ATRM Holdings (ATRM) – Merger Arbitrage – 20% Upside

Current Price – $0.5

Merger Consideration – $0.6

Upside – 20%

Expiration Date – Q1 2019

Announcement and Presentation

 

ATRM is being acquired by Digirad as part of Digirad’s conversion into a holding company. Each ATRM share will be converted into 0.4 shares of DRAD, at current prices this represents a spread of 20%. Worth noting that both securities are illiquid with wide bid/ask spreads, but with patience a reasonably sized position can be established.

Merger rationale

The move is orchestrated by Jeff Eberwein chairman of both ATRM and Digirad as well as Founder/CEO of Lone Star Value Fund known for its activism in microcap space (short interview). Lone Star Value will also be merged into the structure and this will position Digirad as an acquisition vehicle for Eberwein’s further moves. Slide 14 of the presentation suggest Eberwein is trying to recreate the model seen in other holding companies such ALJ Regional Holdings (ALJJ) and HC2 Holdings (HCHC). ATRM acquisition is what they call a ‘kick-off transaction’.

For background on business of both companies see the appendix of the linked presentation – ATRM manufactures modular housing units and Digirad operates within healthcare imaging industry.

This interesting thing about this deal is that ATRM has market cap of only $1.2m (+ net debt of $10m) and is still SEC registered and files regularly (although late at the moment). Cost-wise it clearly does not make much sense for such a small entity to exist as an independent public company, which is also the main reason/synergies for the merger. From the conf call:

On Slide 11, we talk about the cost benefits of this new structure forming the shared services center. We believe that the cost savings will come in phases. The first phase will be some of the obvious things any two public companies don’t need two CFOs, two audits, two D&O insurance policies. So, there is a lot of things that can be eliminated just from having one public company instead of two public companies, but then as we create the shared services center and get deeper into that structure, we think some additional cost savings will come and these will be more in the realm of IT savings, procurement savings, and just greater efficiencies having a lot of the shared services center staff work for multiple companies instead of just working for one company.

From the same slide it can also be clearly seen that the direct synergies between the two companies can only amount for small portion of the total planned corporate cost savings – total ATRM corporate costs were in the range of $1m whereas total planned cost reductions are $3m-$5m. Where exactly these additional savings will come from is not entirely clear – changing corporate structure does not change the underlying business and Eberwein has been chairman of Digirad since 2012, so likely most of the juice has already been squeezed. Also Eberwein’s track record in delivering operational improvements is spotty – back in 2014 Lone Star Value launched and won proxy fight for control of Hudson Global, but it seems that Hudson’s financial performance continued to decline (maybe it was the case of bad business rather than bad jockey). All in all my point is that investors should be skeptical on management’s promises to deliver significant cost savings and huge profits, which make current valuation look extremely cheap. But I do not think that this influences the likelihood of ATRM merger going through.

Also worth noting that, Lone Star Value has invested considerable amounts into ATRM debt and preferred securities and Eberwein extended personal guarantees in order to support the ongoing operations. So it might be that the real motive behind ATRM acquisition is for Eberwein and Loan Star Value to have a chance at recovery of these investments.

 

Likelihood of deal closing

The deal is currently in the stage of ‘non-binding letter of intent’, but keeping in mind that Eberwein is Chairman/CEO of all three companies being merged the ‘negotiation and execution of definitive documentation’ should not be an issue. It also seems that execs to run each division of the new holding company are already in place.

For Digirad this would represent only 5% increase in share count so it is unlikely there will be any strong objections (especially with high profitability boosts depicted in the presentation, although doubling of net debt to $20m is clearly concerning). Additionally, Eberwein personally signed Put Option and Standstill Agreement with the largest shareholder (10.4% – Cannell Capital) of Digirad. In exchange for standstill and voting alignment Eberwein agreed to buy all DRAD shares owned by Cannell at $1.65 (vs. current price of $1.5) on Aug 2019. I think this adds to seriousness of Eberwein’s intentions of pursuing the merger.

It is not explicitly stated whether ATRM shareholder approval will be required, but I expect it will be. Lone Star Value owned 45% of ATRM shares in Jan 2018, but later these holdings were distributed to fund’s partners with Eberwein eventually owning just 17%. However, when it comes to voting I would expect other fund partners to vote in line with Eberwein.

Another condition is for ATRM to get current on its SEC fillings before the merger – at the moment the latest financials are as of Q1 2017.

All in all there does not seem to be any major obstacles in closing the merger – Eberwein’s willingness to pursue the deal to the end will be the key determinant whether this closes or not. And he appears to be financially well-motivated (i.e. investments and personal guarantees on ATRM debt + 17% stock ownership of ATRM) to get this done.

 

Downside

ATRM traded at $0.1-$0.2 before the announcement, so downside is significant and it is quite likely the company would declare bankruptcy in the absence of transaction. So 100% loss of capital is a possibility here. Digirad shares stood 10% higher before the announcement, thus a hedged trade might hurt on both legs.

Additionally, the exchange ratio might still get amended before the final merger agreement is signed.

The possibility of material downside coupled with the letter of intent status of the transaction are likely the main drivers behind the 20% spread.