Current Price: $5.85
Offer Price: $6.17
Upside: 5.4% (high IRR)
Expected Closing: Q4 2020
This idea was shared by John.
This is a rather straightforward merger arbitrage case with only a 5.4% spread, but considerable IRR due to the short timeline until the expected closing in Q4’20 – shareholder vote is expected to take place in November. Liquidity is somewhat limited – average volume for the last 7 trading days is $46k.
In mid-September, Torotel (TTLO) signed a definitive agreement with TT Electronics (TTG.L) to be acquired for $43.4M, or $6.17 per share in cash. 2/3rds of TTLO shareholder approval is required, however, it shouldn’t be a problem. 59.4% of shareholders (and management) have already agreed to vote in favor, while the remaining votes should be easy to get due to a substantial price premium of the offer (over 200%). The transaction is not subject to regulatory approvals or financing – TT Electronics will finance the acquisition with cash on the balance sheet.
This actually seems like a done deal already and the main reason for the spread comes from investors being frightened by a significant downside that could burn TTLO stock for a second-time time this year if the current merger with TT Electronics gets terminated. Torotel acquisition has already failed once earlier this year (April) – that time it was an offer from Standex at $7.77/share. Standex managed to collect all the required approvals, however, the merger was delayed past the expiration date due to pending “a third party consent” under longterm supply agreement from Collins Aerospace. Then COVID struct and Standex walked away from the transaction sending the stock from $7.45/share down to $1.50/share. Despite that, the current situation with TT is different and no longer includes a third party approval risk as consent from Collins is already in the pocket:
On August 18, 2020, following confidential discussions with Collins about a potential change of control transaction with TT necessitating Collins’ consent under its long term agreement with the Company (the “LTA”), Collins provided to the Chief Executive Officer of Torotel its written consent to the proposed transaction in accordance with the terms of the LTA.
Furthermore, it seems unlikely that even if the merger breaks, TTLO would fall all the way through to pre-announcement price ($2/share) once again. It has already received two credible definitive proposals at a significant premium to pre-announcement prices, while according to the proxy:
- During the sale process, a total of 39 parties showed interest in the company, and 4 of them provided non-binding indicative offers. (including Standex and TT Electronics).
- A certain undisclosed party (Party C) also tabled a proposal post-COVID-19, however, at a lower price of $40m.
- Discussions with TT Electronics already stretch since mid’19 as it was one of the initial bidders (together with Standex). Post-COVID, TT Electronics made an offer of $44m and later increased it to $49m following pushback from TTLO management. Then after Q2 results, the buyer reduced it back to $44.4m to reflect covid impact on TTLO performance and finally cut once more to the current $43.4m. I believe this lengthy negotiation process significantly lowers the likelihood of any further surprises down the road.
To estimate the potential downside it seems fair to take the Party C proposal adjusting for lackluster Q2 results – so $35m ($5/share) should be a conservative number here, indicating likely downside of only 15%.
The buyer has a track record of growing the business through M&A in the industrial sector with the recent example being the purchase of the aerospace and power supply business portion of Exelcitas Technologies for $17.7 million in November of 2019. In 2018 it also acquired Stadium Group – the provider of connectivity solutions, power supplies, human-machine interface (HMI), and electronic assemblies.
Rationale and Price
The strategic rationale seems sound and both businesses are definitely complimentary. TTLO offers TT Electronics the opportunity to enhance their US presence in power electronics and defense, selling to blue-chip companies such as Lockheed Martin, Raytheon, and Northrop Grumman. TTLO brings TT Electronics business developments, customer lists, revenue growing at over 10% CAGR for over 5 years, multiple recurring revenue streams, and a strong balance sheet to underpin future growth in an attractive market. From merger presentation:
The price also seems fair. Paying 10.9x adjusted EBITDA for a business with growing margins, multi-year contracts providing recurring revenues growing at 10% CAGR, strong cash conversion, and an 11.5% pre-tax ROIC. In addition, because TTLO sells mainly to the military and has multi-year contracts, the business has not majorly been impacted by Covid-19, which will help diversify TT’s revenue. Also, TT Electronics has a market cap of about $450 million USD, making this a rather small size deal for it.
TTLO
Torotel manufactures and supplies magnetic components (inductors, reactors, chokes, toroidal coils, etc.) to original equipment manufacturers, which use them in defense/aerospace products such as aircraft navigational equipment, digital control devices, medical equipment, avionics equipment, and more. To put it bluntly, for years this company has been a below-average industrial manufacturer. Trading over the pink sheets with a market cap under $7 million. This would be a company that Jordan Belfort would try to sell to your grandparents over a cold call (Aerotyne, anyone?). Basically, with almost no press coverage and minimal growth, the market put this company in a corner and forgot about it. The last three years, however, have been different, the company narrowed its product line and has been riding the coattails of the mighty military-industrial complex, selling parts needed in missiles, fighter jets and helicopters, and air defense systems.
Thanks for the idea. The spread has closed some the past few days, but its worth keeping an eye on this one. Is the shareholder vote the only factor left? Does the acquiring company have any outs on this deal that you know of?
Thanks for the question, aside from the risk that the vote isn’t approved by shareholders, the only other risk I can find is that the vote is somehow delayed past December 31st, 2020. The in-person vote has been scheduled by management on an unannounced date in November, a sudden outbreak of Covid-19 could delay things but its seems likely they’ll just move it online or through mail. The deal is expected to close in a matter of days after the vote, which would make the annualized return even more attractive than what I previously posted. I’m monitoring both companies daily so when the voting date is announced I’ll let everyone know.
Well, it also is a strategic arms deal, subject to antitrust approval and review by the Directorate of Defense Trade Controls (DDTC). Perhaps no big risks, but I don’t see them mentioned in the write-up.
On the 9th of November, shareholders voted in favor of the transaction, and the merger closed on the 10th of Nov.
The idea generated 5.4% profit in 1 month.