net revenue is derived from B2 slots.
    The FOBT (B2) slots stakes should be limited to £2. The stake limit for FOBT (B2) non-slot games should be set at or below £30. Under scenario 1 £30 for all games would translate into a valuation of 40,4p for the CVR.

    In total the value under the proposal will be under 40,4p. But it will be pretty difficult to argue that the circumstances have come up, which could reduce the value for B2 non slots materially. So a reduction will more likely come from the B2 slots, but since they represent a small part of revenue (compared to B2 non slots) the negative effect should be minor.

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