Tarena International (TEDU) – Merger Arbitrage – 9% Upside

Current Price: $3.68

Offer Price: $4.00

Upside: 9%

Expected Closing: TBD

Proxy

 

This is a US-listed Chinese firm privatization by its previous and current management with a signed definitive agreement. Situation offers 9% upside to the announced buy-out price. The company has a somewhat shady history, however, there are a few credible parties involved, which make this situation stand out from most other Chinese privatizations.

On the 8th of December’20, professional and K-12 education company Tarena International announced a non-binding offer from its founder/ex-CEO/current director at $4/share. The definitive agreement was signed on the 30th of April – consideration remained unchanged, while the CEO was joined by a consortium of certain shareholders and Ascendent Capital Partners (financier). Buyer consortium owns 45% of economic and 74% of voting power, which guarantees shareholder approval. Meeting date has not been announced yet.

Based on our previous research, these types of special situations with a signed definitive agreement are rather safe as in several years only 1 such privatization had failed. However, recently we saw another example of a terminated transaction (CXDC), which has now visually increased the risk for all remaining transactions (notably, most spreads for currently ongoing similar transactions have also slightly widened).

There are a two more major positives in TEDU case:

  • Apparently, one of the major shareholders of TEDU is KKR, which owns 14.1% of outstanding shares (increased the stake from 12.3% in May’21). The PE giant is holding shares since 2016 – annual report shows that it owned 42.3% of TEDU at the time. KKR agreed to support this transaction and roll over its shares. Its fair to say that a long-term involvement of KKR hints that TEDU shady history is potentially in the past and significantly reduces likelihood of unexpected issues with the privatization process.
  • No financing condition is included. The company has already secured financing with Ascendent Capital – Chinese PE firm, which seems somewhat credible and at least there’s some visilibity in its ability to fund this transaction. In the beginning of 2020, Ascendent raised $1bn+ for its third China fund (apparently the sam vehicle which will finance this deal). Unrelated, but in Dec’20 Ascendent also formed a SPAC – Silver Crest Acquisition and raised $300m.

 

Risks

  • The company has a shady history. It IPO’ed in 2014 at $9/share with shares more than doubling in a few years after riding the online education hype wave, however, from time to time, different sources, mostly independent research firms (here, here and here) warned about accounting irregularities at TEDU. Then in Nov’2019, TEDU officially announced results of independent research, which found numerous accounting irregularities, conflicts of interest in related party transactions, intereference with external audit process, etc. It was estimated that from 2014 to 2018 revenue misstatement could amount to 11.5% of the total revenues. After that, TEDU quickly announced management and board change, replaced a few people including its CEO and CFO, annd regained compliance with NASDAQ in May’20. The founder/ex-CEO, which leads the current privatization is the same guy, which managed the company till end-2019. This definitiely doesn’t add credibility to the current transaction, however, I believe that the involvement of the above mentioned credible parties, especially KKR, somewhat neutralizes the risk of founder’s track record.
  • TEDU business has not been performing well lately. Since 2017 the company continues to generate losses and revenues are in decline (albeit a slow one).
  • If the deal breaks, the downside might be significant – pre-announcement price (Nov’20) stands at $2.40/share (40% downside).

 

Tarena International

The company offers combined learning solutions (both online and classroom-based) for adults and school children. For adult professionals, they provide practical education in IT and non-IT subjects, especially preparing people for sectors with high growth and strong hiring prospects. For K-12 they specialize in robotics and IT. TEDU currently offers courses in 7 IT subjects, 3 non-IT subjects and 7 K-12 education programs.

Historical financials (10-K):

 

16 COMMENTS

  1. snowball

    Spread has widened to 14%, which seems very wide for a deal with a definitive agreement and with KKR in the consortium.

    1. snowball

      it has been driven by sector-wide sell-off: changes in Chinese gov policy concerning K12 student off-campus tutoring, affecting half of TEDU’s revenues.

    2. rc99ar

      Nothing public I can find. I don’t get a warm and fuzzy feeling though when the spread widens quickly likely this on a Chinese stock. I’m not adding.

      1. rc99ar

        Trading below 2.70 today (21 June). No news publicly but market expectations seem to be that this is off.

      2. rc99ar

        Risk/Reward starting to get pretty compelling at $1.30.

  2. Zulu Investor

    Some crazy plummet today. Dropped 16%. Anyone care to explain why?

  3. ijw

    I think the market is assuming this will likely impair the business so much that the definitive agreement won’t matter:

    https://www.reuters.com/world/china/exclusive-china-unveil-tough-new-rules-private-tutoring-sector-sources-2021-06-16/

    If behind paywall, open in icognito mode.

    “The new rules, which aim both to ease pressure on school children and boost the country’s birth rate by lowering family living costs, could be announced as early as next week and take effect next month, two of the people with knowledge of the plans said.

    The imposition of a trial ban on both online and offline tutoring over the summer and winter holidays in Beijing, Shanghai and other major cities, cited by the sources, goes much further than the planned measures first reported by Reuters last month.

    “The new rules would be stricter than expected,” said one of the sources, a person close to regulators drafting the new rules. “The industry should be preparing for the worst.”

    The trial vacation ban, which adds to plans to bar online and offline tutoring on weekends during term time, could deprive tutoring companies of as much as 70-80% of their annual revenue, two of the sources said.”

    This sounds pretty dire.

    1. snowball

      On the bright side:

      (1) Buyer consortium is rolling over their existing 45% economic interest, and is paying real cash for only the 55% of the company.
      Let’s assume, If as result of impairment of TEDU’s business, the consortium will now value TEDU at $150 million vs the original $231 million, then the original offer is now 50% more “expensive” .
      However, they are overpaying by only 50%x55%= 27.5% or $45 million, because they roll over their own stakes.

      (2) When they consider whether to walk away, they have to weight this against the break fee ($6.8 million), and reputation damages.

      Within the consortium, the two PE firms (KKR and Gaorong) and the strategic investor New Oriental would likely place some value on their reputation.

      (3) the new rules will affect only half of TEDU’s revenues, with the other half (adult education) not impacted.

      (4) TEDU’s liquidity may be impacted, because the new rules will not permit advance deposits of >3 months of tuition fees. Advance deposits have been TEDU’s key sources of liqudiity.

      Staying private (vs being a public company) may be a better way for the consortium to deal with finance/liqudity as well as policy challenges.

      1. ijw

        Revenues Adult training:
        2018: 1915m
        2019: 1527m
        2020: 1137m

        Revenues Kid training:
        2018: 170m
        2019: 524m
        2020: 762m

        I think it is pretty clear from these numbers that Adult training is falling off a cliff, and Kid training was the growth business that the consortium was probably after. And is probably the majority of the value of the company. So if this suddenly goes into free fall as well, I think value of the company might very well be zero with current cost structure.

        So then it becomes a calculus how much they will value their reputation. And how much this really will affect their reputation. And what exactly the contract says about situations like this. It is a bit too risky for me.

  4. Ilja

    The risk of Tarena International privatization transaction failing has increased substantially, while if it does and the new tutoring policy gets approved, the downside could still be very sizeable. Therefore, we have decided to minimize further potential losses and are closing the idea with -23% in one month.

  5. Cerberus

    Any suggestions why it dropped today? I don’t see any relevant news. Thanks.

  6. snowball

    The proposed regulation will ban after-school tutoring of subjects in China’s K-12 school compulsory syllabus.

    TEDU’s K-12 tutoring business focuses on programing, which is not in school syllabus.

    Although the regulation seems neutral to TEDU, there can be both positive and negative second-order impacts:

    Positive: TEDU can prosper because the time and money Chinese parents/children currently spend on school syllabus subjects will be re-directed to the subjects offered by TEDU, such as programming.

    Negative: the other big players (EDU, TAL), driven out of business in school syllabus subjects, will inevitably have to invest heavily in the same subjects offered by TEDU, creating fierce competition. They may have deeper pockets than TEDU, and they certainly have stronger will (because they are fighting for survival).

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