The ExOne Company (XONE) – Merger Arbitrage – 9% Upside

Current Price: $23.48

Offer Price: $25.5

Upside: 9%

Expected Close: Q4 2021

Press release

 

This is a consolidation transaction in the growing U.S. 3D printing industry. Desktop Metal, a 3D printer manufacturer ($2bn market cap), has signed a definitive agreement to acquire The ExOne Company, its smaller peer. Consideration includes a fixed cash portion of $8.5/share and a stock portion, which will amount to $17/share as long as DM’s share price (20-day VWAP 3 days before closing) remains between $7.94/share and $9.7/share. The deal is expected to close in Q4 2021, subject to XONE’s shareholder approval and regulatory consent. XONE’s long-serving chair/largest shareholder (19% stake) supports the merger, other shareholders are likely to follow suit. Regulatory consents shouldn’t be a problem as this is a relatively small $575m deal. DM is an active consolidator in the industry having made 8 acquisitions since 2019 – merger with ExOne appears to fit the pattern and is highly synergistic.

Cheap DM borrow for hedging is available on IB. If the DM VWAP is below or above the $7.94/share and $9.7/share range, the stock consideration will be fixed at 2.1416 or 1.7522 rate respectively. Thus, dynamic hedging may be required.

Notable risks include potential volatility in DM’s stock. 3D printing market experienced a major surge at the beginning of this year following a series of positive industry events (including a broad earnings recovery) as evidenced in ARK 3D printing ETF gains. The stock prices across the industry have declined a bit since Feb’21 highs and have been moving sideways for several months now. However, Q3 results are expected in November and if the merger does not get closed till then, the result announcement could make an impact on DM’s price and in turn merger consideration.

As is the case with many other 3D printing-related companies, ExOne has yet to produce a profit. On an EV/TTM revenues basis, the deal comes at a multiple of 6.62x versus a 2-6x TTM multiple for XONE’s peers. The offer also comes at a premium to historical EV/Revenue multiples of the company as well. E2021 performance is expected to be much higher (the transaction implies a market cap./expected 2021 revenues ratio of 5.5x.). Overall, the offer looks quite generous and XONE shareholders could be fine with cashing out at this price, especially considering the increasing competitive pressure from a range of larger peers, such as 3D Systems and Stratasys.

Aside from the largest shareholder/chair S. Kent Rockwell (owns 19%), who supports the merger, other major shareholders include ARK Investment Management (owns 12%), Nikko Asset Management (7.6%), and Sumitomo Mitsui Trust Holdings (7.6%).

 

3D printing industry and Desktop Metals

The global 3D printing market grew by 21% in 2020 versus 2019 as limited access to traditional manufacturing during COVID and improved technological advancements helped accelerate the growing industry even more. The 3D printing market was valued at around $13 billion in 2020 and is expected to grow at a CAGR of 21% between 2021 and 2028, as the technology’s adoption increases. It is reported that 47% of engineering businesses already use 3D printing for prototyping while 29% use 3D printing technology for aesthetic or functional use. The industry is consolidating – 3D Systems and Stratasys acquired ~60 companies between 2001 and 2015, and a notable uptick in M&A activity continues to be seen today.

Desktop Metals went public via a SPAC deal in 2020 with an emphasized intention to focus on M&A strategy. CEO quote:

The industry is highly fragmented today. […] We want to be a consolidator in this industry. That’s our plan of record and we plan to execute that.

They have been delivering this promise with these recent acquisitions (from 2020 annual and 2021 Q2 reports):

  • Mar’19 – acquired addLEAP AB (Swedish 3D printer R&D company) for $0.4m;
  • Jul’19 – acquired Make Composites (composite printer R&D company) for $5.4m;
  • Oct’20 – acquired Forust Corporation (3D printing R&D company) for $2.5m;
  • Dec’20 – acquired Figur Machine Tools (3D printing R&D company) for $3.5m;
  • Feb’21 – acquired EnvisionTEC (3D printing company) for ~$300m;
  • May’21 – acquired Adaptive 3D Holdings (polymer resin supplier) for $61.8m;
  • Jun’21 – acquired Aerosint SA (a pioneer in multi-material recoating systems for 3D printing) for $17.7m;
  • Jun’21 – acquired Beacon Bio (3D printing R&D company) for $17.7m.

ExOne seems to be the largest, yet still highly synergistic acquisition as recently explained in the earnings call. The transaction will double the IP portfolio to over 650 patents and will add 23 qualified materials to DM’s library, now approaching 250 materials (plus additional 50+ materials under R&D across the combined companies). Expected synergies include cross-selling opportunities in addition to cost savings:

13 COMMENTS

    1. snowball

      I assume the merger will be closed within days after the shareholder meeting today?

  1. snowball

    Is there a better way to hedge this trade?

    The cost of dynamically hedging can be very significant (can easily eat up all potential profits), if DM’s share price whipsaws around $7.94/share, as one would have to repetitively opening a DM short position at low price below $7.94 and covering it at high price above $7.94.

    The best environment for this trade is DM’s stock price staying within one of the three zones.

    Maybe selling some DM calls ($8 strike) can offset some hedging costs?
    And a conservative hedging ratio of 1.7522 DM call for 1 XONE long can limit the max loss from the short call (in the worse scenario in which DM breaks above $9.7).

    1. Lukas

      Yes, it’s a difficult one, but selling calls could work given the short remaining timeline. The merger should close by the end of Nov, I think.

  2. snowball

    The acquirer (Desktop Metal)’s stock price is trading 20% higher after announcement that it tripled manufacturing capacity for Production System P-50.

  3. Michael Lax

    XONE is now trading more than the $25.50 which shareholders would receive if VWAP would be today’s closing price for DM of $8.60, not sure of the rationale

    1. snowball

      The exchange ratio is determined by 20-day VWAP of DM shares, which may differ from the market price at closing.

      If the latter turns out to be higher than the VWAP, then the merger consideration can be worth more than $25.5.

      I think it is a good idea to close the trade for now, because at this moment we are basically taking a directional bet (i.e., whether end-of-period DM price is higher or lower than the 20-day VWAP). It’s difficult to predict or hedge in the next 2-3 weeks.

      As we approach the end of the 20-day window and the exchange ratio is more certain, we may re-open the trade to capture mis-pricing if any arises.

  4. Ilja

    XONE takeover’s upside has been eliminated, so we’re removing this one from the active ideas section. The idea generated +7% in 1.5 months (with fixed hedging at the higher limit exchange rate of 2.1416x). As mentioned by snowball above, the idea might become interesting again, if the spread widens significantly before the transaction closes.

    1. bigdaddy85

      You should explore stock $PQEFF as a write up. It’s an energy stock that developed patented technology to frack oil sands without the leftover spoiled water. Petrotec Energy has proven technology verified by a reputable 3rd party and is starting to gain traction with a new 5% royalty agreement for use if it’s technology. Oh and the kicker, it traders for about $.18 per share and has an activist investor conducting a tender offer at $.59 per share US dollars. There have been several write ups about this company on yahoo, nasdaq, and other major publications the last few weeks. From reading the SEC filings, it seems other potential suitors are likely to come forward with competing bids.

      1. dt

        We actually had a look at this one given the extremely wide spread. The whole company/offer seems to be on the side of scammish (might be wrong – had only superficial look).
        – Extremely promotional management (almost daily press releases);
        – Company has their supposedly game changing technology with hardly any revenues to show to years;
        – Similar takeover offer was announced last year to no avail;
        – No info whats over about the buyer – I am guessing it is an empty shell that Petroteq management is using to propel the share price.

        Some info here:
        http://www.tarsandsresist.org/tar-sands-strip-mining/the-tavaputs-plateau-a-legacy-of-failed-extreme-energy-schemes/mcw-petroteq/

  5. snowball

    I think there seems to be very little risk for shorting XONE at >$27. What can possibly go wrong?
    Any counter-argument is very welcome!

    1
    1. hta

      If DM exceeds 9.70 then the value of XONE starts to exceed 25.50. With XONE at about $28 as I type this there is some cushion with DM at
      about $9.4. Still the extreme volatility of DM is a little scary. Purchasing some DM 10 calls to hedge the risk should produce an attractive return to shorting XONE given the assumption of the deal closing by mid December.

    2. snowball

      XONE merger has been approved on Tuesday, and will close by Friday.

      “Pursuant to the Merger Agreement, the transaction is expected to close within three business days after today, subject to customary closing conditions. ”
      https://www.investor.exone.com/news-releases/news-release-details/exone-shareholders-approve-acquisition-desktop-metal

      I built a model to determine the fair value of XONE, and the most important factor is actually the expected closing date (which determines the 20-day VWAP window and the exchange ratio).

      The longer it takes to close the deal, the lower value XONE will be, because the VWAP window will move out of the low DM price periods in October, VWAP will be drastically higher and the exchange ratio will be much lower.

      It turned out that the market has been quite efficient. Now that we know the closing day is Friday, the model shows that XONE has been consistently overvalued by just 1% (not as much as I wish), and a XONE short position dynamically hedged with DM long will produce just under 1% profit (but the IRR is great).

      If the closing is delayed by just one more week (to next Friday for example), the short profit will be significantly greater at 4%.

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