Xenith IP Group (XIP.AX) – Bidding War – 10%+ Upside

Current price: A$1.92

Merger Consideration: A$2.02

Upside: 5% (with likely overbid)

Expiration Date: TBD

This idea was shared by Ilja.

 

This is an interesting and low risk situation that involves three largest Australian intellectual property companies (services related to patents and trademarks). Xenith shareholders are currently choosing between two buyers - IPH and QantmIPH offer stands at $1.28 + 0.1056 IPH shares (5% spread), whereas Qantm’s offers all stock transaction at 1.22 QIP for each Xenith share (-13% spread).

Antitrust, which has initially been the main concern, has recently approved for both transactions. IPH and Qantm have a very strong motivation to acquire Xenith as whoever manages to get it will become market leader in Australia. It is likely that shareholders will prefer IPH proposal simply because it is higher at current share price levels and has 2/3 of consideration payable in cash (vs all stock for Qantm). Also IPH is the largest shareholder (recently acquired 20%) of Xenith and its stake is almost enough to block the competitor (25% dissenter threshold in Australia) .

Xenith has initially planned merger of equals with Qantm and any IPH’s proposals were simply ignored and rejected (more details on timeline below), but now that the antitrust is no longer an issue, Xenith management might reinstate the discussion with IPH. They have already adjourned shareholder meeting to vote on merger with Qantm (was supposed to take place on the 3rd of April, new date is not set yet).

I would not be surprised if the start of discussions with IPH and potential bidding war between IPH and Qantm would result in materially higher merger consideration payable to Xenith shareholders.

The risk of both buyers walking away is very low, but discussions and bidding process might get prolonged.

 

Background

All three companies provide intellectual property services such as securing, registering, enforcing, commercializing and managing IP rights (patents, trademarks) of the client.

Xenith looks like an attractive target, which last year had higher patent applications growth than either of the peers. Moreover, despite the size, the company already has operations in numerous markets (Europe, US/Canada, Australia/New Zealand, Asia), whereas Qantm operates mostly in Australia and IPH in Australia and Singapore.

IPH has stated numerous times that they want to participate in the consolidation and has even tried to acquire Qantm (on the same date as XIP/QIP merger got announced).

XIP table

Evaluating the Offers

IPH’s proposal is definitely superior in certain ways (cash part, liquidity) and although it was rejected due to antitrust, lack of premium (A$1.97 vs Qantm’s A$2.03 at the time) and loss of control (5% ownership in a merger with IPH vs 45% with Qantm), the market seems to believe the odds are highly on IPH side especially after Qantm shares have dropped by 18% over the last month.

Looking at margin differentials between the companies it is clear that both IPH and Qantm should be able to achieve material synergies on the acquired Xenith revenues. Xenith also trades at significantly lower EBITDA multiple relative to Xenith. Taking into account potential synergies as well as valuation discount, there seems to be plenty of scope for improved acquisition offers.

As to why the margin difference is so large - there does not enough information in the reports for good explanation. But my guess is that higher margins are mainly the result of higher scale which bodes well with the synergies argument.

 

Shareholder Approval

In the most recent Xenith annual report (October 26th) it seems that only about 8.5% (from the top 20 holder list) belongs to the insiders, however in the rejection letter to IPH it is stated that employees hold over 40% of Xenith's shares. While I was not able to verify this information, employee ownership of this extent might play a role in choice between merger of equals (Qantm) vs cashout with minority ownership (IPH offer). Importantly in the letter management was careful not to state that employees would reject merger with IPH:

It is open to questions as to whether the IPH Proposal as currently framed would win support from Xenith employee shareholders who hold over 40% of Xenith shares.

 

Timeline:

  • November 27. Qantm proposes an indicative non-binding merger of equals, in which Qantm and Xenith would own 55% and 45% of the shares respectively. The consideration was worth A$1.76/share (40% premium to last close) at the time.
  • November 27. Later on the same day IPH made an offer for Quantm for A$1.80 (40% premium to last close) in cash and stock. Qantm board has rejected the proposal due to it being highly conditional, hard to execute and undervaluing the company.
  • November 29. IPH has responded to the rejection with some counter arguments, which were on the same day countered again by Qantm.
  • February 13. IPH has acquired 19.9% of Xenith at the price of A$1.85 and has made it clear that they want to participate in the consolidation of the industry, but will not support Qantm/Xenith deal. Both merging companies have responded by saying that they haven’t received any communication from IPH yet and are moving forward with their transaction.
  • March 12. IPH makes a binding offer for Xenith. This offer (A$1.97) came at a discount to the value of Qantm’s offer (A$2.03) at the time. Here is the Qantm’s response.
  • March 19. Xenith rejects IPH offer. The main reasons were antitrust risk, loss of control and no premium relative to Qantm offer at the time.
  • March 20. IPH counter argues the rejection.
  • March 28. Shareholder meeting is postponed without indicating new date.

5 COMMENTS

  1. value_investor

    Thanks for posting this idea !!

    The heading suggests 10% upside vs the 5% in the subtitle. Was the 10% referring to potential overbid ?

  2. Ilja

    As expected, IPH has sweetened their offer (stock part). Total value of the current offer is now worth A$2.16/share. The announcement has been made after the trading has been closed, so the spread currently stands at 13%. Now the question is if Qantm (current offer value is A$1.64) will top it? They have three days to do so.

    https://www.asx.com.au/asxpdf/20190408/pdf/4444sz8nghmpd5.pdf

    1. dt

      Nice call so far! Thanks.

      Regarding another offer from Qantm – I do not think it is very likely:
      – Qantm can hardly increase share consideration as in doing so they would loose control in the joined company.
      – Qantm would need to add c. A$45m of cash consideration to match IPH’s offer. At the end of 2018 company had only A$2.7m in cash.
      – Qantm could borrow the rest, but doubt they will be able to arrange that in a few days. Also additional debt would significantly lever up the joined company – Net debt/EBITDA would increase to 2x vs under 1x for each company currently.

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