Sogou (SOGO) – Going Private Transaction – 9% Upside

Current Price: $8.26

Offer Price: $9.00

Upside: 9%

Expected Closing: mid-2021

Press release

The idea was shared by Dan.

 

2nd largest Chinese search engine Sogou is due to be taken private by the internet giant Tencent, which already owns 58% of the company. Consideration stands at $9/share.

During H2 2020 market considered this transaction to be a done deal and even at the non-binding stage the spread stood at around 3% and then shrunk to 1% after the definitive agreement was signed. However, after the emergence of potential regulatory issues in Dec'20, the spread widened considerably and now fluctuates around 9%-10%. Regulatory risks add substantial uncertainty and are difficult to handicap. However, the spread is really attractive for Tencent's acquisition.

The downside to pre-announcement stands at  40%, however, should be significantly lower given that the non-binding offer was done in July (impact and uncertainty regarding COVID was much stronger).

 

Regulatory Risks

In December SOGO has made a filing stating that due to the regulatory review process it extends the merger termination date from the previous 29th of March to the 31st of June. Apparently, Chinese regulators have decided to introduce a new approach to tackle the empire-building of the giant internet companies and significantly sharpen the scrutiny due to anti-trust concerns. Major firms, including Alibaba and Tencent, received fines under the anti-monopoly law.

Also rumors started spreading that regulators are "particularly keen" on making the Tencent/SOGO acquisition to be an example of the new approach. The decision to outright-block this merger would be kind of strange, given that Tencent already owns a controlling stake in the company, while the consolidation would actually create more chances to level out the search engine market, which is now reigned over by Baidu (67% market share). However, given the unpredictability of Chinese regulators, especially in the context of anti-trust/monopolistic behavior concerns, the regulatory review remains a risk here.

 

Positive aspects of this case

  • Tencent already owns 58% of SOGO and has been with the company since 2013.
  • The merger will be done as a short-form merger under the Cayman laws, so shareholder approval is not required. The transaction was clearly planned to be as clean as possible in order to close without any extra hurdles.
  • The definitive agreement is already in place, which for a US-listed Chinese company takeover signals a very high chance of the transaction going through.
  • Tencent is a credible strategic buyer. It is one of the largest companies in the world ($810bn market cap) and this is a fairly minuscule transaction to them (financing is not an issue). Compared to other Chinese giants Tencent's expansion strategy is more relied on engaging in strategic partnerships/JVs than making acquisitions, however, if the internet giant sets its eyes on a target, the deal usually gets done (there are no cases of Tencent walking away from an already announced transaction). One of the most recent examples - the acquisition of a troubled Bitauto (online automotive classifieds company) last year, which was not derailed even by the pandemic (definitive agreement signed in June'20).
  • The strategic sense is sound. SOGO is the second (after Baidu) largest search engine with 24% market share. Tencent uses SOGO to power its own ecosystem of apps (WeChat, QQ.com, etc.). Previously Tencent was trying to create its own search engine, however, in 2013 it was merged with SOGO with Tencent retaining 36% stake in the combined company.  This partnership is very important for both parties - Sogo receives a considerable amount of traffic from Tencent's users (around 35%), while for Tencent, Sogou provides a significant market share in the online search market and creates competitive pressure against its rival Baidu. Worth noting that the Chinese online advertising market is becoming increasingly competitive, especially with the recent emergence of new players, mainly ByteDance with its TikTok app already generating more online ad revenues than Tencent or even Baidu. Additionally, in 2019 ByteDance has also released its own search engine. So overall, SOGO's acquisition will allow Tencent to secure the market share in this sector and lock-in SOGO's traffic, while improved synergies between the Sogou and Tencent's apps, will make the company better positioned to fight off the competition.
  • That the move also comes shortly after Tencent's announcement of planned $70bn investment in the new infrastructure, increasing its focus on AI, IoT, big data, etc. Merger with SOGO will allow Tencent to integrate SOGO's AI technologies (speech, machine translation, Q&A, and more), while also acquiring its experienced staff.

15 COMMENTS

  1. sacredbiotech

    Thank you for the overview. Any citations on the Chinese regulatory authority concerns translated into English for additional reference?

  2. Ilja

    SOGO share price has been falling since Friday and the spread has widened to 16%. I saw no company / merger specific news that could prompt this sell-off, so it could be related to multiple other Chinese ADR sell-off due to Archegos liquidation.

    1
    1. Terence

      Ilja, your comment had perfect timing – $7.60 at that time, to $8.50 now after news that China will approve deal given some conditions – thank you! Now that deal closing is more probable, is the stock still a buy/hold now, i.e., is 50 cents attractive enough?

      1
      1. Ilja

        Well, it’s a 5% remaining spread on a purely strategic Tencent deal with a definitive agreement already signed. Major risk has recently been lifted and those data security conditions don’t look like a big hurdle to me. Shareholder approval won’t be needed. A short-form merger also indicates that the transaction should close promptly after matters with data conditions are settled. I think the case is still interesting.

        3
  3. Terence

    1Q results out early this morning, and update on the merger. Big drop in revenues/income vs last year, but maybe all these were expected. Spread remains at 7.5%, seems still high for a few months wait.

    https://finance.yahoo.com/news/sogou-announces-first-quarter-2021-050000119.html

    “The parties currently expect the Merger to be completed after the second quarter of 2021, subject to the satisfaction or waiver of all the conditions to the Merger, including the receipt of regulatory approvals such as clearance of anti-trust filings.

    The Company does not undertake any obligation to provide any updates with respect to the Merger, the Share Purchase, or any other transaction, except as required under applicable law.”

  4. Terence

    8.4% spread, with closing “after the 2Q2021”. No news on merger since news of 1Q results.

  5. Evgeny

    The stock has started moving up to 8.60 today. Are there any new positive developments?

  6. nostradamus

    Reuters reports this deal will be approved by Chinese regulator later this month.

  7. Evg

    Today it has been officially approved by China’s regulator.

    Any idea on the time before the deal is finalized and the stock delisted?

  8. Evg

    Based on yesterday’s filing the termination date has been moved from 31 July to 31 December:
    Amendment No. 2 to Merger Agreement
    On July 19, 2021, the Issuer, THL A21, Parent and Tencent Mobility Limited entered into an Amendment No. 2 to Agreement and Plan of Merger (the“Amendment No. 2 to Merger Agreement”), pursuant to which the termination date under the Merger Agreement is extended from July 31, 2021 to December 31, 2021.

    It seems that the spread has widened, but only insignificantly.

    Any thoughts on the situation (especially given what is happening to Didi at the moment)? Could it actually become almost a short at this level?

    1. Vincent

      Why do you want to short this? I think the deal is already approved by regulator.

      1. snowball

        Shorting SOGO can be a very low-cost asymmetric bet.

        The downside is capped at 1.4% (at the takeout price of $9), and there is a possibility that authorities change their mind and torpedo the deal (upside is very substantial).

        Just watch New Oriental Education (EDU)’s performance today once NYSE opens (its dual-listed share in Hong Kong is already down by 40% today so far), and we will agree that gov policies can be more volatile than investors expected.

        1. Evg

          Yes, exactly. The fact that they are extending the deadline by 6 months is quite worrying. Unfortunately I don’t have fantastic experience/knowledge about the Chinese regulator, but the fact that they are extending the deadline (why 6 months? hasn’t everything been prepared already for a year?)+ attacks on Didi + destruction of private education industry show that there’s definitely a small chance of things changing quickly (China is trying to weaken the power of tech firms, why allow Tencent grow bigger?)

  9. Tan

    It could be that the deadline extension is to tie up some loose ends and the default extensions previously have been around 6 months, not that it could take that long more to complete.

  10. snowball

    Sumo Group (SUMO), another privatization deal proposed by Tencent is interesting.

    Spread stands at 5.6%, with analysts expecting no resistance but also no counter-bid.

    Tencent may have very strong incentive to close this deal (or other similar international deals), in light of the increasingly tighter grip by anti-trust authorities on its domestic acquisitions.

    “Asia’s most valuable firm is offering 513 pence per share for Sumo, a 43% premium to the British company’s previous close. On a fully diluted basis, the offer values Sumo at about 919 million pounds ($1.26 billion). Tencent already owns about 8.75% of Sumo, giving the outstanding shares a value of about 803 million pounds.”

    https://www.reuters.com/world/uk/tencent-buy-british-video-game-company-sumo-13-bln-deal-2021-07-19/

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