Meten EdtechX Education Group (METXW) – Warrant Arbitrage – 200% Upside

Current Price: $0.285

Intrinsic Value: $0.86

Upside: 200%

Expiration date: 5th January 2021

Offer document

This idea was hinted by Ryan.

 

Meten EdtechX Education Group is a failed post-merger SPAC that has temporarily reduced the exercise price of their warrants from $11.50 to $1.40 per each warrant. At the current prices, if the transactions goes through the warrant should be worth $0.86 ($2.26 stock price less $1.4 exercise price). So this idea presents either 200% potential upside on the warrant price or 36% potential upside on warrant+exercise price. Borrow is also available on IB - 200k+ shortable shares at a 29% annual fee. The offer expires on the 5th of January. Given a very short timeline, hedging costs make only a small impact ($0.07/share) on the potential upside.

There are a few aspects that make this situation attractive and suggest favorable outcome for the arbitrageurs:

  • The rationale behind the offer makes sense and it seems that management should be incentivized to proceed with it on current terms. METX operates in China education sector (offline/online English language services) and had a severe impact from the COVID-19. Merger with SPAC was closed on the 30th of March - the timing was very unfortunate and resulted in 95% of shareholders abandoning the deal (redeeming their shares). The acquisition was carried out with lower than expected capital (except for last minute Azitum and PIPE investments) and the company is now in a difficult liquidity situation. The company burns around US$10m per quarter and as of Q3 it had $30m of cash remaining. This warrant program will allow them to raise an additional $17m. Moreover, given how beaten down METX share price is today, this move could also be a cheap way for insiders to increase their ownership in the company (the sponsor currently owns 26% of common shares).
  • There is a 65% acceptance condition. However, a sponsor owns 30% of warrants and will submit 2/3rd of it for the offer. A further 25% of warrants are likely to belong to PIPE participants (assuming they still hold the position), who are also likely to participate. Overall, given the financial incentive this offer provides for the warrant holders, I don't think this condition will be a problem.
  • METX a rather unknown company with very limited coverage in the media or retail investor forums, etc. This coupled with sharp share price decline and limited/expensive borrow could partially explain the spread.

Nonetheless, there are several risks involved as well:

  • The offer could get canceled or the terms (e.g. exercise price or timline) might get amended. There is not much to add besides what has already been stated above. METX management should be incentivized to raise cash through warrant exercise and should proceed with the offer.
  • METX is not very liquid and borrow costs could increase substantially - decreasing or eliminating the upside or even causing a short squeeze. A recent example is what happened to the hedged AHT preferred/common exchange - although the situation provided very generous return eventually, the hedged leg was at a significant loss till the expiration.
  • Warrant exercises will result in substantial dilution (12.7m warrants in total, share count to increase +24% assuming full exercise), so the share price is likely to be pressured after the exchange.

 

METX

METX is a result of a merger between EdtechX Holdings (SPAC) and Meten International Education Group. The acquisition was closed on the 30th of March'20. Initially, share price skyrocketed (putting the company at a unicorn status for a short time), but eventually crashed down to current levels due to the impact on METX business from the pandemic.

EdtechX Holdings SPAC was sponsored by IBIS Capital - an investment bank and a minor SPAC player. They've recently announced intentions to launch another, larger SPAC. IBIS still owns 26% of METX ordinary shares and 30% of warrants. They've agreed to exercise 65% of their total warrants in the current offer and sell the remaining 35%. EdtechX SPAC was also supported by Azimut - a large Italian asset manager with $60bn AUM. Shortly before the closing of the merger, Azimut, together with a few other parties have made investments of $32m in exchange for METX units. Given how illiquid the warrants were before the current offer, I expect that Azimut and PIPE investors still hold the majority of their warrants and will exercise them in this temporary program.

METX offers English language training services in China. It owns a portfolio of course for multiple ELT segments and operates an offline-online (63%/37% revenue split in 2019) business model. The company owns 110 physical language training centers and 13 additional franchised centers. Due to COVID impact, all of them were closed earlier this year. This resulted in a severe impact on the business. Recent results show 9M 2020 revenue falling -39% YoY (-30% YoY in Q3), while gross billings decreased even further -56% YoY in 9M'20 and -49% in Q3. During the pandemic, most of the business was transferred to online, so this segment has improved, but not very substantially +25% YoY in 9M'20 and +7% Q3. The number of registered online users increased by 54% YoY. The company burns about US$10m cash per quarter. Regarding the future prospects, in 2021 METX expects to recover to pre-COVID levels and forecasts $31m EBITDA and $18m net income in 2021. So the company currently trades at 3.5x 2021 EBITDA and 6.6x 2021 earnings, which looks very cheap assuming full recovery in 2021.

53 COMMENTS

  1. Maple Fun

    Based on my understanding of the offer:
    the sponsor IBIS capital will exericise 65% of their warrants on a cashless basis and sell 35% of warrants on the market.
    I do not like it: for one, they are asking other warrant holders for cash but the sponsor can get additional shares without paying any cash; for two, the sponsor is willing to sell warrants on the market at a huge discount (34% upside, man!). A bad signal….

    1. dt

      Agree that it is a bad signal, that’s why there is a spread.

      However, the volume is way too low for sponsor to dispose of such a large amount of warrants in the open market if the transaction is only meant to temporarily push the price up. So IMHO sponsor wants the exchange to happen. What do you think are their intentions with this offer?

      Also there might have been some ownership restriction, which did not allow them to exchange all warrants (but I did not notice any restrictions mentioned in the fillings). As for opting for cashless exercise – this is what SPAC sponsors do – they usually do not risk any funds (aside from own expenses) when acquiring the target, so for me it is also not very surprising they now want cashless exercise.

      In any case, this is a failed SPAC + China business + expensive borrow + wide spread suggesting transaction will not happen – so one should size this accordingly if at all.

  2. Maple Fun

    Still one thing I don’t understand after further thought:

    Why does the sponsor/IBIS decide to keep 35% of METXW to sell on the market? why not convert 100% of their holdings into METX? Since it’s cashless exercise, no cash outlay for IBIS anyway, while the liquidity fro METX is much better than that of METXW. Also, 200% upside as claimed here for conversion.

    It seems fishy to me.

  3. R

    Good question regarding motivation for sponsor to keep 35% of METXW – I am not sure. Is it possible for the sponsor’s Placement Warrants to be sold now, or do they need to be registered prior to trading? The volume of METXW since this offer announcement is 1.13 million warrants – closing in on the 1.35 million warrant position amount to be sold under “commercially reasonable efforts”.

    Curious if those Placement Warrant sales could already be underway (perhaps almost complete?), or if they cannot be sold yet due to a pending registration statement (sorry for the novice question).

    1. Ilja

      Sponsor can freely sell its warrants in the open market, registration has nothing to do with it.

      Regarding the registration statement condition, a supplement is needed to reduce the exercise price of the IPO warrants. As I understand, the company already has it in place:

      “The Company has an effective Registration Statement that, as supplemented by the Supplement, cover the exercise of 6,325,000 IPO Warrants at the reduced exercise price of $1.40 per share. The prospectus included in the Registration Statements, as supplemented by the Supplement, reflects the terms of the Warrants as modified by this Offer to Exercise.”

      Regarding the remaining warrants (private placement and post-merger), there are no outstanding conditions there:

      “The Company will rely on the exemption from registration provided by Section 4(a)(2) of the Securities Act for the exercise of the remaining 6,380,000 outstanding Placement Warrants and Post-Merger Warrants, which were issued in private placements.”

      https://www.sec.gov/Archives/edgar/data/1796514/000121390020041376/sctoi120420exa1b_meten.htm

      1. R

        Thanks Ilja, appreciate your response. The spread at the time of the write up ($0.285 vs. $0.86) has tightened to $0.36 vs. $0.80 as I type this comment…curious if the sponsor could have sold the majority of their 1.35 million block already and as those sales slow down (now approx. 1.23 million warrant volume since announcement), the spread tightens.

  4. Vinn

    How do you get to 3% hedging costs? From my understanding you short the stock, so that’s a $3 collateral basis per warrant, with a 29% annualised fee. That’s equal to 290% based on a $0.3 warrant price.

    1. dt

      You are correct. This was a typo on our side (corrected now).
      At the current rate borrow will consume c. $0.07/share of the upside vs. $0.57 spread at the time of the write-up. So still a minor cost if borrow rates remain unchanged.

  5. AleksRud

    Sorry for my ignorance but I am quite new to all of it. In IB I currently only see a warrant with expiration in Mar 2025 and strike $11.50. Is it the security that is discussed in the post? I am just a bit confused and don’t see where the strike price changed to $1.40. Would appreciate if someone could clarify! Thank you in advance

  6. Michael Lax

    It is under news if you use the stock quote function in Yahoo Finance or similar for METX

  7. Warrant Buffet

    Please be aware: This is from a conversation with an IB representative “We support trading METXW warrant but we do not support exercising it because we do not support the settlement of exercise. Currently, we do not have any information about supporting exercise. Please let us know if you have further” questions.

    1. dt

      Thanks. Interesting information. I would be very surprised if IB does not allow to tender warrants in this exchange. The exercise will happen as part of the tender processes based on provided documentation. I will check with IB as well.

    2. bigdaddy85

      It’s probably because interactive brokers hasn’t received the proxy statement or letter of transmittal that discusses how brokerages should handle this. This isn’t surprising since the company hasn’t filed on yet. This is very common.

  8. Michael Lax

    Probably IB’s Corporate Action tool just does not yet have the new warrant tender information, sometimes they can take until closer to the deadline to update.

  9. EC

    I noticed that if this offer goes through, post-transaction, the warrants will have their exercise price reduced to $2.50.

    It will cause the warrant premium to increase (or at least stay the same). I ran the values through Black-Scholes before the transaction was announced, to get the implied vol they were trading at, and then used that implied vol assuming the transaction goes through with the new exercise and estimated dilution. This might have been a way to get the warrant holders on board with the dilution and why they may be retaining some warrants.

    This may be paranoid, but in the latest Tender Offer Statement, it notes that “The transaction value is calculated pursuant to Rule 0-11 using $2.77 per ordinary share, which represents the average of the high and low sales price of the ordinary shares on December 1, 2020, as reported by the Nasdaq Capital Market.” If you assume a dilution of 25% at $1.40, the post-dilution value is $2.50, which is the new exercise price of the warrants…

  10. R

    65% acceptance condition was waived today. Perhaps lower participation thus far than anticipated?

    Intrinsic value at $0.55 as of today’s close vs. $0.21 warrant closing price.

      1. R

        Still Jan 5th, I didn’t see anything about an extension. I use Fidelity and they have a Jan 4th deadline.

    1. bigdaddy85

      The way I’m seeing this is $ .21 warrant cost, plus a $1.40 is a total cost of $1.61. You can sell the shares short now at $1.95 for a total return of 21%, excluding cost of borrow.

  11. R

    g4734g – no, nothing available to short at Fidelity. I’ve checked a few times over the past couple weeks and haven’t seen any shares. Curious to know from other members who have multiple accounts if other brokers (IB?) are typically better for finding shares to short.

  12. g4734g

    Seems shares are more available this morning……i realize the gap has closed but 1.4 plus .2 for warrant and sell for 1.85 is an astronomical annual return. Yes risk of borrow rate going crazy, but we are only a few days out. Other risks?

  13. blades

    Yes. At IB, the time to use the corporate action tool expired yesterday (I didn’t know that when I put the trade on yesterday). So, I’ll have to use a ticket and ask for best efforts. It should be ok because the deadline is evening of January 5, but a risk.

  14. R

    I’ve noticed a few large volume/price spikes in METX as a buyer comes in over the past several days when METX is below $1.90 including one today just after 11:30am ET.

    Seems to be a good sign for warrant holders participating in this deal that someone is accumulating large blocks of METX shares. With warrants still around $0.20, I would think an interested buyer of METX would simply buy the warrants now to ultimately get METX at a $1.60 cost including the exercise cost but perhaps there is not sufficient volume available of the warrants?

  15. EC

    I tried to do this trade yesterday 12/30 but when I went to submit my warrants in IBKR for exercise, it informed me that the deadline had expired.
    I just checked again today 12/31 after the close, and the corporate action has disappeared.

  16. hillegass

    Blades and EC I could be wrong but I believe the corporate action choice for METX on IB is available today until 1:00 pm. I just used it. I believe this “expires” at 1 pm daily until the actual expiration on the 5th. I’m not sure why they do it this way.

  17. blades

    EC, see my comment of 12/31. I think you should submit a ticket asking IB to use best efforts to exercise. Hopefully, they have plenty of time.

    Also, alarmingly, after I did the trade on 12/31, I got the message below. All the more reason to do get the exercise done, although I could not find this term in the terms of the exchange offer. Any thoughts from those interested on this?

    From IB “Please Note: Holders who do not exercise their warrants prior to expiration date will have their warrants expire and redeemed for .01 USD per warrant as soon as applicable after the 2021-01-05 deadline.”

  18. blades

    EC, update: the corporate action tool to exercise the warrants is back up at IB, The deadline for IB is now Jan 4 1:00 pm

    1. EC

      Thanks, I see it.

      I received that message from IB too about the warrants expiring and being redeemed after the deadline. Nowhere in the tender offer does it say anything about them being redeemed. I decided to hold on to some of them and see what happens afterwards.

      1. bigdaddy85

        I bought warrants on 12/31 and they are still not showing up in Interactive Brokers. I sent an email to IB Support and they said: “The final deadline is January 5th. IBKR closes the offer everyday to make elections. We then open it back up daily.”

        Its been a few days since then and my warrants still aren’t showing eligible for election.

  19. smartone capital

    Is it too late to do this? I’m not sure the warrants will be settled by the deadline if I buy them Monday morning. Thanks in advance if anyone has any info or past experience on this.

  20. Rodger Campbell

    Updates and individual experiences on the outcome? I had no skin in it but looking to learn.

  21. Michael Lax

    My warrants at IB were placed in a contratrade position, so I am hoping that the shares will be issued soon. I hedged the position fully, so the primary risk for me was a change in the tender offer or the short shares being called.

  22. bigdaddy85

    Anyone receive their shares yet from the conversion? I haven’t seen anything from IB

  23. R

    Processed for me at Fidelity this morning before the open. I was unhedged so closed out at $1.93 pre-market, or $0.53 above exercise price. Once the selling pressure subsides, I am curious to see if this moves significantly higher similar to ATCX ($5 to almost $9 currently) following that warrant offer, so am considering getting back in when the price stabilizes.

  24. dt

    METX trade played out really well, especially for the hedged positions.

    Hedged trades resulted in +175% return on cost of warrants in a month (after deducting borrow fees).

    Unheged trades returned a much more modest but still substantial +40% in a month (using yesterday’s closing price of $1.8).

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