UQM Technologies (UQM) – Merger Arbitrage – 6% Upside

Current price: $1.62

Acquisition Offer: $1.71

Upside: 6%

Expiration Date: early Q3 2019

Merger Proxy

This idea was shared by Ilja.

 

In Jan’19 Denmark based Danfoss Power Solutions agreed to acquire US based UQM Technologies in all-cash transaction of c. $100m ($1.71 per share). This transaction has already been approved by shareholders and has traded at a narrow (2-3%) spread until recently. Last week CFIUS (the only remaining approval) has extended the investigation period and caused the spread to widen to 14%. The stock has rebounded since and the remaining spread stands at 6% now. CFIUS approval is very likely (deadline set for the 25th) and acquisition should close shortly afterwords.

Gabelli Funds, now the largest shareholder (10.7%) of UQM has increased its stake by about 2.5% (from 8.2%) right after the share price drop following the CFIUS review extension.

In case the transaction fails, downside to pre-announcement prices is 30%. However, due to positive Q4,18 and Q1’19 results the actual downside might be lower than that.

 

Some Background

UQM Technologies ($100m market cap) is manufacturer of electrical motors, generators, motor controllers, fuel cell compressor and hybrid systems for passenger and commercial vehicles. The company sells to OEMs and revenue for 2018 stands at $14m. The company is seen as a play on vehicle (mainly buses, particularly in China) electrification or propulsion by alternative fuels and trades at high revenue multiple despite ongoing losses.

Danfoss Power Solutions is a large industrial group with global businesses and products across number of markets including hydraulic, cooling, heating and motor controller industries. Sales for 2018 stood at $6.8bn.

 

CFIUS Approval

CFIUS usually takes a decision based on these four factors:

• The likely impact of proposed transaction on national defense requirements.
• The foreign investor’s nationality and the extent of its ownership by foreign governments.
• The target’s involvement in and ties to national security-related activity and “critical infrastructure” in the United States.
• The proximity of the target’s assets to sensitive US government locations, such as military installations (which may be known or unknown to the target).

Neither of the companies is involved in national defense or related activities, which could pose a threat to US national security. Danfoss is almost entirely owned by it’s founders Mads Clausen Foundation so no risk there either. UQM does not seem to be involved in any critical infrastructure related activities and currently does not generated any revenues from the U.S. government. Regarding the fourth point, if there had been an issue with government sensitive locations, CFIUS would block it straight away without issuing any extensions.

However, CFIUS might be concerned by potential misappropriation of IP owned by UQM Technologies.

In 2017 UQM has tried to enter Chinese new energy vehicle market by forming a joint venture with Chinese National Heavy Duty Truck Group (CNHTC), a subsidiary of Sinotruk (state owned third largest truck manufacturer in China). The deal was supposed to happen in two stages: in the first one CNHTC has acquired 9.9% of UQM and in the second it was supposed to raise its stake to 34%, however CFIUS blocked the latter. Here are the comments on the event from UQM management:

Because of CFIUS’ general concerns regarding risks of misappropriation of UQM’s intellectual property and trade secrets by Chinese-based investors, the Company concluded Chinese investors would no longer be a viable option. Accordingly, the Company turned its focus to North American, European and Indian based companies.

In contrast to CNHTC, Danfoss is global company with most of its revenues coming from Europe (46%) and US (24%). Although 18% of sales are to China, it is unlikely to be an issue. Here is what the CEO of UQM had to say on this in the Q1 call:

I mean when we had discussions with CFIUS in the past, obviously the big concern was Chinese companies buying up US based companies and the transfer of the intellectual property. And Danfoss being a global company with thousands of employees here in the United States and as with most companies have businesses all over the world and this type of merger and alliance was exactly what CFIUS was encouraging to look for when they blocked the previous deal. So it’s our expectation that this should go through without major issues. And we’re in regular discussion with CFIUS and answering follow on questions, so we expect this process to continue and be successful in the end.

UQM management has been very positive on the approval (they are obviously biased). In the most recent press release on the CFIUS extension UQM commented that:

Management has been given no reason to believe that the results will differ from earlier expectations about the successful closing of the merger with Danfoss. Given the extended review period, management now believes that the closing with Danfoss should occur in the early part of the third quarter of 2019 following CFIUS approval.

UQM is a very fast growing company – revenues up 148% in 2018 YoY and Q1 revenues up 231% YoY, but it constantly operates at a loss (average $7.6m for 5 last years). As of Q1 2019 UQM had only $2.9m of cash on the balance sheet. Management has repeated numerous times that it needs some strategic deal to attract funds for further operations (the main reason behind the attempted JV with CHNTC). In the absence of merger with Danfoss company will be forced to reach out to capital markets. From the annual report:

We expect to fund our operations over the next year from existing cash and cash equivalent balances and, to the extent all closing conditions are satisfied (including obtaining CFIUS approval), our merger with Danfoss Power Solutions.  In the event the merger is not completed, we will need to pursue other sources of capital that have not been identified.