EHi Car Services (EHIC) – Merger Arbitrage – 9%+ Upside

Current Price – $13.22

Merger Consideration – $13.5 and competing big at $14.5

Upside – 9%+

Expiration Date – Q3 2018

 

This is one of those tails I win and heads I win even more type of situations.

EHi Car is a fast growing car rental company in China with 4.5k rental locations and 62k vehicles. Since Nov 2017 a number of groups have shown interest to acquire it. In April the 'Teamsport' consortium led by company's CEO and Chairman Mr. Zang announced proposal to take the company private at $13.5/share and shortly thereafter the Board approved this despite superior offer (at $14.5) from another 'Ocean Link' Consortium.

Transaction needs to be approved by 2/3 shareholder votes (present or by proxy). And now we have a situation where Teamsport consortium has 37.5% voting power and Ocean consortium has 43.9% voting power (although 10.7% of 'bought' votes are being contested by management). Shareholder meeting date has not been set yet.

This letter from Burford Capital (not affiliated with Ocean consortium) nicely sums up the situation:

We write to express our disappointment with eHi’s Board of Directors’ (“Board”) decision not to pursue a competitive and fair sales process. We believe that this stems, at least in part, from your consortium’s declaration that, as controller of 37.5% of the Company’s voting power, it is “interested only in pursuing the Acquisition” and is “not interested in selling their shares in any other transaction involving the Company.” Unfortunately, in recent years this has become a well-trodden path among companies incorporated under the laws of the Cayman Islands: An insider with super-voting shares, backed by handpicked sponsors, squeezing out minority shareholders at below fair value to pursue a transaction with no independent business purpose. <...>

The Board still has the opportunity to do right by eHi shareholders and deem the competing bid “reasonably likely to lead to a Superior Proposal.” We hope that it does so.

But if the Board instead continues to ignore a conspicuously Superior Proposal—despite its duty to shareholders—and the current Agreement and Plan of Merger is subsequently consummated, we plan to exercise dissenters’ rights to receive payment of the fair value for our Class A shares.<...>

These iniquitous transactions are typically struck with the endgame of relisting in China’s A-Share IPO market shortly after squeezing out minority shareholders at a fraction of the anticipated IPO valuation.

This scheme has proven immensely profitable thus far: Research has pegged the average relisting premium at several hundred percent compared to the “fair value” paid to erstwhile minority shareholders who were unceremoniously squeezed out. The most recent relisting in this vein was that of Qihoo 360 Technology Co. Ltd (“Qihoo”). After being taken private in July 2016 for $9.3 billion, Qihoo relisted in February 2018 at a valuation of more than $60 billion. Qihoo’s CEO, who had spearheaded the take-private, reportedly made $12 billion alone upon relisting, more than the valuation afforded to the entire company just 18 months earlier.

To get full grasp of the developments I recommend reading through the latest filling by the Ocean Consortium.

I am unable to comment on Cayman Island regulation or whether EHIC insiders might find a way to circumvent the 2/3 vote requirement and take EHIC private at $13.5/share. But as it stands now both parties seem to have a blocking power over the transaction:

If the ROFO Purchases are consummated, the Class A Common Shares and the Class B Common Shares beneficially owned by the Filing Persons represent approximately 43.9% of the aggregate voting power of the total outstanding Common Shares, thus giving the Ocean Consortium a blocking right to all corporate matters of the Company that requires a special resolution, which is a resolution passed by not less than two-thirds of votes casted by the Company’s shareholders.

Worth noting that Ocean consortium proposal is preliminary and non-binding as they were not given access to perform due diligence yet. However, if management starts treating Ocean proposal fairly, then a bidding war might start pushing the price beyond $14.5/share.

 

Burford Capital

Burford Capital has started to invest in EHIC (here and here) since mid-April and has already accumulated 2.5m ADS shares at $13.17 average price (I am deducting short hedges). I think this is a pure $33m bet on the exact special situation I am writing up here. Interestingly, this would also be the largest public investment carried out by Burford (public portfolio as of March 2018).

Burford Capital is not a traditional asset manager, rather it is a $4.2bn London listed litigation financing company that has done very well in recent years in terms of financial  as well as share price performance. So we have litigation experts who have made a $30m+ bet on a merger arbitrage with considerable legal aspects. Seems to be a good company to be joining. Obviously, on the negative side we have Burford's absence of any public equities investing track record.

 

Risks

The main risk here is that management outright cancels the sale of the company. EHIC traded at c. $11/share before the November 'Goliath' proposal was received. However, keeping in mind that a number of parties seem to be in pursuit, I do not think the price would revert to these levels.

Also any legal battle might extend this for considerable time, by which EHIC performance might start deteriorating and any potential suitors might loose interest.

EHIC currently trades at EV/Operating Profit=24 with 78% growth in operating profit during 2017. Company continues to burn cash due to fleet/location growth investments.

33 COMMENTS

    1. dt

      To be fair, your guess is as good as mine. Before the deal closes I am quite sure there will be further back and forth between Ocean and the company.
      If EHIC continues to perform well, then insiders have an incentive to take the company private asap, as otherwise the buyout price might start looking as obviously cheap.

  1. BPstyler

    Stock plummets after hours following announcement of almost 15% higher bid to previous highest offer. Crazy.

    Under the terms of the Revised Proposal, eHi shareholders other than those in the Ocean Link Consortium will receive US$7.75 in cash for each Share they hold or US$15.50 in cash for each American depositary share, each representing two Shares (an “ADS”) they hold. The price represents a premium of approximately 18.7% over the closing trading price of the Company’s ADS on June 28, 2018, the last trading day prior to submission of this Revised Proposal, and is $2 per ADS or 14.8% higher than the price offered in the agreement and plan of merger entered into between eHi and the buyer consortium led by Mr. Ray Ruiping Zhang, chief executive officer of eHi on April 6, 2018.

  2. BPstyler

    May be part of the reason? Bad headline?

    *CORRECTION: Ctrip, Ocean Link Partners Submit Revised Higher Offer To Buy eHi Car Services For $15.50/ADS Or $7.75/Share; Initial headline suggested the ADS value was $7.75; this was incorrect
    Benzinga

  3. Terence

    News of the $15.50 was out at 3:13pm on Friday. Isn’t it unusual for such news to be released during market hours? Note that this is pre-dawn time on Saturday in China.

    Seems even more unusual, or “Crazy” as BPstyler said above, is that the stock rose to $14+ for about 5 minutes, and then started to drop to even lower than the pre-news price!

    My only explanation for this is that the market doubts the buyout offers are real. Any thoughts?

  4. dt

    Ctrip petition was dismissed in the court – which likely affected trading patterns on Friday:

    https://www.specialsituationinvestments.com/2018/06/ehi-car-services-ehic-merger-arbitrage-9-upside/

    I do not think this changes the thesis in any way. I still do not see how either group can reach 2/3 majority votes needed to approved the sale. However, this statement is a bit worrying:

    “The Company also noted that claims made by the members of the Ctrip Consortium that it holds 33.2% of the outstanding voting power of the Company are misleading in light of the ongoing legal proceedings relating to the validity of the prior transfer of Shares to members of the Ctrip Consortium that the Company and members of the Buyer Group are vigorously pursuing. ”

    This seems to question Ocean consortium shareholding outside of the ROFO purchases (which were known to be in dispute).

  5. Rick Sanchez

    I guess I have to add a little more opportunistically here to lower my cost basis. Price reaction is baffling however.

    1. Austin

      I don’t think the price reaction yesterday was baffling. The lawsuit news was definitely an incremental negative. It’s also becoming more clear that management and its allies are willing to go to great lengths to “steal” the company from shareholders at a low value.

      1. Rick Sanchez

        I read the details of the ruling and agree with you Austin. $13.50 looks more likely now than $15.50 so the lower bid is my base case now.

  6. dt

    IGC shares have been sold to Crawford (Chairman’s consortium) – ADS for $13.5 and Class B for $14.5. The same is likely to happen for GS shares. Both sale agreements leave IGC and GS upside is eventual company’s sale price will be higher.

    https://www.sec.gov/Archives/edgar/data/1180453/000119312518247631/d604329dsc13da.htm

    On the other side of this fight, Ctrip spun-off it’s interest in Shanghai XiCui – ownership of this entity was the key objection from the company (claiming Ctrip was competitor due to this) opposing higher offer. Ctrip still has not been granted access to perform due diligence.

    https://www.sec.gov/Archives/edgar/data/1269238/000110465918050359/a18-12799_1sc13e3a.htm

  7. Rick Sanchez

    so many players here. dt, so what do you think this means for the rest of us holding the ADS?

  8. dt

    With share purchase agreements from IGC and GS Chairman’s consortium ($13.5 offer) now has more voting power than the Ocean/Ctrip consortium ($15.5 offer), but still not sufficient to close the deal outright (2/3 majority required). So this part of news was definitely negative. However, news that Ctrip has spun-off Shanghai XiCui is definitely a positive as EHIC board now lost the key argument for not engaging in further talks with Ctrip/Ocean.

    I think this deal will close one way or another and with shares trading below the lower offer and activists fighting battles to increase the offer price I am quite comfortable holding the position.

  9. Rick Sanchez

    I wish us small fries could cut the same purchase agreements with the Chairman and get taken out right now at $13.50.

  10. Rick Sanchez

    probably only due to macro picture but EHIC is down today to ~$11.25; could be good entry point if $13.50 buyout is still looking intact (20% returns)

  11. work 22

    True the Chinese markets are down substantially this year, but also i think somebody knows something we don’t in EHIC. This feels like two buck deer with their racks locked together in combat; neither can win, neither can pull back; both can starve to death if they don’t retreat. Both have blocking shareholding stakes, both want to “win” by taking out EHIC and relisting in China, neither will give ground. They really should compromise. But oh well, we’ll see what the news is.

  12. Eric

    It could have been someone just needing to dump shares for whatever reason. I didn’t see any material changes. I actually bought some more shares the day after the stock slid down by 10%-ish. It’s not unusual for someone to get out after a deal is taking longer than expected or the prices goes down by X amount and then someone decides to take their losses and move on. All of these scenarios are possible.

    1. dt

      Most probably shareholders are getting tired on zero news re takeover and are selling at the end of the year (tax reasons?) – today’s drop is on very low volume.
      I have not seen any other news yet besides half a year financial statements in beginning of December.

  13. Writser

    Share down up to ~7% today. Spread now ~4%. An (according to my googling) notorious dissenter disclosed a ~7% stake. A quick scan of the merger agreement suggested to me that the maximum number of dissenters is 10%? I might be wrong on that.

    Anyway, we’ll see if this becomes the next Chinese going-private transaction that will be delayed or even cancelled due to dissenters.

    I’ve always thought that the dissenting system is a bit fucked up. A large player can sue the buyer because they think the take-over price is too low. Small fish don’t share the upside of the lawsuit but they do share the downside risk of the merger being delayed or even cancelled.

  14. Terence

    Return this under “Active Ideas”? Upside of 4%, merger voting on April 8, with “dissenters’ risk” per Writser.

  15. dt

    Terrence, Writser – what kind of play do you see here? Do you expect the shareholders to vote down the proposal, upon which the share price will jump in expectation of higher offer? Or is it more 4% gain on the deal very likely to close?

    I do not know much about Mason Capital, but if I get Writser’s comment right, then Mason’s larger pay-off would come after the merger closes and they start litigating. Thus no further upside for the remaining shareholders. Also Mason filed 13G instead of 13D, so it does not seem they will be taking activist route before the merger closes.

    Can any conclusions be drawn from Mason’s previous deals?

    1. Writser

      I don’t see any clear play here, just posted an update. 4% is juicy but the risk of delays / cancellation is very real.

      Still, some anecdotal evidence: with similar deals in the past where the buyer announced a ‘deal review’ because too many holders were dissenting shares absolutely cratered. But in the end the deal was usually too good for the buyer to pass so they eventually reached a compromise with dissenters after scaring / smoking them out a bit.

      IKANG was a recent example I can remember: http://www.cornerofberkshireandfairfax.ca/forum/investment-ideas/kang-ikang-healthcare/ . 32% of shareholders were requesting an appraisal. Buyer had the option to terminate the deal if >15% of shareholders were requesting appraisal rights. The deal was delayed a few times, stock trading very panicky but in a few months the deal was still finalized.

      Something similar might happen here. Might be interesting to keep an eye on this. Still, at a 4% spread I’m not going to get burned. Risky stuff.

  16. Terence

    DT, I normally defer to you on all arbs here.

    For EHIC, my own (often wrong) opinion is:
    More on 3-4% gain on deal likely to close. Yesterday was an over reaction to the Maso news.
    If merger is voted down, price will drop to $9-10, where it was when the $13.50 deal was delayed.
    Future higher offers are less likely and have credibility issues.

  17. Writser

    Shareholders approved the deal. Congrats to those who took a gamble. Risk / reward didn’t look super favorable to me but maybe I misread the situation.

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