Edgewater Bancorp (EGDW) – Merger Arbitrage – 15% Upside

Current Price: $37.55

Offer Price: $39.47-$43.22

Upside: 5%-15%

Expected Closing: Q2 2021

Press Release

 

This is a tiny (<$20m) ex-mutual bank acquisition by a credit union. On the 27th of October, Edgewater Bancorp agreed to combine with United Federal Credit Union (private). Consideration is estimated at $39.47 to $43.22 per each EGDW share in cash. Target's shareholder approval is acquired, but given a considerable 1.6x-1.75x BV multiple it seems that the approval shouldn't be a problem. The timeline is quite extended - closing is expected only in Q2 2021, while cash distribution will occur within 150 days after completing the merger.

Since 2018 EGDW no longer files with SEC. The available information is somewhat limited and proxy has not been released yet. EGDW used to be quite illiquid, but since the announcement volume has been elevated - about $600k daily average over the last 8 days.

Aside from the prolonged timeline, part of the spread can be explained by uncertainty regarding the merger consideration amount (estimated at $39.47 to $43.22 per share) which will depend on several aspects:

  • EGDW equity at closing;
  • Cash held by EGDW at closing;
  • Future operating results;
  • Liquidation costs (UFCU will acquire the assets of EGDW, with the proceeds then distributed to target's shareholders).
  • The amount of corporate-level taxation of such transaction
  • The treatment of costs associated with the liquidation account. Before 2014 EGDW was a mutual bank. After conversion to a commercial bank, liquidation account was created for the legacy depositors. Liquidation account represents the potential interest of eligible account holders and supplemental eligible account holders in the mutual holding company's net worth at the time of conversion (source). PR states that the company expects to fully pay-off the liquidation account (so the given merger consideration range should already reflect that): "It is anticipated that Edgewater Bank will pay out the balance of this liquidation account to the holders of sub-accounts therein in connection with the Liquidation.".

None of the aspects were explained in more detail by the companies so far, however, given a very stable and COVID resistant performance of EGDW, as well as quite safe and secure composition of its loan portfolio, it seems that the first three aspects shouldn't make any negative impact on the consideration going forwards. Whereas, the impact of variation in liquidation costs, taxes, and costs related to liquidation account should be minor.

Moreover, EGDW transaction is very similar to the other two ex-mutual bank acquisitions (WEIN and BFFI), both of which were pioneer examples of ex-mutual bank mergers with the credit union and had very similar uncertainties (and available information) regarding the final merger consideration and treatment of liquidation account. Both cases closed successfully this year (more info below) with the final price settling at a higher limit for WEIN and lower for BFFI (although the reason for this difference is not clear). So overall, it seems fair to assume that EGDW consideration also won't fall below the price range.

Due to a large premium, the downside to pre-announcement is quite significant at 38%.

 

Similar cases

This year we've already had two very similar transactions:

  • West End Indiana Bancshares - announced in August'19 with consideration range of $34.91 to $36.81. Shareholder approval was received and the merger closed successfully in 10 months. Final price was set at $36.69 (upper limit) and payment was distributed 4 months after the closing. The liquidation account was paid out to depositors.
  • Ben Franklin Bank - announced in July'19 with consideration ranging from $10.33 to $10.70. Closed successfully in 9.5 months. The final price was set at $10.35 (lower range) and paid out over the next 5.5 months.

 

Edgewater Bancshares

EGDW is a holding company for Edgewater bank, which has 7 branches in Michigan. Total bank assets stand at $250m.

Despite its size, EGDW is performing rather well and saw minimal impact from COVID.

Loan portfolio:

  • 73% - real estate (residential 1-4 family, commercial real estate, and construction/land dev.). Assets are secured by real estate properties;
  • 15% - Commercial and industrial (working capital needs, equipment, expansions);
  • 10% - warehouse;
  • 3% - consumer. Secured by consumer assets such as automobiles and other personal property.

Historical performance:

So the offer comes at a very considerable premium to book value and is also above the peer average multiple (about 1.40x) pre-COVID outbreak.

However, the premium can likely be justified by good performance and COVID-resistance of the bank. In Q1'20 it had only $30k of loan loss provisions (on $152m total loans), in Q2 - $85k (vs $45k YoY) and in Q3 - $195k (vs. $90k YoY). Besides that, in 2020 the book value continued to grow steadily, while ROE was virtually unimpacted as well.

 

United Federal Credit Union

UFCU has 35 branches with 14 of them in Michigan (6 are in Berrien country, so geographic rationale is there). The asset size is $3.2bn.

The credit union offers a diverse array of traditional banking products and services for businesses and individuals.

Apparently, this merger will be the first for the buyer.

10 COMMENTS

  1. Terence

    5%-10%-15% in one year: at min-mid-max of price range, and if 2Q closing means June or 7 months + another 5 months = 12 months to get cash. Downside of 38%, as per write-up, if back to pre-merger news. Risk/reward attractive enough? Pretty sure small % gain + Small chance of big % loss.

    Since Oct 27 8am news, trade at a tight range, mostly $37-37.50, excluding a wider range in the first 2 days.

    Just to add to the info in write-up:
    WEIN price range was adjusted upwards to $37-40, then back down to $35-37 which is close to the original range. Final 36.69.
    BFFI price range was decreased to $10.21-10.40. Final 10.35.
    So, both ended up near the high of the final estimated range.
    https://www.businesswire.com/news/home/20200430006010/en/Ben-Franklin-Financial-Inc.-Completes-Purchase-and-Assumption-Transaction-With-Corporate-America-Family-Credit-Union

    1. snowball

      How do they define “closing” or “completion of merger”?

      “cash distribution will occur within 150 days after completing the merger”

      If end-of-April (shareholder approval on 04/20 and press release on 04/30) was the closing event, then we should expect cash distribution by end of September (i.e., only two months away)?

      1
      1. Terence

        Yes and yes, closed 4-30-21, +150 days = 9-30 for cash distribution. But I assume it can be earlier or later, and it seems no disclosed update on this timing nor range of cash amount.

        “… United, headquartered in St. Joseph, Michigan, will acquire the assets and assume the liabilities of Edgewater Bank in an all-cash transaction (the “Transaction”). On April 30, 2021, Edgewater and United completed the Transaction …”

        https://donnellypenman.com/edgewater-bank-and-united-federal-credit-union-announce-strategic-acquisition/
        https://mibiz.com/sections/finance/edgewater-bank-ufcu-complete-merger

        Illiquid, bid/ask 40.45/41, vs est range of $39.47-$43.22 (per write-up). So, if buy now at 41, downside/upside of 1.50/2.22. Are you feeling lucky?

  2. bigdaddy85

    It is still trading. I just bought some on 05/18. I am not sure what the hold up is or what price will be given

  3. dt

    EGDW takeover arbitrage resulted in 10% gain and a further $2.44/share (additional 6% upside) potentially to be distributed during 2022. This has taken far longer than expected – almost a full year since the write-up. The initial distribution of $41/share will be paid out on the 9th of November and EDGW will get delisted afterward. As the case is no longer actionable, we are removing this from active ideas.

    Btw, have so far not stumbled upon such a comment in company liquidation:
    “After the distribution(s) to stockholders discussed above, and the settlement of any final claims and expenses, the Board of Directors may donate any remaining reserve funds to charitable organizations.”

    1
    1. AV

      I think I have seen that multiple times before. I think it’s mainly in case there is a immaterial amount of money left, doesn’t make sense to distribute a few hundred/thousand bucks (if that is even possible, given associated expenses).

      1
  4. Terence

    Per write-up above, “The timeline is quite extended – closing is expected only in Q2 2021, while cash distribution will occur within 150 days after completing the merger.” The actual closing occurred two month earlier, 4-30-21, but the distribution was delayed by two months beyond the targeted 150 days also. Net result is the same waiting time as originally expected, one year.

    As DT points out, 10% + another 6% potential gain. Not bad for one year wait. The low end estimate would have yielded only a 5% gain, but it seems most deals want to forecast a conservative estimate, making arbs like this more profitable (but of course deal cancellation remains a risk).

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