Tufin Software Technologies (TUFN) – Merger Arbitrage – 10% Upside

Current Price: $11.73

Offer Price: $13.00

Upside: 10%

Expiration Date: July 2022

This seems like a timely idea with the merger expected to close in two weeks. The spread seems way too wide right now, but it’s definitely possible that I’ve missed something obvious.

NYSE-listed Israeli-based cybersecurity automation software provider TUFN is getting acquired by a PE firm Turn/River Capital. Consideration stands at $13/share. Pretty much all of the conditions have been satisfied already (including shareholder and regulatory approvals) except for the Israeli Statutory Waiting Period condition. The condition says that 30 days must pass after shareholder approval (June 6) before the merger can be closed. The initial estimates were that this merger will close in Q2, so now it seems it will move slightly into Q3. Overall, this pretty much appears to be a done deal, but despite it all, the spread (which used to be minimal) has widened to 10%.

On a quick glance, it seems that the market putting a decent risk of a deal termination here. Here are a few arguments on why the market might be overestimating the risk:

• Timing-wise, the widening of TUFN deal spread wasn’t unusual as during the recent market sell-off the spread of most other M&A deals has widened as well. For example, SAIL/Thoma Bravo acquisition spread has also spiked from 3% to 9-10% pretty much at the same exact time (June 9-10). For software mergers, in particular, the impact might’ve been additionally increased by the recent announcement (June 6) that Thoma Bravo has cut the offer price for another one of its acquisitions – Anaplan (also a software company). However, the adjustment was only 3.4%. The remaining spread for the Anaplan deal is currently zero. Compared to these large-cap mergers, TUFN has a significantly shorter remaining timeline (basically two weeks) and no condition approval risk. Offer price cut is also unlikely given that shareholder approval has already been received. TUFN is not exactly a popular/well-known stock among investors and it kind of looks like the situation might’ve been temporarily mispriced due to the market volatility.
• Turn/River Capital describes itself as a “software investment firm that’s made up of software operators and investors”. The fund specializes in acquiring and growing SaaS businesses. Turn/River Capital has also just recently raised $1.35bn for their 5th fund with the TUFN acquisition being the opening deal. Overall, this is a credible, highly knowledgeable buyer and seems unlikely to tarnish its reputation by canceling a ‘done’ transaction weeks before closing.
• TUFN provides network security policy management tools and also has a growing cloud product. TUFN’s clients are enterprises (19% of Global 2000) with complex network systems. More details on the business can be found in this VIC write-up. TUFN started to gradually shift toward a subscription-based model at the beginning of last year and has grown its ARR from 60% to 65% (the transition is expected to take 3 years). So it’s a relatively stable business that has been growing 20-30% annually pre-COVID. Pandemic has temporarily extinguished growth, however, last year the company still managed to increase revenues +10%, all while switching to the subscription-based model (lower revenues/higher margins). The recent Q1’22 showed revenues growing +22% YoY. The main caveat here is that the business still lacks scale and is unprofitable. However, TUFN’s cash position remains pretty sizeable relative to the cash burn. Overall, it’s pretty clear why Turn/River Capital is interested here, and it’s unlikely that the recent events have diminished the interest to the point of deal termination.

The major risk is the downside at -23% to pre-announcement levels and potentially more given the sell-off in the market.