Low & Bonar (LWB.L) – Merger Arbitrage – 40% Upside

Current Price: 11p

Offer Price: 15.5p

Upside: 40%

Expiration Date: expected in H1 2020

Scheme Document

This idea was shared by Vladimir.

 

On the 30th of Sep, 2019 Freudenberg (Acquirer) signed an agreement to acquire Low & Bonar PLC (LSE:LWB) from a group of shareholders for approximately £110 million. Under terms of the transaction, Freudenberg will pay £0.155 per share, representing 40% upside to current prices.

Low & Bonar's shareholders approved the transaction on the 5th of Nov and merger remains subject to EU antitrust and court approvals. The scheme will become effective during H1 2020 and the long stop date is June 30, 2020. LWB's year-end update noted that competition approval remains the key outstanding condition and that European level review is ongoing in the normal course. No further updates on expected timeline were provided.

Merger consideration will be funded from Freudenberg's existing cash resources. The acquirer has agreed to pay Low & Bonar, a break payment in the amount of £1.5 million if the acquisition lapses or is withdrawn as a result of acquirer invoking.

 

Low & Bonar Background

Low & Bonar PLC manufactures and supplies technical textiles/fabrics worldwide for industrial/commercial applications. The company offers its products under the BonarBuilt, BonarPure, Xeroflor, EnkaSolutions, Colback, Bonar Yarns, Valmex, Polymar, Airtex, Plastel, Corotex, Bontec, Tipptex, and Adfil brands. Low & Bonar PLC was founded in 1903 and is headquartered in London, the United Kingdom.

Company had a challenging period in 2017 and 2018 during which it changed Chairman, CEO and CFO and reversed its previous strategy to grow its Civil Engineering division. Moreover, in early 2019 it had to make a £50 million equity raise at the price of 15 pence (current buy-out price), which provided some necessary support to the balance sheet and enabled the company to begin much needed investment, especially in its Asheville facility in the US and both CTT plants in Germany. Whilst progress has been made in reducing net debt, continued challenging market conditions and ongoing operational inefficiencies resulted in lower profitability than anticipated during 2019 and hence greater pressure on the banking covenants.

So in a way current transaction is a result of poor company performance and if it fails to complete Target is likely to move towards bankruptcy.

 

Freudenberg Background

Freudenberg looks as a credible company. It develops leading-edge technologies and products and services for about 40 markets and for numerous applications: seals, vibration control components, technical textiles, filters, specialty chemicals, medical products and the most modern cleaning products.

In 2018, the Freudenberg Group employed more than 49,000 people in some 60 countries worldwide and generated sales of more than €9.4 billion.

 

Key Financials and Rationale

Freudenberg has given assurances to the Low & Bonar Directors that existing employee rights, including pension rights, of current employees will be fully safeguarded. Freudenberg's intention is to close Low & Bonar's London head office and provide the respective functions from Freudenberg's existing offices in the United Kingdom or Freudenberg's headquarters in Weinheim, Germany. This office will be closed within 18-24 months following completion of the Acquisition as part of the wider integration process, but such closure is not expected to take place within the first six months following completion of the acquisition.

From Acquirer perspective, given it plans to close Target's head office, the transaction makes a lot of sense. Target's G&A expenses accounts for GBP 40m, so if you eliminate those your EBITDA may double from roughly GBP 35m (using May'19 TTM figures) to more than GBP 70m. If we look on the multiples of this transaction, even before potential cost synergies it is not expensive at EV/EBITDA 7.0x. Therefore, I believe that Acquirer is reasonably interested in the transaction and may extract some value by optimizing Target G&A expenses.

Low & Bonar historical P&L

LWB financials

Results have deteriorated further over the last half a year. From the year-end update:

Further to the trading update of 20 September 2019, conditions affecting the Group's trading remained largely unchanged during the period to 30 November 2019.  As a result, the Board currently expects, subject to audit, reported revenue for the year to 30 November 2019 from continuing operations to be £317m, underlying EBITDA to be approximately £18m and underlying profitability before taxation and amortisation to be approximately break-even

However, worth noting that LWB sold Construction Fibres and Needle-punched Non-Wovens businesses in summer of 2019 (and before the current acquisition announcement). These businesses represented c. 18% of 2018 revenues, so the 2019 revenue decline is not as sharp as might seem initially - effectively 11% drop in revenues for continuing operations from GBP354m to GBP317m. This is in line with 10% decline in H1 2019, so seemingly nothing the acquirer should be surprised about.

 

Risks

As the deal has already been approved by shareholders the only outstanding risk is approval by European commission of competition. Given the tiny size of the business of the Target it doesn’t look as a big concern. Acquirer has already secured the approval from the Russian authority.

Company is in breach of financial covenants from debt holders that has been waived to allow to accomplish the transaction. Covenant tests are scheduled to restart restart at 31st of May 2020 (threshold requirement of 3xEBITDA vs current levels of 5xEBITDA).

Agreement was reached with Low & Bonar's lenders to amend the terms of the Group's financing facilities to assist the Company in progressing the Acquisition.  As part of these amendments the testing of financial covenants as at 30 November 2019 was waived.  As set out on 10 October 2019, should the Acquisition lapse, covenants would be reinstated and tested within 14 days with respect to the financial position as at the month-end previous to such lapse.  In the event that the Acquisition does not complete by 30 June 2020, the scheduled covenant test as at 31 May 2020 would occur.  Shareholders should note that there remains a significant risk that, should the financial covenants be tested, the Group would fail to comply.

Why The Opportunity Exists

I couldn’t really think of anything except the obvious reasons of a small size, low liquidity and absence of any coverage. I couldn’t even find a ticker on seeking alpha, which probably is the main reason why this stock offers such high returns. Another reason is lack of update on the timeline and relatively long timeline for such a small transaction. Right after the announcement LWB was trading at 14.5p/share and then gradually declined to current levels during the next 6 months.

Published on: March 5, 2020  •  Published by:
Category: M&A
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30 COMMENTS

  1. dt

    I think part of the stock weakness and widening of the spread is explained by number of factors:
    – There was clearly some year-end tax loss selling as volume spiked up at the end of December;
    – Arena Investors has sold a total of 5m shares (>50% of its position) in the open market over the last two months. That’s probably around 1/3 of the total volume, so clearly a considerable selling pressure. Arena Investors received it’s stake as part of some derivative transaction (link below) and has been selling down since.
    – Year-end update showed significant decline in EBITDA and almost no reduction in net debt despite GBP20m received from the sold businesses. On the new EBITDA figure the company does not look as cheap although coupled with potential synergies still seems as an attractive target.
    – Also quite interestingly Sterling Strategic Value Fund stopped buying after the year-end update. Following merger announcement they have been adding to already sizable position (c. 22% ownership of LWB, but almost all of it established before the current situation at much higher prices).

    This is a tiny acquisition for Freudenberg and delay seems to be explained by EU regulatory review rather than hesitation on the buyer’s size. But LWB is definitely in very weak position and would hardly be able to say anything if Freudenberg amends the offer to let’s say 10p/share.

    Arena Investors initial transactions:
    https://otp.tools.investis.com/clients/uk/lowandbonar3/rns/regulatory-story.aspx?cid=241&newsid=1358803
    https://otp.tools.investis.com/clients/uk/lowandbonar3/rns/regulatory-story.aspx?cid=241&newsid=1358795

  2. Michael

    I noticed the following. Do you have a rough sense of how this might reduce the consideration to US holders?

    The receipt of cash pursuant to the Acquisition by a US holder as consideration for the transfer of its Low & Bonar Shares pursuant to the Scheme will likely be a taxable transaction for US federal income tax purposes and under applicable US state and local, as well as foreign and other, tax laws. Each Low & Bonar Shareholder is urged to consult his or her independent professional adviser immediately regarding the tax consequences of the Acquisition applicable to him or her.

  3. jwestern

    The weak negotiating position of LWB is what I find most frightening here.

  4. ijw

    Seems that if Germans think long term, and they liked this company long term, they would not let this company fall into bankruptcy. Since it would probably damage the business long term? As company would probably have to fire people, aggressively cut costs. They might lose customers. Which would probably be the opposite of what they want to do with it long term. So in a way short term issues because of the virus could actually increase the odds of merger happening (albeit at a lower price possibly).

    They seem to have had some manufacturing issues, which have been resolved now, which were the cause of a 10% sales decline. So a chapter 11 is probably not going to bring a whole lot of confidence to regain customers. But being part of a much larger organization just might.

    I get net debt of around 70-80 million, which does not seem a lot for a business that did around 30m in ebit before they had manufacturing issues (in 2017). In 2008 and 2009 they did about 15m in EBITA (adding back amortization of intangibles).

    Or am I being far too optimistic here?

    1. dt

      Agreed, both are positive signs, although filing for the antitrust review was kind of expected and it is a bit too early too see business disruptions in Europe. Lock downs only starting this week.
      The main risk is that Freudenberg walks away or pushes for lower prices in these turbulent times.

      1. ijw

        Yeah maybe things will have calmed down a month from now when regulators get their verdict.

        In hindsight I think special situations in these turbulent times are not a great idea. Especially not this one. Unless you wouldn’t mind owning the stock itself anyway. Like for example with Asta Funding.

        1. over2u

          Agree, there is obviously the risk that the company goes bankrupt if the deal cancelled (as it was before the virus). Though, I would argue that the price revision is more likely rather than just cancelation. EU will obviously help big business like Freudenberg and they can still make good money on the deal especially for the price at 10p for example.

  5. over2u

    Company published its FY end results for 2019. Among other things there is an update on the transaction. Currently there is no mentioning of any negotiations with the Acquirer (though it may happen after clearence received).

    “· As first announced on 20 September 2019, the Board recommended to shareholders a cash offer from FV Beteiligungs-GmbH (“FVB”, a subsidiary of Freudenberg SE) to acquire the whole Group at a price of 15.5p per share, and this was approved by shareholders on 5 November 2019 (the “Offer”).
    · The proposed Offer is conditional upon a successful outcome from an EU competition review, which is in process. We expect a final decision as to whether Phase I clearance will be granted during April 2020.
    · In the event that Phase I clearance is granted, all outstanding conditions of the Offer would have been satisfied and it is expected that the Offer would proceed to completion on the most expedient practical timetable.”

  6. Knight142

    If Freudenberg were looking to revise the offer down, it might be difficult given the timeline as the Rule 2.7 announcement is filed and the amended transaction would also be a Class 1 transaction and subject to a shareholder circular being prepared and shareholder approval – idk if there is time for all of this before the 30 June deadline?

    1. dt

      I do not think that pre-COVID deadline should be used as a strong anchoring point for timeline – that’s kind of best case scenario. If Freudenberg wants to change the terms, it can always be postponed.

  7. over2u

    Transaction has been agreed by EU regulator as expected. Acquisition is expected to become effective by 12th of May.

    “Low & Bonar is delighted with this outcome. Completion of the acquisition will provide certainty and security for the company’s employees, members of its pension schemes, and its customers and suppliers, as well as for shareholders and lenders. To the extent allowed by regulation, the company will also cooperate closely with Freudenberg in the coming weeks to ensure as smooth a transition as possible once all conditions to the acquisition are fulfilled.”

    1. dt

      Press release on Freudenberg website is worded somewhat differently, but seems they are still committed.

      Freudenberg: “Given the current disruption due to the COVID-19 pandemic, it is not yet possible to establish a definitive timetable for completion of the transaction. Further announcements will follow as appropriate.”

      vs.

      Low & Bonar: “Subject to the Court sanctioning the Scheme, the Scheme is expected to become effective on 12 May 2020.”

      https://www.freudenberg.com/newsroom/press-releases/detail/european-commission-grants-approval-under-the-eu-merger-regulation/
      https://otp.tools.investis.com/clients/uk/lowandbonar3/rns/regulatory-story.aspx?cid=241&newsid=1386568

  8. ActOfWill

    Hi dt – given the stringency of the takeover rules how did you imagine in the first place how they would renege?

    1. dt

      Not sure I understand your question. I do not think Freudenberg will walk away – Friday’s announcements suggest transaction will close shortly. Just highlighting the differences in wording regarding expected timeline – Freudenberg sounds more cautious than Low & Bonar.

  9. ActOfWill

    Question relates to your earlier comment :

    March 16: “The main risk is that Freudenberg walks away or pushes for lower prices in these turbulent times”

    Basically apart from the EC condition (being now fulfilled) there are no obvious mechanisms to walk away – unless I have missed something. So hence the question.

    1. Vinn

      There are always a list of standard conditions, including often a material change in prospects of business condition.

      This is from the Scheme Document:
      “no adverse change and no circumstance having arisen which would or might reasonably be expected to
      result in any adverse change in, the business, assets, financial or trading position or profits or prospects
      or operational performance of any member of the Wider Low & Bonar Group which is material in the
      context of the Wider Low & Bonar Group taken as a whole or is material in the context of the
      Acquisition;”

      I don’t think it would be hard to argue for Freudenberg that COVID-19 triggers this condition.

      That said I do think they want to close it, and the spread should be largely eliminated by trading open today.

      1. ActOfWill

        I don’t think anyone has ever argued successfully to apply the the broad based MAC language on a recommended takeover.

        The debt covenant is moot as it was mentioned in the circular as a “rationale” for the offer in the first place.

        I think the most crucial piece in my thinking is rule 13.5 (emphasis mine):

        “An offeror should not invoke any condition or pre-condition so as to cause the offer not to proceed, to lapse or to be withdrawn unless the the circumstances which give rise to the right to invoke the condition or pre-condition are of MATERIAL SIGNIFICANCE to the OFFEROR in the context of the offer.The acceptance condition is not subject to this provision.”

        This overrides the language of a broad MAC and definitely overrides any “I can get a cheaper price” argument.

        So the way I would read this is that given that the takeover consideration is a low % of the book equity of Freudenberg and the fact that the strategic rational still stands – I conclude they would not been granted exemption on COVID-19 grounds.

        If it were a merger of equals – perhaps.

        1. ActOfWill

          Indeed very interesting to follow.

          The offeror here consists of some individuals for which you can argue that the current circumstances could be “materially significant” which is different from LWB (although not tested). I really hope to see a written opinion coming out of this so we can see the exact break down of the reasoning.

        2. ActOfWill

          http://www.thetakeoverpanel.org.uk/publication/view/2020-4-moss-bros-plc

          “Having considered each of the submissions received and the further representations
          made, the Panel Executive has ruled that Brigadier has not established that the
          circumstances which give rise to its right to invoke the relevant conditions are of
          material significance to it in the context of its offer as required by Rule 13.5(a) of the
          Takeover Code and, therefore, that Brigadier should not be permitted to invoke any of
          the Relevant Conditions at this time.”

          This clearly puts the bar v high to invoke a general MAC condition…

    2. dt

      The risk of some of the conditions not being met, was never the reason for the spread. It was rather the risk of Freudenberg cancelling the deal for one reason or another.

      I am not a legal expert, but I subscribe to the view that If the buyer wants to walk away from the transaction, they will usually find a way to do it even if that means potential litigation. Strict documentation language and stringent take-over rules certainly help, but do not eliminate the risk of buyer changing the view on the transaction.

      And as Vinn noted, in this particular case Freudenberg seemingly had all the excuses it might have wanted to due covid-19.

      1. nostradamus

        From the wording in previous PR’s, it seemed to me the biggest risk was EU not necessarily saying blocking the merger, but delaying things. Either because they needed more time to study the merger, or they needed more time in general because of COVID-situation and being understaffed. This would have meant deal would not be done by the long stop date, Freudenberg could have walked away and, if you read a recent PR, apparently signalled to Low & Bonar that it would. So I do think immediate EC approval was very important here, a delay for whatever reason would have killed it.

        1. ActOfWill

          I do agree that EC was the main risk and in my view the only “mechanism” by which the offeror can “game” the situation post recommendation. They could submit answers and data that reflect negatively on competition etc.

          I think we would not get an automatic kill if the EC would have gone past their self-imposed deadline and that being the cause of the long-stop date being breached. But would not want to take a position against it.

          Which PR signalled Freudenberg walking away?

      2. ActOfWill

        A recommended offer is definitive contract subject to closing conditions. Without triggering 13.5 – walking away would have been a breach of contract . So it’s direct litigation not potential – the threshold is very high.

        As said below the only loophole was to maybe commit moral hazard to the EC data input process and sway them hoping to get P2 referrral

        Having said all that the AMZN/Deliveroo situation shows a favourable anti-competition aspect due to COVID-19. And I wonder now whether it played a role in LWB:

        https://assets.publishing.service.gov.uk/media/5e99a03686650c0318258f45/Amazon-Deliveroo_PFs_Summary__NON-CONFIDENTIAL__—.pdf

        “We have provisionally concluded that the Transaction would not be expected
        to result in an SLC in either the market for online restaurant platforms or the
        market for online convenience groceries on the basis that, as a result of the
        Coronavirus (COVID-19) crisis, Deliveroo is likely to exit the market unless it
        receives the additional funding available through the Transaction. We have
        provisionally found that no less anti-competitive investor was available.
        Finally, we have provisionally concluded that the loss of Deliveroo as a
        competitor would be more detrimental to competition and to consumers than
        permitting the Amazon investment to proceed and therefore, the Transaction
        would not be expected to result in an SLC.”

  10. nmeile87

    If shortly closing of transaction is expected, How come the spread remains so large then?

  11. dt

    LWB stock is up 100% today. Remaining upside to acquisition price 3.5% with 3 weeks expected timeline.

  12. over2u

    I believe it is a good sign overall for other risk arb situations where fundamental value hasn’t been impaired a lot by the current situation. DT and everyone in this thread – thanks a lot for your comments

    1. dt

      Thanks for sharing this idea.

      +35% return in 6 weeks – with cash coming in when you most need it.

      As nostradamus noted above, maybe we are just lucky this time, that EU turned around the review so quickly limiting the possibilities for Freudenberg to skip on the deal with a clean slate.

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