Neo Performance Materials (NEO.TO) – Merger Arbitrage – 12% Upside

Current Price – C$15.15

Acquisition Price – C$17.05

Upside – 11%

Expiration Date – TBD (expected H1 2019)

Merger Announcement

This idea was suggested by Bill.

 

This is a quite a fresh merger case between two rare earths and metals companies. Merger consideration stands at C$8.00 in cash and 0.395 shares of Luxfer Holdings per Neo Performance Materials share – resulting in 12% spread. LXFR borrow is cheap and available.

Oaktree Capital Management is involved as a main shareholder of Neo and is supporting the transaction, so only the buyer’s shareholders approval will be needed. Regulatory approvals will have to be gathered across the world, but this is only C$800m deal and so far no comments were made about any difficulties in getting them, so I don’t expect any problems with that. Financing of $375m has already been arranged.

Proxy as well as the shareholder meeting are expected in Q1 2019.

 

Rationale for the Merger

Although both companies operate more or less in the same industry, according to Luxfer’s CEO only 20% of their businesses are overlapping – this should make regulatory approvals easier to obtain. This acquisition will considerably expand Luxfer’s portfolio by adding magnequench (rare earth magnetic powders, which are 50% of Neo revenues) as well as chemicals and oxides (Neo is a leading global producer of Gallium Trichloride, used in LEDs) businesses. What is more, Neo has a substantial access to the Asian market (55% of their revenues vs 11% for Luxfer) and as stated by Luxfer’s CEO: “Neo is the only non-Chinese company with a license to separate rare earth in China”.

The transaction is expected to realize at least US$15 million of cost synergies, largely from the elimination of duplicative public company costs and sourcing benefits from vertical integration of rare earths. In addition, integration of Luxfer’s zirconium chemicals business with Neo’s Chemicals and Oxides unit is expected to lead to growth synergies.

 

Approvals

As OCM is already supporting this acquisition, only the approval of Luxfer’s shareholders is needed. Taking into account portfolio expansion, access to the Asian markets, license in China, synergies and financials, I expect that they should favor the transaction.

Regulatory approvals will be needed in a few countries, but not in China, which is a relief. Luxfer’s CEO commented:

There are no specifics — so we’re working through a lot of these issues and a lot of several — got lots of strides. But we don’t expect any specific regulatory requirements in China, still to be proven right now. But from a broader question, there are a few geographies like Germany and Japan, where we know we are required to fire regulatory anti-trust clearance. Besides that, there are no other regulatory requirements that we aware of. But the system is and analysis and configuration.

I see Luxfer shareholder approval as the main uncertainty here. LXFR will give up 37% ownership of the merged company and lever up to pay the cash portion of the deal. Luxfer is currently trading at c. 6.5x adjusted EBITDA and it is acquiring Neo at almost 8x adjusted EBITDA. However, if cost synergies are taken into account then acquisition multiple drops to 6x-6.5x. So at least from the trailing profitability perspective the acquisition does not seem to be dilutive to Luxfer shareholders.

LXFR ownership is quite concentrated with Top 6 shareholders owning 50%+ of the equity. This might make it easier to achieve the required approval.

 

Further Bits and Pieces

Luxfer Holdings is based in UK. It went public in 2012 and is currently trading in NYSE. The company has done a number of acquisition before – a few examples I managed to gather:

• 2017 – ESM (not much info).

• 2014 – Truetech and Innotech. It was a $64m deal, which was completed in 1.5 months.

• 2012 – Dynetek Industries. $5m transaction.

So the merger with Neo is by far the largest one so far.

Neo Performance has emerged from the bankruptcy of Molycorp in 2016. At the time of bankruptcy the financial giant Oaktree Capital Management (OCM) was its largest creditor, and so became the largest shareholder after restructuring. At the end of last year OCM brought Neo public in a not-so-successful IPO: the initial amount that was expected to be raised was C$345m, with a price of C$19-C$21, but IPO ended up at C$18/share raising just over C$200m. OCM was left with 65% stake instead of planned 58%-53%. It seems that so far the company is doing quite well, as their revenues and EBITDA have improved materially over the last year.