Gilat Satellite Networks (GILT) – Merger Arbitrage – 22% Upside

Current Price: $7.20

Offer Price: $8.75

Upside: 22%

Expected Closing: H2 2020

Proxy

 

On the 29th of January Israeli satellite services networking communications equipment Gilat Satellite Networks has agreed to combine with its US peer Comtech. Consideration stands at 0.08425 CMTL + $7.18/share in cash, so the target company currently trades at the cash portion level. Borrow is available and cheap. Closing is expected in H2'20. Financing has already been secured and shareholder approval has been received. Approval from US regulators has also been granted, so apparently the only remaining hurdle is the consent of Russian regulators.

GILT used to trade at a tights spread both before and after the market fall in March, however the spread has increased significantly over the last few days after the Q1 results were released.

gilt new

The primary reason for wider spread seems to be the update on another acquisition by CMTL (UHP Networks) - Comtech stated that they've amended the terms and reduced the consideration by 24%. And although the terms of GILT transaction have not been changed so far, the market apparently became cautious of this possibility.

Moreover, it was reported that Russian regulatory review has been extended, potentially up to several months (conf. call):

Comtech received notification from the Federal Antimonopoly Service or FAS of the Russian Federation that it was extending the review period for Comtech’s application to purchase Gilat. This extension is intended to allow the Russian government sufficient time to determine under the Russian Federal Investment Law, whether approval of the Gilat transaction is required from the Chairman, from the Russian Government Commission for supervising foreign investments. The Russian Government Commission is an interagency group with the authority to review certain foreign investments.

Here, let me give you some more color. If the Chairman decides a review, but the commission is not warranted, our application will continue to be processed by the Russian Federal Antimonopoly Service or FAS. If the Chairman decides a review, but the commission is not warranted, our application will continue to be processed by the Russian Federal Antimonopoly Service or FAS. If the Chairman decides to send it to the commission, we will need to fill out a second application, and this process could take a number of months.

From antitrust perspective this seems to be a minor hurdle as Russian segment generates only a small portion of revenues for both companies and the combined company is unlikely to have material market share in Russia. However, both firms provide services to numerous governments (major segment for CMTL) around the world including the Russian government, so there might be some strategic/political considerations involved. Companies don't disclose many details about these relationships (although GILT states that Gazprom is one of its customers), so it is not clear to what extent this could pose a threat to the acquisition. However, from the statement made in the conference call above this seems to be more of an administrational issue rather than a major threat, especially when US regulators have already approved the transaction.

 

Gilat Satellite Networks

Gilat designs and manufactures ground-based satellite networking equipment, which is then sold to communication service providers, operators, government or residential users as either network components (modems, antennas etc.) or complete network solutions. 85% of GILT revenues are generated by its commercial segment and 15% by government (the company provides services to Latin American and US governments).

COVID-19 caused slowdown in the company's business (postponed orders, suspended-decision making by the clients). Q1 report showed revenues dropping 23% YoY and net loss at $12m vs $3m profit YoY.

 

Comtech

CMTL also provides ground based satellite technologies (modems, amplifiers etc.), but has a significantly larger government segment - 58% of revenues are generated by commercial segment and 42% by government (Middle East, Europe, Americas, Asia Pacific).

Q1 resulted in 21% fall in revenues and $4m net loss vs $7.6m profit YoY. So the performance of both companies has been quite similar.

Comtech has emphasized growth through acquisitions strategy (see table below) and over the last 4 years conducted 7 mergers (including UHP and GILT). Gilat will be their largest acquisition so far and is expected to diversify CMTL revenue base (expand international market segment), add complementary technologies, boost R&D capability, increase margins and liquidity.

CMTL acquisitions

 

13 COMMENTS

  1. ijw

    CMTL should have a significant incentive to get a lower price or find a way to cancel? The other merger was pretty small and mostly a stock deal. This is mostly cash and the size of CMTL’s market cap, so CMTL will lever up to buy this. So either they lower price or issue more stock, or both? Debt/ebitda will go from <2 to around 7x (depending on how optimistic you are about GILT).

    To add, valuation for GILT is now 14x LTM EV/EBITDA and for CMTL it is 10x (latter also having more stable earnings due to higher government exposure?).

    Is there a risk that somehow the regulatory process in Russia is used to cancel the merger, or lower price? Don't have a lot of faith in the integrity of their institutions.

    1. Ilja

      Not sure about the Russian regulators, but the risk of price adjustment (I don’t think they will go for termination) is definitely very high, as reflected by the current spread (43%).

  2. Daniel

    How do you think they could get a price adjustment? The deal has already been approved by both sets of shareholders, the debt has been raised, US reg approval done and the document has a pretty tight MAC – so if they ask for a lower price why wouldn’t GILT tell them to get stuffed and take them to Court?

    This looks really attractive, but I’m just trying to work out what the market could be missing and why the “$100 bill is lying on the ground”

    1. ijw

      They trade at similar estimated Next twelve month EV/Ebitda multiples now (GILT slightly higher than CMTL). Although difference in LTM Ev/Ebitda is higher. So downside should be limited here to maybe 15-30%? I really have no idea how to handicap odds of deal going through at close to current price.

      Expected synergies are very small according to CMTL presentation.

      I find this one hard to analyze. Probably if you wait another month or two, the odds of this going through do improve? So sitting on the sidelines while mulling it over a little longer does not seem like a bad idea here.

  3. DavidW

    I have to agree with Daniel here. We must be missing something, I’ve been googling for 1 hour straight but can’t find anything, I’ve even changed my language to Hebrew and Russian but that didn’t help either (admittedly I could have overlooked something). The spread started widening again after Comtech’s Q3 results where they mentioned the reduction in price for UHP as well as the Russian antitrust approval issues. Intuitively I think the Russian antitrust is mostly responsible for a lot of the uncertainty. UHP is such a small and different deal, I doubt you can draw a lot of conclusions from a 24% reduction in price.

    I have no idea how corrupt Russian antitrust approval is, and if it’s possible for comtech to apply leverage this way. Comtech is an American company, so you’d think there might not be a whole lot of leverage in Russia, otoh they do ‘generate significant sales from Brazil, Russia, India and China’, so who knows..

    But simply looking at current spread compared to the information I have I think I’m able to bear the uncertainty in this case. I guess waiting is an option, but there’s a risk of getting a less favorable price as well.

    1. Writser

      Well, for one thing a pandemic is not explicitly excluded as a ‘material adverse effect’. This is the most relevant exclusion I guess: “earthquakes, hurricanes or other natural disasters or any other acts of God”. One of Gilat’s businesses is in-flight connectivity ( https://www.gilat.com/solution/in-flight-connectivity/ ), obviously not the best place to be in right now.

      I’m not so sure the Russian approval is the biggest deal. The merger agreement even allows for an extension if all conditions have been met except for regulatory approval.

      I think the biggest risk is that CMTL does not want to take on a shitload of debt right now while both companies are affected by Corona, and that they will try to use the ‘MAE’ clause to wriggle out of the deal (and might have a pretty good shot at that).

      Still, the discount is enormous, and the market so far really seems to dislike the uncertainty, so it might still be attractive. I have to think about it a bit more.

  4. DavidW

    It’s interesting they haven’t hinted at using the MAE clause yet, a lot of mergers already renegotiated a lower price by now. And it also doesn’t explain the widening of the spread at June 3? There’s nothing in that announcement about using the pandemic as a way to lower the price. Just looking at the graph in this post spread has been constant since the chaos in March, and recently widened again. That makes me think a decent part of the current spread is because of Comtech’s 8K on June 3.

    On the other hand, I can’t think of one reason why they wouldn’t try to invoke the mac. They are in a terrible situation and have a decent shot at putting enough pressure to at least lower the price a bit.

    1. Writser

      Yes. Also, if the Russians delay things for a few more months (until the end of October) CMTL has basically a very easy excuse to get away from the merger.

      Very suspicious price action intraday today: GILT down ~15% on massive volume while CMTL is up around the same time. Looks likely something has leaked – I am staying away.

      1. nostradamus

        Apparently, simply delaying things is CMTL’s plan:

        “Such purported complaint was allegedly filed in response to Gilat’s demand that, in connection with Comtech’s pending application to the Russian regulatory authorities and contrary to its actions thus far, Comtech is obligated to use its reasonable best efforts to consummate the merger, and that Gilat does not intend to sit idly and wait for the drop-dead date of the Merger Agreement.”

        1. DavidW

          That does make sense given how silent they’ve been last couple of months. Thanks to writser I’ve adapted my thoughts on this one a bit. Comtech absolutely doesn’t want this deal, it’s a huge deal for them. I underestimated how toxic the combination of this being a huge deal for the acquirer + an enormous drop in value of Gilat would be. It also doens’t help that the pandemic isn’t mentioned in the MAC, so CMTL has every incentive to drag this out and get away from it. Outside date getting closer doesn’t help either.

          Purely from a merger perspective GILT looks quite attractive, but at this point you pretty much need to assess IV of GILT and maybe add a small merger premium on top of this. I have no idea what GILT is worth, I’m sure there could be value here for people who know how to value GILT on a standalone basis, but I’m not one of them.

  5. Ilja

    Late update. On the 13th of July CMTL has amended its complaint and is now looking into whether GILT has suffered a disproportionate impact from COVID due to its in-flight connectivity business. This comes on top of the previous request for declaratory judgment on whether any potential business changes (disposals, restructurings) connected with the outstanding Russian regulatory approval would breach GILT obligations.

    So the situation remains very speculative as it is not exactly clear what portion of the GILT business has been affected by the airline crisis neither what is the current state of the Russian regulatory approval. Overall, my bet is that the companies will settle for a price cut.

    https://www.sec.gov/Archives/edgar/data/23197/000002319720000062/exhibit991pressreleasejuly.htm

  6. Ilja

    Q2 results were released showing considerable impact of COVID-19 on GILT revenues – down 36% YoY. Nonetheless, the CEO states that most areas of operations are seeing recovery and that H2 should be significantly better than H1.

    Regarding the merger, no updates were provided on the Russian regulatory consent so far. Meanwhile, the trial is scheduled for early October. 53% spread remains.

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