Integrated Asset Management (IAM.TO) – Merger Arbitrage – 13% Upside

Current price: C$2.62

Merger Consideration: C$2.57 + Residual Cash Balance + CVR

Upside: 3% + 10% (expected)

Expiration Date: Q2 2019

Merger Announcement

 

Fiera Capital is acquiring Canadian listed Integrated Asset Management (IAM) at C$2.576/share payable in cash and stock. On top of this base merger consideration IAM shareholders will get any residual cash balance distributed as dividends and CVRs that will pay out depending on performance of two IAM managed funds. All in all, shareholders are expected to receive the value equal to current share price as the base merger consideration and then any dividends + CVR (potentially 13% in value) would come in as free upside.

Merger is expected to close during Q2 with shareholder vote in May/June 2019.

Risk of transaction falling apart is very low. 62% of IAM shareholders (top management + other insiders) entered into support agreements. Acquisition makes sense for Fiera which will be able to integrated IAM operations (C$3.1bn in AUM) within Fiera's wider portfolio (C$137bn AUM) achieving scale efficiencies. Fiera has been serial acquirer of smaller asset managers over the last few years (9 closed acquisitions since 2015) and IAM deal fits the pattern.

This opportunity is well covered here and I recommend reading through the post for any additional information or different assumptions re. the upside.

When I started looking at IAM it was fairly liquid (probably due to post-announcement volume) and traded somewhat lower, but over the last week liquidity dried up. Patience is required to establish even small position.

 

Merger Consideration

  • C$1.932 in cash.
  • C$0.644 in Fiera Capital shares. Exchange ratio will be determined by 5-Day VWAP preceding the closure. Hedging might be necessary when exchange ratio is known - at the moment borrow is cheap with plenty of availability.
  • C$0.13 (estimate) in pre-merger dividends from adjusted cash balance in excess of C$10m. The definition of adjusted cash balance is outlined in Schedule D of the merger agreement and is basically net cash+receivables+investments less payables and any transaction related costs (severance, bonuses, change of control fees, any professional fees related to transaction). As of Dec 2018 IAM had C$17m of cash+receivables+investments less all liabilities (treatment of certain liabilities - like long term bonuses - is not fully clear, but most probably these will need to be paid out). Assuming transaction closes by the end of Q2, IAM is likely to generate additional cash of C$1.5m, bringing the total to C$18.5m. Now it is uncertain how much will need to be deducted for severance, additional bonuses and other transaction related fees - a conservative suggestion here offers using half a year salaries for this resulting in total of $5m of severance and closing costs. This brings us to $3.5m of expected excess cash or C$0.13/share.
  • C$0.175 (estimate) in CVR payouts based on after bonus incentive fees from two IAM real estate funds maturing in 2021 and 2024. As of Dec'18 unrealized performance fees from these two funds stand at C$10.7m, employee bonuses are 25% of that (as per merger agreement) and various taxes might deduct another 10%, leaving C$7m for CVR distributions. Discounting this at 10% to today results in additional C$0.175/share in value. Incidentally, management decided to value CVR at C$0.174/share for tax purposes. These CVR payouts are highly dependent on the value at which real estate assets from these funds will eventually be sold and zero is clearly a possibility.

In short, upon close of the merger (Q2 2019) shareholders will receive current share price value in base merger consideration and potentially another 5% in excess cash dividends. A further upside of 10% might be realized from CVR payouts in 2021 and 2024.

24 COMMENTS

  1. cam1830

    “unrealized performance fees from these two funds stand at C$10.7m” – where do you see that?

    1. fishwithwings

      Is there info about how the incentive fees will be calculated for the CVR? Are performance fees and incentive fees the same thing in this situation?

      1. dt

        As you suggest performance and incentive fees seem to be the same thing in this situation, although that has not been explicitly stated. But at least per share tax valuation of incentive fees seems to correspond to the discounted value of unrealized performance fees.

        Employee bonuses (historically at 25%) will be deducted from this amount and there also might be some taxes.

  2. AV

    In the merger agreement there are some details how the CVR calculation works. Employees indeed get 25%, but don’t have to pay taxes. So after taxes CVR holders will approximately get ~50% of the unrealized performance fees.

    1. dt

      Why do you think that taxes will amount to another 25% of performance fees?
      This would mean that taxes are 100% of the bonus pay-outs.

      1. Tyler

        IAM’s tax rate is 26.5%. So out of the $10.7 million:

        – bonuses are 25% (I wrote they were 35% off memory so I was mistaken),

        – then I think it’s prudent to estimate another 10% for other expenses/taxes that you mention (“such taxes to also include any health tax and similar employer taxes and contributions payable with respect to the payment of the remaining 25% of the RE12LP Incentive Fee to the employees”), but you can note this does not include corporate income tax,

        – then IAM will be paying 26.5% for income tax.

        All told, 40-50% of the $10.7 million is probably right.

        1. dt

          26.5% on income tax does not sound right. There will be no IAM when performance fees get paid out and in any case these are revenues from the company perspective. I think what AV had in mind is that additional taxes will have to be paid on behalf of employees for the bonuses they receive. But even if the taxes on employee payouts are 40%, the total deduction is 25%*(1+40%)=35%.

          Am I wrong in thinking this way?

          1. AV

            I assume they will have to pay 26.5% on the full performance fees, otherwise the acquiring party ends up paying taxes on them without getting anything (unlikely to happen!). So you will get 100% * (1 – 0.265) – 25% = 48.5% of the performance fees (25% going to employees, and 26.5% going to taxes).

            1. Tyler

              This is the right way to think about it, minus any extra expenses/taxes that might come up. 48.5% is the best case.

  3. Austin

    Press release today:

    * Special meeting will be held on June 14th

    * Shareholders of record as of May 14th will be able to vote

    * ” The Transaction is expected to close in the second quarter of calendar year 2019.”

  4. nmeile

    IB offers the selection to ask for all cash payment (2.576); seems like the better choice vs receiving stock consideration?
    If chosen cash, would one still be entitled to pre-merger special dividend (if any is paid)?

    1. work 22

      Choosing cash still allows you the pre-merger special dividend (which seems doubtful to be paid) and the CVR. Unlikely anyone will get 100% cash, as the deal is prorated $55 million cash, $18 million in stock. Though some may choose all stock for tax reasons or they want to hold FSZ. Depends on how much equity risk you want to take.

      1. Tyler

        What makes you think the dividend won’t be paid? Seems very likely to me that a dividend of at least $0.03.

    2. Tyler

      nmeile, yes if you choose the cash option, you will still get any special dividend that is paid.

      As for the cash vs stock, cash will be best for all but a few. Koloshuk and Hirsch for instance will most likely have a huge tax bill to pay if they receive cash, so there’s a chance they take Fiera shares so they can choose when to pay those taxes.

      There’s also the argument that Fiera might be undervalued, so you can get shares under their intrinsic value, so the stock option “pays” more (if you value the shares at intrinsic value). I haven’t looked too closely so I can’t say whether Fiera is undervalued or not. But with these asset managers, a lot of which are undervalued, there is a real chance Fiera is worth more than the ~$12 it will be when the deal goes through.

      As for me, I picked the cash only option.

    3. fishwithwings

      Cash or stock option shouldn’t make a big difference because the stock component is based on the 5day VWAP.
      You will still be entitled to the special dividend if you select cash.

  5. Tyler

    According to a source of mine that asked management, the effective date will be June 27th, and the dividend announcement will be mid next week. There’s still some upside, and now that there is a known time frame (I’m assuming my source is correct), $2.62 should still be a good entry.

    1. work 22

      sorry i mean, that the special dividend will be paid way above and beyond the $10 million on balance sheet required. i mean its possible, but just something i’m not banking on. the CVR payout looks likely etc though

  6. Tyler

    Special dividend is $0.08, better than I estimated, and better than the recent fears that the dividend would be fairly small.

    https://finance.yahoo.com/news/integrated-asset-management-announces-special-225854804.html

    Will be interesting to see what IAM trades at tomorrow now. We’re now set to get $2.656 in cash and shares within a week or two, so the difference between tomorrow’s trading price and $2.65 – $2.66 is the value being attributed to the CVRs.

    As much as it would pain me to add more over $2.66, the CVRs do have a value and even buying at $2.70 would mean buying CVRs worth $0.10 – $0.20 (present value) for $0.04. We’ll see…

  7. work 22

    So just to be extra clear, the offer is not reduced by the amount of the special dividend, so you get $2.656 cash and shares now (NOT a reduction now to 2.496 cash/shares)? I did a Ctrl-F search on special dividend in the Circular and didn’t find any indication of a reduction, so that is good news. Extra bonus. (many deals reduce the takeover price for dividends paid out before closing is why i am asking).

    1. dt

      Special dividend is paid before the merger consideration and the amount of merger consideration is not affected by the payout of special dividend.

  8. dt

    Merger closed – cash, Fiera stock, dividends and CVR have already been distributed.

    Special dividend from the residual cash balance turned out smaller than expected (C$0.08/share vs C$0.13/share), but overall, full initial investment was recovered with additional upside coming from potential CVR payouts few years down the line.

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