Gridsum Holdings (GSUM) – Going Private – 10% Upside

Current Price: $1.82

Offer Price: $2.00

Upside: 10%

Expected Closing: Q1 2021

Press Release

 

Chinese data analytics firm entered into a definitive agreement to be taken private by its management – two co-founders (CEO/chair and COO), Hangzhou Yutao Capital, and Innovation Fund. Shareholder approval is guaranteed as 2/3rds of voting power support will be needed, while the consortium holds 68%. $115m financing will apparently be provided by the consortium members. Despite the already signed definitive agreement, which indicates high chances of a successful closing and virtually secured shareholder approval, GSUM trades at 10%-12%, which indicates beyond the average risk of things going south:

• In case the deal fails, the downside could be very significant. Pre-announcement price stands at $1.21/share (33% downside), however, the stock could fall way lower as without the current merger, GSUM would likely face bankruptcy shortly.
• GSUM has defaulted on its $42m debt (currently $48m) already two times this year already. They’ve managed to extend the payment at egregious terms (24% annual rate) until May’20, however, still did not manage to pay in time. The current financial position of the company will hardly allow them to raise debt or cash to repay these notes.
• COVID-19 outbreak only accelerated the deterioration of its operations. In the annual report (June’20) management stated significant concerns going forward and that it is running out of cash: “there is substantial doubt as to whether existing cash and cash equivalents will be sufficient to fund our operations within one year from the date of this annual report”.
• The buyers/consortium is hardly trustable, even for a Chinese firm. The timeline is quite prolonged as well. The initial non-binding offer was made in July’19 and since then the consortium members changed 3 times with the most credible party stepping out before the definitive agreement was signed. Moreover, there’s almost no information available on the two current consortium members (besides co-founders), therefore the legitimacy of the financing is rather uncertain.

As a counter-argument to these caveats, I can only say that so far there’s been only 1 Chinese going-private case with a failed definitive agreement. Also, management actually holds 37% of economic interest in GSUM, so should be highly incentivized to proceed with the transaction and avoid bankruptcy.

 

Timeline

• May’18 – FutureX, 9% Class B shareholder, made a non-binding acquisition proposal for $8.70/share and both parties went silent for 1.5 years.
• July’19 – GSUM received a non-binding proposal from management and Beta Dynamic, an affiliate of Hammer Capital (this seems to be the only somewhat credible party in this whole game – not much info is available on it, however, it is currently in consortium with Tencent to acquire Bitauto). Pricing was set to $3.80/share.
• Jan’20 FutureX withdrew the proposal and stated no intention to join the management’s consortium. At that time FutureX owned 17% of class B and had 8.2% voting power.
• May’20 – management revised the offer to $2/share due to volatility in the markets, deteriorating GSUM price since the non-binding proposal announcement, lackluster operating performance, US-China trade war impact, etc. The consortium was joined by two other members – Shenzhen Qianhai Banyan Capital Investment & Management + Hangzhou Yutao Capital.
• Oct’20 – definitive agreement is signed with no changes to the price. Apparently, two previous consortium members (Hammer Cap, Shenzen Qianhai) have left, while the current buyer’s group now consists of the management + Hangzhou Yutao + Innovation Fund.

 

Background and some further thoughts

Gridsum provides data analysis software (big-data and AI solutions) for multinational and domestic (China) companies as well as the Chinese government. Over the years it has struggled to keep up with much larger peers such as Tencent, Alibaba, IBM, Adobe, and Oracle.

GSUM was incorporated in 2005 and not for a single year since then has managed to be even operationally profitable (in fact, the losses have only been increasing). The company IPO’ed on NasdaqGS in 2016 at $13/share.

Since 2016 it’s class B (regular voting stock) share count has increased by 20%, while in face of a $63m market cap and constant, increasing losses, the debt stands at $62m. In 2018 the company issued $40m convertible notes (convertible at $6.70/share) to FutureX at a rate of 2.80%. GSUM failed to repay/refinance this debt before the Dec’19 deadline, and FutureX threatened to claim the company insolvent, however, both parties managed to agree on an extension until May’20 with the interest rate increasing to 24%. The debt is still outstanding, however, according to the note issue agreement, it has to be repaid before any merger/privatization transaction takes place:

Moreover, it is likely that the proposed going private transaction will be deemed a “fundamental change,” and we will have to repay the FutureX Convertible Note in full upon the consummation of such transaction. The terms of the note also prohibit us from merging with other companies or disposing of all or substantially all of our properties and assets upon the occurrence of any event of default, including our payment default as a result of our failure to repay the note by May 31, 2020. If we are not able to obtain new financing in a sufficient amount to repay the note in full, we will be prevented from completing any proposed going private transaction.

$115m committed financing already sourced by the consortium members seems to cover this debt, so FutureX is likely now waiting for the current transaction to be consummated.

In the most recent annual report the company also stated that if the current transaction fails, other lenders may also push their claims, leaving no value for shareholders:

If we cannot work out a viable debt restructuring plan, we may not be able to maintain our liquidity and continue our normal business operation. Even if we successfully enter into arrangements to restructure or resolve our debt, it is possible that our existing creditors and potential financing providers may impose additional conditions, increase interest rates and demand payment of extension fees or penalties in connection with such arrangements, leaving little or no value for our shareholders.