Quick Pitches For TRQ, TBRD.V, SCU

TRQ.TO – Merger Arbitrage and Appraisal Rights

TBRD.V – Activist Campaign/Potential Sale

SCU – Strategic Review/Potential Sale – Upside TBD

NEW QUICK PITCHES

Turquoise Hill Resources (TRQ) – Merger Arbitrage and Dissent Rights – Upside TBD
This is a somewhat unusual arbitrage opportunity with the whole upside coming from the dissenting rights. Minority investors have a chance to hitch their wagon to two dissenting shareholders and hopefully benefit from the eventually higher court-determined price. TRQ has listings in US and Canada and reports financials in USD, however, all the figures below are in CAD as it is the currency used in the takeover press releases and proxy.

Rio Tinto/Turquoise Hill Resources merger has been one of the more eventful takeover sagas this year and has drawn many eyes due to very vocal minority shareholder opposition. RIO owns 51% of TRQ and is buying the minority shareholders at C$43/share with the remaining spread hovering at 1-2%. Approval from the majority of minority votes cast will be required. The shareholder meeting date is now set for December 9, but only shareholders of record as of September 19 will be able to vote. The two largest minority shareholders (Pentwater Capital and SailingStone, 16% combined stake) have initially been opposing the transaction saying that the fair value of TRQ is closer to C$56/share. Eventually, the parties came to an agreement whereby the opposing shareholders will withhold from the vote and exercise their dissent rights in order to try to beat out a higher price in court. At a later stage, the other minority shareholders have also been allowed to dissent. The payout process for dissenting shareholders is quite unusual – they will get 80% of the offer price (C$34.40/share) as an upfront payment a few days after the merger closes. The remaining balance between the upfront payment and the court’s determined fair value will be paid after the court proceedings are finished (probably 1 year or more). Any unpaid portion will also accrue interest at Canadian 1 Year T Bill rate, currently 4.3%.

The bet here for dissenting shareholders is two-fold. Firstly, the merger needs to be approved by a majority of votes cast (meeting Dec 9). And secondly, the court determined fair value needs for the balance payment needs to be higher than C$7.72/share. At the very least the risk of getting less than C$7.72/share plus interest seems negligible – the court is very unlikely to rule that Rio Tinto, an informed buyer with 51% stake in the company, has overpaid to cash out the minority shareholders. Thus, assuming the merger closes successfully, the dissenting shareholders are getting a risk-free upside for freezing a portion of their investment at 4% rates.

I think the merger is very likely to be approved by minority shareholders. The offer from Rio Tinto was declared as final after being raised by +26% from the initial C$34/share offer in Mar’22. Any shareholder voting down the merger would be facing 30%+ downside and significant financing/timeline/Mongolia’s geopolitical risks that the standalone TRQ would need to deal with (see comment here). Hence, many are likely to take the same path as Pentwater/SailingStone and allow the merger to pass while attempting to get a fairer price in court. The minimal remaining spread is also indicative of likely successful closing. Also, as only the record shareholders as of September 19 can vote, anyone buying the stock today can dissent and it will not affect the merger voting outcome in any way.

As for the second point, there are several reasons to think that the court-determined fair value would end up higher than C$43/share. The TLDR version is that all the parties involved – including RIO itself – have signaled that the dissenting rights have value and that the final payout might turn out higher than the current offer.

• TRQ board rejected the initial C$34/share offer in mid-August basing the decision partially on an independent analysis by TD Securities, which indicated TRQ fair value of C$42-C$58/share. The two opposing shareholders also called the offer as significantly undervaluing the company.
• When RIO came back with C$40/share and eventually with C$43 bids in September, both opposing shareholders (Pentwater Capital here and here, SailingStone here and here) promptly rejected the improved bids saying they want to see at least $56/share – in line with the upper range of independent analyst fair value estimate and also the price at which RIO holds TRQ stake on its balance sheet.
• At the time Pentwater also started buying TRQ shares in the open market increasing its stake from 10% to 13.8%.
• Eventually, the opposing shareholders and RIO reached a settlement agreement, whereby both Pentwater and SailingStone received dissenting rights in exchange for withholding their votes (i.e. agreeing not to vote against the buyout). The terms of dissenting rights were very similar to the current ones, just the fair value would have been decided through mediation/arbitration rather than a court-led process. I do not see any reason why these shareholders would have suddenly given up if they did not expect a material win from the court-settled price.
• Initially, these dissent rights were granted only to the two opposing shareholders rather than all of the minority shareholders. I take it as a tell, that RIO saw/sees material risk of the court-determined fair value being higher than the current offer – it is much cheaper to cash out only 16% of shareholders at a higher price rather than all of the 49%.
• This exclusive settlement has angered the remaining minority shareholders who noted unfair treatment and differentiation between Pentwater/SailingStone and the rest. Do not think minority shareholders would have voiced so much noise if they saw limited value from dissenting rights. The former chair of OSC (Canadian SEC equivalent) also said that the merger is likely to get halted by regulators due to the unfair minority treatment.
• Finally, only after inquiries from regulators and a few shareholder meeting postponements, RIO announced the termination of the exclusive agreement with Pentwater/SailingStone and allowed all of the minority shareholders to get equal dissent rights. Clearly not the path RIO wanted to take initially.

I won’t be able to shed any additional light on what is supposed to be the fair value of TRQ. A quick glance at TRQ’s Oyu Tolgoi mine NPV (see here) as well as activist shareholder’s arguments on undervaluation below seem to make sense. Some comments on TRQ valuation from Pentwater Capital:

The proposed price implies an equity value of $8.65 billion CAD, which is a fraction of the free cash flow that Pentwater expects Turquoise Hill to generate over the next decade. Pentwater expects Turquoise Hill to generate over $10.5 billion CAD of free cash flow through 2030 assuming $3.50 USD copper and almost $14.2 billion CAD of free cash flow assuming $4.00 USD copper. Pentwater believes that as the world transitions to a green economy, the demand for copper will continue to increase and that there is a high probability that the price of copper will be in excess of $4.00 USD over the next decade.

A little bit of background on Turquoise Hill. The company owns a 66% stake in a very large copper-gold mine Oyu Tolgoi in Mongolia. The remaining stake is held by the Mongolian government. The open pit deposits are already producing, however, the main resources are underground and production there is planned to start only in 2027+. Rio Tinto owns 51% of TRQ and is a contractor for the underground mine development project. More details on the background can be found in the previous SSI pitch on TRQ.

Keep in mind that the dissent notices must be received by the company by Dec 8 and must be submitted by record holders of the shares, i.e. beneficial owners have to send instructions through their brokers. More information on dissent rights and the dissenting process can be found in this press release as well as general information here.

 

Thunderbird Entertainment (TBRD-V) – Activist Campaign/Potential Sale – Upside TBD
Thunderbird Entertainment is a Canadian content creation (animation, TV shows) company. This month the company became a target of an activist campaign run by major long-term shareholders – Voss Capital (owns 13.3%) and Railroad Ranch (6.9%). Voss Capital is fed up with TBRD’s orphaned stock status and urges management to put the company up for sale instead of continuing an ineffective roll-up strategy. Voss Capital intends to nominate its own director slate in the upcoming shareholder meeting and is targeting all 6 out of 6 TBRD board seats. The meeting was initially planned for December 6, but TBRD has now postponed it to Q1 2023 to better prepare for an upcoming proxy fight. Shortly after Voss Capital’s letter, another major shareholder Railroad Ranch also expressed support for the campaign. The activists argue that TBRD share price will hardly ever reach its fair value due to the company’s limited shareholder communication (because of various non-disclosure agreements around projects, etc.) and limited liquidity. Low public market valuation (7x TTM EBITDA) is also a major hurdle for the company’s acquisition strategy putting more accretive/larger stock-for-stock deals out of reach. Industry dynamics support the timing for a sale – a larger private peer eOne Film has been put for sale last week, while another Canadian peer WOW.TO was acquired earlier this year by US peer Genius brands (the situation was covered on SSI here). The activists own a combined 20% stake and Voss has said that many shareholders are also unhappy about the current standing of the company (mainly due to capital allocation concerns). It’s not unusual for the activist to make such statements, however, the low valuation, the dry-down of the trading volume, and comments on this VIC write-up  – are all confirmatory points. This whole setup puts considerable pressure on the board to act – I wouldn’t be surprised to see a settlement and the start of the strategic alternatives before the shareholder meeting next quarter.

TBRD trades at 7x TTM adj. EBITDA (including interim project financing as debt in EV calculation) vs WOW.TO acquisition at 11x adj. EBITDA earlier this year. Another public peer WILD.TO trades at 13x TTM adj. EBITDA, although it is a larger company that has a bigger proprietary IP portfolio as well as a higher share of revenues coming from these IP assets. BRMI.TO trades at 6.3x and it seems to be quite comparable to TBRD in terms of size and revenue split between IP and production, however, BRMI is significantly more levered than TBRD.

TBRD’s animation division Atomic Cartoons makes animated TV shows and films (Last Kids on Earth, Marvel’s Spidey and His Amazing Friends, Lego Star Wars: Terrifying Tales, etc.). The factual division makes unscripted TV shows (Highway Through Hell, Gut Job, Deadman’s Curse, etc.). The company has its own IP (mostly in the factual division), but the biggest revenue share and growth come from production work for external brands (mostly animation). It’s worth noting that Lionsgate Entertainment founder billionaire Frank Giustra sits on TBRD board and owns a 12.8% stake. So far he said he will support the current management. The activists, however, argue that the board is entrenched – most board members are only visually independent and in reality have had long-standing relationships before. Voss Capital noted that Frank Giustra’s involvement is the core reason behind mismanagement and lack of independence.

Voss Capital is a value-oriented hedge fund, which rarely does public campaigns. Currently, it is also the main activist in the GFF situation (covered on SSI here), where the campaign for the business split/sale seems to be proceeding quite well so far. Voss acquired most of its stake in TBRD in September’21 when the stock was trading around C$4.8/share – so the activist sits on a sizeable loss on its position.

 

Sculptor Capital Management (SCU) – Strategic Review/Potential Sale – Upside TBD
SCU is a $600m market cap alternative asset manager focused on credit and real estate. Recently, the company started exploring strategic alternatives/ potential sale after the settlement with SCU’s founder/ex-CEO Daniel Och, who pressured current management saying certain third parties are interested in acquiring SCU. There seems to be a long-running feud between Daniel Och and the hedge fund’s current CEO Jimmy Levin. Financial Times covered the saga pretty well and I recommend reading the article before digging any further:

Sculptor’s share price shows one big reason why the board has taken this step. Its stock is down 53 per cent this year to $10.25. The IPO back in November 2007 was at $32 apiece and raised $1.15bn. Its market cap is now less than half that — which, even for a hedge fund, is a pretty stunning level of capital incineration.

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However, the main reason for the proposed sale is the long shadow of a mid-noughties bribery debacle and the embarrassing, debilitating, long-running, very public brawl that followed between founder Daniel Och and his one time protégé Jimmy Levin.

Daniel Och left SCU in 2018 but retains 15% voting power and 1% economic interest in the listed entity (and probably additional ownership through the management company). As a continuation of a multi-year feud, last month Och raised concerns over SCU’s underperformance and egregious management compensation, including a $146m CEO salary in 2021. Och and other SCU’s former executives also filed a lawsuit asking the company to provide books and records related to the executive pay. As part of the recent settlement, SCU put itself for sale and will now hand over the required records whereas Daniel Och will dismiss previous legal claims. SCU management has 50%+ economic and voting power in the group as a whole (the structure is a bit complicated, see page 20 of 10K).

The author of the financial times article appears to be skeptical of any forthcoming third-party offers, however, a comparison with peers suggests Sculptor is significantly undervalued. Any acquirer could easily eliminate excessive management compensation and retain a stable management fee revenue stream. On EV/management fee revenue basis (excluding any incentive fees) SCU trades at 1x multiple – materially below 2.5x-2.6x multiples for peers EMG.L ($3.3bn market cap), BSIG ($0.8bn), and FSZ.TO ($0.7bn). SCU’s management also seems to think that the company is cheap as $22m worth of SCU’s stock was repurchased in the last two quarters at an average price of $10.45/share – in line with the current share price. Ignoring the huge incentive fees, SCU’s fixed salary expenses are just slightly higher than for peers – 28% of management fee revenues vs c. 23% for EMG.L and BSIG.

It is not yet clear if SCU’s extremely well-compensated management team is genuinely interested in the sale of the company. The strategic review might simply be just a show in order to temporarily settle the feud with SCU’s founder.

 

PREVIOUS QUICK PITCHES PLAYING OUT

Pasithea Therapeutics (KTTA) – Net-Net/Activist Pressure – 30% Discount To Net Cash Remains
Pasithea Therapeutics was originally covered in June with updates in September and October. KTTA is a net-net biopharma trading at a 30% discount to net cash ($1.45/share). This year, the company has been pressured by activist Camac Partners (12% ownership stake). Camac successfully pushed for KTTA chairman’s resignation and managed to call a special shareholder meeting which was eventually approved by the board. Notably, Camac garnered the support of at least 25% of votes, suggesting there is a good chance of winning board seats. The special shareholder meeting was initially set for November 29, however, one day before KTTA’s management postponed the meeting to December 9. This seems to be a positive sign, suggesting that the current management is struggling to gather the required support.

The Valens Company (VLNS) – Merger Arbitrage – Completed +6.5%
This merger of two Canadian cannabis industry players was covered in mid-September. The Valens Company was getting acquired by SNDL, the largest Canadian distributor of cannabis. I thought this one had a high chance of closing successfully in short order as SNDL was a motivated buyer, that was/is pursuing a roll-up strategy with a number of similar acquisitions already under its belt. The offer price seemed more than fair to receive VLNS shareholder approval. This week, VLNS shareholders approved the merger and the spread narrowed to minimal levels, delivering 6.5% return (after borrow fees) in less than 3 months.

Theravance Biopharma (TBPH) – Tender Offer – Completed +8%
Commercial stage biopharma TBPH launched tender offer for 13%-15% of outstanding shares at $9.75-$10.5/share. Shares traded right at the low end of the range, providing risk-free upside for odd-lot holders. The offer came as one of the final steps in the capital return program following TBPH’s large royalty interest sale. The buyback was quite sizeable and management did not intend to participate. The tender ended up massively undersubscribed, with participation from only 0.2% of outstanding shares, and was priced at the upper limit. TBPH shares continue to trade above the upper limit.

Scholastic Corporation (SCHL) – Odd Lot Tender Offer – Completed +$260
In early November, we highlighted SCHL tender offer with an odd lot provision for 6% of outstanding shares launched by the publisher of children’s book Scholastic Corporation. The tender range was $35-$40/share. At the time, SCHL shares traded around at the midpoint of the tender range. The offer ended up undersubscribed and priced at the upper limit, resulting in a short-term $260 gain for odd-lot positions. Company’s shares continue to trade above the upper limit.