Countrywide (CWD.L) – Merger Arbitrage – 22% Upside

Current Price: £2.04

Offer Price: £2.50

Upside: 22%

Expected Closing: TBD

Press Release

This idea was shared by Ilja.

 

This is a fresh merger arbitrage case in UK. On the 9th of November Countrywide, one of the largest RE agencies in the country, has received a preliminary offer at £2.50/share in cash from its peer Connells Group (private). A firm offer is subject to due diligence and board approval. The deadline is set for the 7th of December (put up or shut up). Approval from 75% of the total votes cast will be required.

Uncertainty regarding the firm offer (and potential price amendments) remains and the situation is still largely speculative. Despite that, there are a couple of points that hint at potentially favorable developments for this case:

  • The offer comes as an alternative to an extremely dilutive recapitalization transaction proposed last month under which the remaining shareholders would be diluted by 50%-68%. CWD business has been in a downtrend for 4 years already and the board concluded that it won't be able to comply with existing revolving credit facility covenants by Sept'21. So the company desperately needs to some measures while raising further debt does not seem to be an option. The proposed merger with Connells offers a significantly better pathway, and it's difficult to see the board or shareholders rejecting the offer. Under the proposed recapitalization scheme, the CWD chairman and managing director would receive generous golden-parachutes, so there is literally no reason for them to oppose the merger.
  • The buyer, Connells, seems credible and is backed by a large mutual lending and savings organization with £25bn AUM, so financing of the merger shouldn't be an issue. Connells has been on an acquisition spree for several years now and recently indicated openness for further expansion. Price looks fair and the strategic rationale is sound - Connells is a substantially more efficient operator and this acquisition allows them to double the number of their branches at an opportunistic timing (while CWD.L stock is beaten down by numerous factors).
  • There is an activist involvement from Catalist Partners (owns 10.5% of CWD.L), which since mid-2020 has been pressuring the company for a change (states that non-core assets alone are worth +£300m) and rejected the recapitalization transaction. They haven't made any comment on the Connells' offer yet, however, given the alternatives, it's likely that they will eventually show support. Catalist acquired its stake post COVID at around £1.10-£1.20/share.
  • The upside to merger consideration is 22% and the downside to pre-announcement stands at 28%. So the risk/reward is very close, while the chances of the situation developing favorably seem much higher.

The main risks are offer termination (28% downside) or adjustment the merger consideration.

 

Timeline of events

  • 24th February. Just before the COVID-19 outbreak, rumors appear regarding merger talks between CWD.L and another of its peers LSL.L.
  • 19th August. 10.5% shareholder Catalist Partners issues a complaining letter calling for change and stating that the downtrending performance of CWD.L can no longer continue. One of the recommendations by the activist is to deleverage by disposing of non-core assets ("+£300m of unrecognised value.").
  • 22nd October. The company announces lackluster H1'20 results - revenue fell 28%, adj. EBITDA 22%, operating loss widens by 10% (£40m). Additionally, the board assessed its future cashflow forecasts and stated that its financial covenants would be breached by September 2021. The share price fell 13% upon announcement.
  • 22nd October. CWD.L announces recapitalization strategy - £90m strategic investment from private equity firm Alchemy (at £1.35 vs £1.84.5 pre-announcement) + "covenant-lite" £75m term loan investment from existing lenders. Current shareholders are to be diluted by 50%-68%. According to the agreement with Alchemy, the new CEO and chair are to be announced in Q4'20. All in all, CWD states that it is in a dire financial condition and desperately needs the recapitalization to reduce excessive debt, fund a turnaround plan (proposed in March'18), and tackle COVID-19 impact/future uncertainty. Interestingly CWD lenders don't support assets disposal strategy:

The Group is at a critical inflection point and is in urgent need of recapitalisation to reduce its net debt and lessen the exposure it has to its lending group under the Current Credit Facilities Agreement

Since the beginning of 2018, Countrywide has agreed six different amendments to the Current Credit Facilities, and the lenders under the Current Credit Facilities Agreement have expressed an unwillingness to either provide the Company with additional financial covenant headroom or extend the term of their debt commitments to the Company without an agreement by the Company to reduce indebtedness to the lenders under the Current Credit Facilities Agreement by at least £50 million. Furthermore, the lenders have indicated that they would not be supportive of a disposal strategy as a means by which to deleverage the Group's balance sheet.

  • 22nd October. Catalist Partners oppose the deal with Alchemy stating it is "unnecessary, ill-judged and dilutive transaction which, while clearly a very attractive deal for Alchemy, is destructive for shareholders and only serves to fund the continuation of a flawed 'back to basics' business plan".
  • 30th October. Alchemy transaction prospectus is published.
  • 9th November. Countrywide confirms a preliminary offer from Connells and postpones the general meeting to approve the recapitalization transactions (was set for the 18th of November).
  • 9th November. Statement from Connells regarding the offer. The buyer approached the board on the 26th of October and is currently conducting the due diligence. The buyer believes that CWD.L needs a new management team, significant and sustained investment in technology and network to "put the business back on a solid footing", which would likely reduce CWD.L profitability and cash flow in the short and medium-term (it makes sense to go private). It is also mentioned that:

Countrywide believes that, in the absence of a recapitalisation, Countrywide is unlikely to be able to execute its business strategy over the short and medium term and there is a risk that it could end up in administration, with Countrywide shareholders losing all or a substantial portion of their investment.

 

Price

CWD comparison with LSL Property Securities (a similar real estate agency) is supportive of this statement in the activist letter:

The decline in Countrywide’s financial performance over the past four years has been disappointing. The Company’s competitors have outperformed on several key metrics and now command far higher valuations, despite generating lower revenues.

Overall, given the significantly weaker CWD.L performance and higher leverage, a discount to LSL valuation seems justifiable.

Additionally, the table includes the available information on Connells (annual results, interim results), which clearly shows superior performance of the buyer. Connels generates a substantially higher EBITDA margin and had zero debt as of 2019 (no information was provided regarding H1'20).

 

Countrywide

CWD is a full-service real estate agent group with over 700 branches in the UK.  It has 1 core segment:

  • Sales and lettings (rents) - the estate agency business of CWD.L and also its largest segment generating 65% of revenues and 73% adj. EBITDA (H1). According to the activist, Countrywide's real estate agency is largest in UK, with 2x revenues of its closest peer, exceptional brands and over 85k of properties under management (lettings).

And 3 non-core segments (called non-core by the activist):

  • Financial services - brokerage services for mortgages, insurance and etc. According to the activist, CWD.L is the largest mortgage broker in the UK (£21bn written mortgages in 2019). It also states that 7x-10x EBITDA multiple should be achievable in case of sale resulting in £116-£165m valuation for this segment.
  • B2B - surveying, mortgage lending and distribution, asset management, etc. This is a recurrent, non-cyclical, and high-margin business. Catalist Partners estimates valuation potential in the range of £144-£220m on 8x-10x EBITDA.
  • Lambert Smith Hampton (LSH) - commercial real estate division currently held for sale (more info below).

CWD.L became public in 2013 (worth £750m at the time) and in 2016 the business entered a sharp downtrend - became unprofitable and started losing market share. CWD stock reflected these trends.

CWD is being pressured by the sluggish UK real estate market due to uncertainty regarding Brexit, problematic RE affordability (tax change-induced price increases), competition from cheaper online rivals, etc. In 2018 the company announced a turnaround plan that was supposed to re-focus on the core business (RE sales and lettings), improve the selling of complementary services (conveyancing, mortgages, insurance, etc.), and continue growing B2B and financial services business units. The results were somewhat positive in 2019 with adj. EBITDA up by 16%, sales and lettings segment returning to profitability, increased income from complementary services, and improved landlord retention rates. However, following the COVID-19 outbreak and lockdowns, H1'20 results showed a revenue decrease of 28% and adj. EBITDA falling 22% YoY. With Britain again in lock-down mode the same trends are expected to continue.

As of Q2 the company had already drawn all of its original revolving credit facility (RCF) of £125m and managed to secure an additional £20m super senior debt facility (matures in October 2021). Any additional debt raising is likely not an option. So far, due to COVID outbreak lenders have already agreed to waive debt covenants for March'20 and to amend the covenants going forward until Sept'21. The board forecasts that without additional liquidity CWD.L will breach Sept'21 covenants.

CWD is in the process of selling its failed commercial real estate business (Lambert Smith Hampton). The company had a buyer already (documents signed, shareholder approval received) that agreed to pay £38m for the division, however, at the last moment transaction failed. The company states that it is in talks with some other acquirers and still expects to sell it shortly, however, given the current market environment the chances of a swift sale are very low (no substantial updates were made in the last six months). Net proceeds (after transaction costs) are expected at around £20m (15% of EV, so still fairly significant, here and here). No details were provider on this, but understanding is that Connells' offer already includes LSH division as well (they won't need to wait for the sale to be completed).

CWD shareholders as of April'20:

Since then:

  • Catalist Partners became substantial shareholders with 10.5% ownership. Purchases were done in July likely at £1.10-£1.20/share range.
  • Hosking Partners (managing account for other beneficial owners) doubled their stake from 7.83% to 14% (most of purchases were done since Sept, so in a range of £1.70-£1.90/share).

 

Connells Group

Connels is one of UK's largest high street real estate agencies and property service providers. Its services include sales and lettings, mortgage services, conveyancing, surveying, and more. The company operates over 500 branches and is a subsidiary of Skipton Building Society (mutual lending and savings organization with £25bn AUM).

Connells Previously made other real estate agency acquisitions, although significantly smaller than CWD.L:

  • 2015 - Gascoigne Halman with 18 branches.
  • 2016 - Black Country.
  • 2017 - Robert & Co's lettings division (manages 800 properties vs. over 80k by CWD.L)
  • Sept'19 - Acquired three-branch RE agency Optima Property and said it is looking for more acquisitions.
  • Jan'20 - Acquired Miller Metcalfe Surveyors out of bankruptcy.

 

Alchemy Partners

Alchemy is an investment firm specializing in debt and equity special situations across Europe.

4 COMMENTS

  1. Ilja

    Connels has completed the DD and reconfirmed the offer at £2.50/share in cash. Firm offer is now subject only to the board approval and irrevocable undertakings from CWD major shareholders. Connels reserved the right to waive both conditions.

    CWD discussions with major shareholders indicated insufficient support for Alchemy’s offer (recapitalization). The company is continuing to review other strategic options including Connels’ offer, recapitalization with Alchemy on amended terms, and potential capital raise from existing shareholders of the company.

    So far the situation has been developing rather positively (12% return since posting this arbitrage). It is difficult to say what are the chances of management coming up with something more attractive than the Connels’ offer. I think the odds are in favor of the merger. Deadline for the firm offer is set for the 7th of December, so only a week of waiting remains to see the final outcome. 10% spread remains.

    Worth noting that, some kind of a mess/disagreements seem to be going on inside the company as the executive chairman has stepped down and retired as a director, while the managing director also indicated that he will retire in Nov’21.

  2. Maple Fun

    Alchemy Partners amended the possible offer. Now investor have two options:
    1. Sell shares to Alchemy @ £2.5
    2. Hold and participate an “open offer” @ £1

    I wonder if a non-UK resident can participate this open offer and subscribe at £1. Anyone has any experience in this type of things?

    an Open Offer of 35m shares for an issue price of £1.00 per share. The Open Offer would occur following completion of the Placing and Possible Offer, with the result that the shares acquired by Alchemy pursuant to the Placing and the Possible Offer would be entitled to participate in the Open Offer. The Open Offer would be underwritten by Alchemy. Shareholders, other than Alchemy, would be entitled to make excess applications once Alchemy has achieved a 50.1% shareholding;

  3. Ilja

    This turned out to be a great play. After Alchemy’s revised proposal, which includes both the buyout and reinvestment options (see Maple Fun comment above), Connells’ has responded with a firm offer at £3.25/share in cash. The offer is clearly superior to Alchemy’s proposal. Alchemy has previously stated that merger with Connells will raise substantial antitrust concerns, however, it seems that Connells’ offer is not conditioned on CMA (competition watchdog) approval. However, the offer is conditioned on a 90% acceptance rate and certain other regulatory approvals (financial authority).

    Neither CWD.L board, major shareholders or Alchemy have responded to the revised offer yet. However, the firm proposal comes at 30% premium to the initial offer and values CWD.L at 3.85x adj. EBITDA’19, which is now quite close to the valuation of significantly better-performing peer LSL.L. Overall, the price now seems rather full and any further bid increases are less likely. Combing this with the 90% acceptance condition and only 4% remaining spread, it might be a good time to take money off the table and close this idea.

    Overall, +53% in one month.

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