Inuvo (INUV) – Merger Arbitrage – 80% Upside

Current Price – $1.25

Acquisition Price – $2.22

Upside – 78%

Expiration Date – Q1 2019

This opportunity was shared by Ilja.

 

This is an interesting stock for stock reverse merger with large potential upside, but with many important pieces of information missing (S4 to be published in coming weeks) and with no possibilities to hedge (acquirer not-listed). Nonetheless based on my research, this is a case worth having a speculative position in even before the S4 gets released.

Advertising technology company Inuvo (target) has agreed to merge with private e-commerce technology firm ConversionPoint (CPT – buyer). According to management, combined company plans to compete with Shopify. Inuvo shareholders will get $0.45 in cash + 0.18877 of new stock for each INUV share. Unlisted shares of CPT will be exchanged into  0.9840 of the new stock. Companies will control 29% and 71% of the combined entity respectively. Based on a recent (July 2018) funding round CPT was valued at $9.21/share - resulting in see-through acquisition price of $2.22 per Inuvo share (78% spread). Although both boards are supportive of the $75m transaction, it is still subject to INUV shareholder approval and the buyer raising $36m to fund the cash part of the deal. 70% of CPT shareholders are already in favor of the merger.

Large apparent spread clearly indicates either that the market does not believe the $9.21/share valuation for unlisted CPT or that CPT is unlikely to be successful in raising $36m necessary to close the deal. I am partially addressing both of these below. The unaffected INUV price stands at $0.4/share, so if the deal breaks the downside is c. 70%.

What does CPT do?

Although management is aiming to portray the company as direct competitor to Shopify, I do not think this is really the case. As the name of the company suggests CoversionPoint Technologies is more of a collection of tools and services to improve customer acquisition/retention and online marketing. This interview with CEO sheds further light on the business:

We are an e-commerce customer acquisition platform that integrates solutions for such needs as media optimization, customer relationship management and fulfillment. Our platform emerged from failings we saw in piecemeal solutions. We’ve scaled the business from launch in mid-2016 to estimated revenues of about $70 million last year.

When Facebook and Google account for half of all paid media buys, you have to stay proactive if you want to have a hope of avoiding the havoc an algorithm change can wreak on metrics. That never-ending battle aside, there’s also the challenge of integrating our system smoothly with the big guys in the e-commerce ecosystem like Amazon and Shopify.

And another interview here:

We have two sides of our business. First, we have a “direct to consumer” side which was really our genesis. We cut our teeth on identifying a product that would sell well and using our technology to lower the customer acquisition cost, capture better metrics and effectively re-market and re-target.

We quickly saw success and began to have companies come to us asking to mirror the same ecommerce marketing for them. This is when we decided to create an enterprise software as a service (SaaS) offering. Our SaaS customers are high volume sellers of products or “offers” such as insurance and car quotes. We deal with brands to optimize their online sales and lower the cost to acquire a customer.

 

 

Points on CPT Valuation

  • CPT had a revenue of $50m (according to call transcript) in 2017, although press release says $60m and CEO in an interview above mentions $70m. In three years the company has grown 568% and got into the 5000 largest growing private companies list.
  • Based on the latest funding round CPT is estimated to be worth $146m or 3x revenues multiple.
  • Based Crunchbase data, CPT raised $1.5 and $2m by issuing convertible notes in 2016 and 2017 and then in July of 2018 did Series A round for $10m. Inuvo press release  refers to ‘recent $15m private offering’. However, browsing through earlier CPT press releases I was only able to find $2m convertible debt and $2m equity investments from Falcon Capital in 2017 (the only investor known at the moment). If the funding round used as reference for $9.21/share was the one done in July 2018 then I would argue that the valuation is quite real (i.e. why would investors from couple months back agree to go public if shares would be expected to trade significantly below their acquisition price – that is unless the ship started sinking.). S4 should shed full light on previous funding rounds, investors and valuation at the time.
  • Falcon Capital has invested into 8 companies that got listed so far and all of them have done straight (as opposed back-door) IPOs. So the current CPT situation stands out. Majority of these companies trade significantly below their IPO prices (except Hailiang Education which was 9x multi-bagger since IPO). I was not able to find into on how IPO prices compared relative to valuations on the latest pre-IPO funding rounds.
  • Inuvo insiders own c. 16% of the company. They have most likely already received access to non-public information on CPT and have agreed to the merger (as BoD has approved the deal).
  • At the end of 2017, CPT has acquired Sellpoints, an e-commerce technology provider. Not much information about the company or it’s value, except that its investors included IBM and Menlo Ventures.
  • Chairman and co-founder of CPT is quite remarkable entrepreneur. He founded Ad Exchange in 2013 and company reached $100m in revenues within 19 months – maybe that is the reason why investors are so eager to fund his next venture.

 

Does the acquisition price make sense (at 535% premium)

CPT is paying $75m for Inuvo. This is 535% premium to pre-announcement market cap of $14m. Inuvo market cap stood at only 10% of CPT’s valuation in the latest funding round. However, after the merger Inuvo shareholders will own 29% of the combined company, so CPT seems to be giving away 1/3 of the business for something that the market thought is worth significantly less. To justify this price-tag, one needs to refer to INUV peak share prices during 2015, when the company sported high revenue growth and was generating rather than burning cash.

Current Inuvo situation is quite different – growth has slowed down and even turned negative in the latest quarter (down 17%). However in Q3 results call, management explained that this decline in revenues was a result of intentional strategic shift and likely to be temporary:

As discussed over the last year, we have been shifting our focus from the supply, or publisher, side of our business in an effort to drive growth in our higher-margin demand, or advertiser, business with the IntentKey. During the third quarter, this supply side decreased at a rate faster than we anticipated due to our reallocation of resources, which negatively impacted our top and bottom line.

Despite the impact from our de-emphasized business, the revenue mix change led to an improvement in gross margin to 63.1%. We have also continued to gain momentum from the IntentKey with several recent new client wins, including a top insurer, a global audio brand and a leading online loan marketplace, among others.

Also IntentKey is positioned as a key reason (and key value driver) for CPT acquisition:

Since launching our next-gen AI-powered IntentKey solution last year, we have been actively searching for a partner like ConversionPoint that has the right platform to maximize the value and commercial potential of our technology. Given ConversionPoint’s growing client list of major global brands and Fortune 500 retail partners, as well as their robust eCommerce offering, we have already identified several near-term cross-sell opportunities to accelerate revenue growth and drive margin expansion.

We plan to build off this base leading into the close of the acquisition, where ConversionPoint is expected to bring a number of near-term upsell opportunities to many of their existing eCommerce clients.

Despite current losses, Inuvo has c. $46m in TTM gross profit. So depending on what synergies can be achieved (I would expect these to be quite material), the$75m price tag might look reasonable, especially when coupled with the above mentioned cross-selling opportunities. In the call, management talked about “numerous potential revenue and margin enhancing collaborations” and “numerous expense synergies”, however no numbers or anything more specific were given – again a full presentation on this is likely to come out together with S4 filling.

 

Cheap relative to Shopify

So CPT saves the trouble of doing IPO and plans to combine Inuvo’s AI advertising technology with their current backdoor office and marketing platforms to compete with Shopify. SHOP is currently valued at $15bn and had $673m revenues last year. It trades at 16x revenues. CPT was valued at 3x revenues in the latest funding round and is paying only 1x revenues for Inuvo. The combined company currently trades at 0.6x revenues using Inuvo share price.

Obviously Shopify is already large scale platform business with wide product/service offering and thus direct comparison is clearly flawed (CPT would probably be more comparable to one of Shopify’s modules dealing with customer acquisition and advertising ROI), but nevertheless revenues multiple differences seem to be out of wack.

 

Bottom line

I am mostly hinging to the fact that CPT was valued at $9.21/share in the latest funding round (which I assume was the $10m in July 2018) and that material cost synergies and cross selling opportunities should be realized from this transaction. I am expecting the upcoming S4 info to surprise investors on the positive side.

What’s really worrying is that this is a back-door IPO and that CPT is paying huge premium to INUV unaffected price, albeit the later can be somewhat justified by the ongoing strategy/product shift to IntentKey. Also worth noting that my knowledge in the e-commerce software/solutions market is limited at most.

1 COMMENT

  1. Ilja

    So my core idea that after the S4 (filed on the 17th of Dec), the stock price will go up didn’t work out. My arbitrage thesis mostly hinged on the idea that ConversionPoint is worth $9.21/share and I no longer think that is the case.

    S-4 revealed a few bits of interesting information about CPT:
    - Top line revenue declined by 27% during 9M 2018 eventhough the 2018 period included full 9 months of revenues of Push (acquired in April 2017) and 9 months of revenues (acquired in Nov 2017). Excluding these acquisitions, organic growth figures would have been even worse. Management tried to explain this drop in revenues by “strategic effort by ConversionPoint to transition its business model from e-commerce products revenues to technology managed services and SaaS, which have higher gross margins”. It’s hard to judge how much truth is in that without further info (which was not shared), but gross margin for 9M 2018 was 5% lower than for 2017.
    - In Oct 2018, CPT Executive Management voluntarily cancelled 2.7m warrants to acquire shares at $9.21. These warrants had BV of $5.7 and I doubt management would have cancelled then if there was any chance they will be in the money.

    It seems that 2018 was a significantly worse year for CPT (revenues down, weighty net loss) and therefore I think that the valuation of $9.21/share is not applicable anymore as the equity raise, which was based on that price was, done on the back of 2017 growth as well as expectation of successful Push and SellPoints integration.

    It is also doubtful whether the financing condition will be met as CPT needs to raise $36m for this merger to go through. That is 3x larger than the amount raised during H1 2018 and 10x the amount of 2017. Thus given the lackluster results of 2018, it might prove problematic.

    Luckily Inuvo shares are trading almost at the same levels were I initiated the position and I am closing this with minor loss only.

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