Forescout Technologies (FSCT) – Merger Arbitrage – 35% Upside

Current Price: $24.50

Offer Price: $33.00 (likely to be amended/terminated)

Upside: 35%

Expected Closing: TBD

Proxy

 

This is short note/case study on a potential merger that has high likelihood of being amended/terminated as the buyer already wants to walk away. Possible outcomes could be straightaway termination (through lawsuits or mutual agreement to settle), however it seems that the initial intentions of the buyer was to amend to terms rather than to dump the acquisition, therefore the price cut is also a possibility here. So far it is difficult to tell which way the tables will turn and the downside is material.

This is also an interesting case study to keep track of to see how easy merger agreements can be broken citing adverse effects due to covid.

 

Timeline

  • Feb 6. IoT cybersecurity company Forescout agreed to get acquired by one of the largest PE firms Advent International for $33/share in cash. Conditions included regulatory and shareholder approvals, however market expected both to be easily satisfied given the pre-covid spread of only 1%. Even after the market fall in March the stock recovered relatively quickly and traded at a tight spread at the beginning of April. The merger was expected to close in Q2'20.

FSCT

  • Apr 23. Shareholders have approved the transaction.
  • May 18. Despite all required conditions being satisfied, Advent stated that they will not be proceeding with the transaction citing material adverse effects.  PR stated: "Forescout and Advent are engaged in ongoing discussions regarding timing to close and the terms of the transaction". As a result the spread has exploded and at one point even reached 66%.
  • May 20. Forescount went to court arguing that no MAE has occurred:

All companies have been challenged by this pandemic, and it is highly disappointing that Advent would attempt to exploit market volatility to renege on its contractual obligations, particularly when the merger agreement explicitly excludes the effects of a pandemic as a material adverse event.

It seems that the initial intentions of Advent were to amend the terms rather than to cancel the transaction outright. The PE firm claims to: "Had been engaged in ongoing discussions with Forescout about an alternative transaction, and we are disappointed the company has now chosen to pursue litigation".

  • May 22. Reportedly the hearing has been set on the 2-3rd of June.

 

Additional points

FSCT provides device visibility and control solutions. Its software monitors all devices that are connected to the organization's network and takes action in case any threat arises.  As of the Dec'19 the company had 3700 clients in 90 countries (including 25% of Global 2000). Revenue is generated by 3 main segments ('19 data):

  • 52% license - perpetual or term license sales on software and hardware products.
  • 42% subscription - support and maintenance contracts.
  • 6% professional services - customer fees for optional installation of the Company’s products or training.

Apparently the company was strongly impacted by COVID-19 and had very weak Q1 results. It was explained as a result of office closures, travel ban (FSCT couldn't sell its hardware products) and cut in available budget its clients were ready to spend on the services (rather prioritizing employee healthcare, cost savings etc.).

Nonetheless, it seems that all competitors have done significantly better in the current conditions:

FSCT table

Of course, part of this difference could be due to smaller size. This is also noted by FSCT (annual report):

We believe we compete favorably with our competitors on the basis of these factors as a result of the features and performance of our solution, the ease of integration of our products with network infrastructure, and the breadth of our capabilities. However, many of our competitors have substantially greater financial, technical and other resources, greater name recognition, larger sales and marketing budgets, deeper customer relationships, broader distribution, and larger and more mature intellectual property portfolios.

In any case FSCT drop in revenues was the largest among peers and probably not all of the negative effect is related to covid. Therefore, although this data is barely a scratch on the surface, it still seems Advent's claim of Material Adverse Effects would have some ground in court.

Furthermore, there is also a risk that companies might just mutually agree to settle and terminate the merger. One recent example could be the Sycamore terminated acquisition of 55% stake in Victoria Secret from L Brands. After Sycamore announced intentions to walk away on the 22nd of April and despite the exchanged lawsuits and L Brands' claims to "vigorously defend the lawsuit and pursue all legal remedies to enforce its contractual rights, including the right of specific performance", both companies agreed to mutually terminate the merger on the 4th of May.

 

6 COMMENTS

  1. g4734g

    I have been in and out of this one for a while….there was news friday, (apologies I can not put my hands on a press release) of some sort of standstill between advent and ForeScout and if I’m not mistaken the court date was postponed until early July…..You can see on last Friday’s chart a quick move from 20 to 24 on the news.

  2. DendriteResearch

    I just have a theoretical question about these types of plays. It seems like there are large error bars on anyone’s estimate of how likely it is that the transaction will go through. Like, the only people who can really handicap it properly are largish merger arb funds that can afford $10k in legal fees to review all the docs. Where’s our edge? I don’t want to be on the other side of a trade from those guys.

    1. dt

      I agree that for transactions of $1bn+ the spread usually accurately represents the risks of deal breaking. That applies to FSCT as well. We highlighted this one mainly to track how easy it is to get out of the merger agreement citing MAEs due to covid-19.

      1. Zulu Investor

        So, now I have a question. TCO was another larger-cap merger. Would you feel the same in regards to TCO as well then?

        TCO has a better case than FSCT, IMO. The terms of the TCO/SPG are as air-tight as I have ever seen. I’m sure they must have had their own team of lawyers as well, and despite already having a glimpse of the pandemic in Feb, they still went through and signed the deal. With large spreads like these, I think to some extent it reflects having legal expertise staff on board to at least reduce, if not steer away from TCO.

        On the other hand, I think another factor is emotions. You can’t quantify fear and emotions entirely by looking at the spreads. That’s basically the EMH. Large caps tend to be more efficiently priced in, so good opportunities are a little less common. The keyword is “tend.” I think large caps tend to have more oversold or overbought movements, especially during times like this because there are also more people just staring at it.

        As long as you can provide reasoning behind your investment thesis, large or small, it can still be a good investment opportunity.

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