Artilium (ARTA.L) – Merger Arbitrage – 16% Upside

Current Price – £0.204

Merger Consideration – £0.237

Upside – 16%

Expiration Date – 13th of September, 2018

Merger Announcement and Presentation

 

This is one of those microcap merger arbitrage situations where large spread seems to exist without significant risks.

In June Pareteum (TEUM) agreed to acquire UK listed Artilium by offering 0.1016 Pareteum shares and £0.019 in cash for each share of Artilium – current spread stands at 16%. Shareholder meetings are scheduled for 13th and 14th of September. 60% of Artilium shareholders already entered into voting agreement, so it seems that Pareteum shareholder vote is the main risk here. Borrow is expensive (50%) but there seems to be plenty of availability on IB. I would expect the spread to close (or significantly narrow) after shareholders approve the deal. Accumulating material position is difficult due to low Artilium liquidity.

Both companies provide software services (SaaS) to mobile and fixed network operators. In Oct 2017 they formed strategic alliance and since then have cross-ownership in each other.  This significantly reduces the risk of any of them walking out on the deal as companies have been cooperating already for a while and know each other well. So there should be minimal surprises down the road.

Like many other SaaS companies these two also trade at high revenue multiples (8x and 10x) while burning cash. Clearly not a typical value type investment and unhedged bets on the spread might not pay-off. If the spread does not close after the meetings it might take till mid October for new Pareteum shares to be distributed (see expected timeline). With unchanged borrowing costs the short leg of the trade would consume 1/3 of the spread (or 6%). There is a risk that timeline gets extended in which case borrow costs might consume the whole spread.

On Pareteum vote risk. Ownership is dispersed with majority of shares in the hands of retail investors. I would expect that management discussed this transaction with small number of institutional investors (and larger retail investors) and received ok from them. Most of retail investors will likely not be present in the meeting, but their broker non-votes would still count towards the quorum, which increases the likelihood that the vote will pass. As per proxy:

Broker non-votes do not count for voting purposes, but are considered “present” at the meeting for purposes of determining whether a quorum exists.”

Downside here is quite hard to assess. Artilium traded at £0.17 (17% below current prices) before the announcement. However, in the same period Pareteum share price has also increased by a similar degree. So hedged trade might breakeven even if the deal is cancelled.

14 COMMENTS

  1. dnitka

    Just a question about the listed prices. $ARTA.L shows a price on LSE of Gbp 19.60. You show a price of .204? Also looks like $TEUM is trading at USD $2.70. So should we be buying $ARTA.L at 19.60?

    1. dt

      Stock prices in UK are quoted on pence rather than pounds. To avoid confusion I indicated all prices in pounds (GBp 19.60 = £0.196).

      For each ARTA.L share investors will receive 0.1016 of TEUM shares and £0.019 in cash. With TEUM at $2.7 this merger consideration is worth £0.2312 (at the time when I posted TEUM was at $2.77).

      This is still 18% spread to £0.196 and 13% spread to £0.204 (bid ask spread for ARTA.L is relatively wide so return depends on good entry on the long leg of the trade.).

      Keep in mind that unhedged trade is quite risky here and that TEUM borrow is expensive.

    1. dt

      Fa, sorry for late response, somehow skipped your question. My understanding is that this is a done deal already as the remaining steps are formalities only. From the announcement:

      “Next Steps and Expected Timetable

      Completion of the Acquisition remains conditional on the satisfaction or waiver of the remaining Conditions set out in the Scheme Document, including the Court’s sanction of the Scheme and the delivery of a copy of the Court Order to the Registrar of Companies.

      On the basis of the current indicative timetable for the Scheme and subject to the Court sanction of the Scheme, the Scheme is expected to become Effective on 1 October 2018 (the “Effective Date”), the last day of dealings in, and for registration of transfers of, Artilium Ordinary Shares will be Friday 28 September 2018. At 7.00 a.m. on 2 October 2018, the admission of Artilium Ordinary Shares to trading on AIM is expected to be cancelled.”

      I find the remaining almost 15% spread quite puzzling.

  2. dt

    One additional important point I failed to mention in the write-up.

    Artilium shareholders will receive Pareteum CDIs (quite similar to US ADRs) traded in UK rather than direct shares in Pareteum. From the Scheme document:

    Unlike Artilium Shares, New Pareteum Shares are not capable of being held, transferred or settled directly through the CREST settlement system. For this reason, a Scheme Shareholder who holds Scheme Shares in uncertificated form through CREST (directly or through a broker or other nominee with a CREST account) immediately prior to the Scheme Record Time will not be issued New Pareteum Shares directly but will be issued Pareteum CDIs through an existing CDI programme administered through CREST in respect of Pareteum Shares. Under the arrangements, one Pareteum CDI will represent one Pareteum Share.

    https://www.sec.gov/Archives/edgar/data/1084384/000114420418041940/tv500110_defm14a.htm

    My understanding is that spread between US and UK listings should be small – just to cover the costs/profits of market makers rather than actual separate listing of the shares. CDIs are quire well explained here:

    https://the-international-investor.com/investment-faq/crest-depository-interest-cdi

    It’s also worth being aware that since CDIs of a foreign stock will usually be traded through a UK market maker, the price that the market maker quotes will not be the same as is available on the overseas exchange, since they need to earn a profit on the transaction.

    When quoting the sterling price for a foreign security, the mark-up will usually range from 0.5% for smaller trades to about 0.25% or lower for larger ones. This is not a deficiency of the CDI system itself, just a reality of the market. Using CDIs can still be cost-effective relative to the costs of trading directly overseas, since your broker does not need to incorporate other costs of an international service.

    Most of the CDIs are usually for large cap stocks, so I am not sure what will be the eventual spread on small cap like TEUM.

    There also seems to be convertibility option on TEUM CDIs, but not sure what this involves and how long it normally takes.

    Holders of Pareteum CDIs will be able to cancel their Pareteum CDIs by settling a cross-border delivery transaction in respect of the underlying New Pareteum Shares through CREST to a DTC participant, in accordance with the rules and practices of CREST and DTC.

    So the bottom line is that the merger spread might not be fully eliminated upon closing of the transaction (although I expect it to narrow significantly) and expensive borrow on the short leg of the trade will eat into profits while the position is open. Another related concern is that bid/ask spread on the new Pareteum CDIs will also remain wide (as it is now for Artilium), which will limit the opportunities to exit the position efficiently.

    I tried to get clarification form Artilium IR representatives, but failed to get any definitive answers – they claimed to not know the details and person with knowledge was away multiple times I tried. Did not manage to reach TEUM IR yet.

    If anyone has more experience with CDIs (especially convertibility option), feel free to share any further insights.

  3. dt

    Borrow rate on TEUM shares is gradually declining – now at 30% vs 50% two weeks ago.

  4. Thinley w

    This is a silly questions, but does one need to buy this stock & other mergers/acquisitions a few days ahead of the delisting in order to be a shareholder of record (e.g. dividends)?

    1. dt

      For dividends – yes, but also not for all dividends.
      For merger – as long as you manage to get it before trading is suspended (for ARTA today should be the last day if I am not mistaken) you will receive merger consideration.
      However, the spread has narrowed considerably over the last week.

    1. work 22

      if you have ARTA.mrg listed on your IB account as a position, it is a placeholder for the TEUM shares in transit for the deal. That can be 2 weeks from the effective date- when the merger closed. Note the price for ARTA.mrg is close to TEUM’s price when adjusted by the GBP.

  5. dt

    Today ARTA shares were exchanged into new TEUM and my hedge got settled. In the end ARTA investors received the same TEUM shares as the ones traded in US instead of separately priced CDIs.
    Cross border micro cap arbitrages seem to be quite lucrative.

    Overall arbitrage returned 16%, but 3% were consumed by TEUM borrow, resulting in 13% net return in a month.

  6. Rick Sanchez

    which broker do you guys recommend for trading foreign securities? IB?

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