Merger Arbitrage
NBLY is a C$800m market cap Canadian roll-up of independent pharmacies, mainly focusing on small underserved areas in the country where there’s less competition. Last week, the company entered into a letter of intent to be taken private at C$20.5/share by its controlling shareholder, PE firm Persistence Capital Partners (50% stake and 4/7 board seats). The spread stands at 12% mostly due to pending financing and the non-binding stage of the agreement. The buyout is expected to close in Q4’23-Q1’24. The downside to pre-announcement levels stands at 34%.
PSP has been granted exclusivity until November 13 to arrange financing and sign a definitive agreement. The pending financing seems to be the key driver of the spread. Cashing out the remaining minority shareholders would cost PSP C$457m. The firm generally focuses on much smaller acquisitions/investments and this will likely be PSP’s largest transaction by far. So it is understandable that the market is a bit cautious. The press release indicated that financing arrangements (mix of debt and equity) are already in advanced stages of negotiations. PSP’s existing 50% ownership of NBLY should go a long way in convincing the financiers to sponsor this buyout.
After the financing is settled, I would expect the transaction to reach a definitive stage rather quickly. The buyer knows the company inside out and any surprises during the final negotiation stages are unlikely. The offer has already been approved by NBLY’s board. Minority shareholder approval would come at a later stage.
The offer to buyout minority shareholders comes at an opportunistic timing with NBLY’s shares having drifted down 60% over the last two years. This was driven by a combination of margin pressure from increasing labor costs, high leverage in the rising interest rate environment, and ongoing integrations of the 2023 acquisition spree. The stock now trades at a substantial discount to the C$17/share IPO price in May’21 and to where PSP later increased its stake at C$29/share in Apr’22 and C$21/share in Aug’22. Since the IPO, NBLY has used the proceeds to partially reduce its debt burden (4.5x net leverage at the time vs. 3.5x currently) and to continue the pharmacy roll-up strategy. The company has really stepped on gas with M&A over the last fiscal year spending C$462m on acquisitions in FY23, compared to C$103m in FY22 and C$70m in FY21. Pro-forma revenues have increased by 115% and adjusted EBITDA by 90% since the IPO. NBLY’s market share in the Canadian pharmacy market went from 1% to 2.5%. PSP is now buying NBLY back at 13x (depressed) EBITDA multiple vs 19x multiple at the time of the IPO.
PSP’s potential playbook could be to acquire NBLY, finalize integration of the recent acquisitions, sort out the operational matters, and bring the business back to the public markets at a later stage. There should be a substantial growth runway for the company in the highly fragmented Canadian pharmacy market (half of the country’s pharmacies are independently owned).
Persistence Capital Partners specializes in the Canadian healthcare sector. Fund’s primary focus is to identify opportunities in the fragmented healthcare market in Canada, with an emphasis on growth through roll-ups of private players. PSP first invested in NBLY in 2015 and subsequently led the IPO in 2021. Other PSP investments include Anova Fertility & Reproductive Health (a fertility clinic), MCA Dental Group (dental service organization), and MedSpa Partners (cosmetic dermatology clinics). While PSP’s AUM is not disclosed, the buyer raised nearly C$225 for its second buyout fund back in 2019. PSP has also pursued sizable investments in the past with co-investing partners, including the “significant equity commitment” made into MCA Dental Group in Jul’21 along with one of the world’s largest asset managers DWS Group ($859 billion in AUM).
I find this trade at the current level of CAD 17.30 interesting:
– According to the press release the financing risk seems to be low now. Debt financing is secured. Finalizing equity commitments. Debt is expected to be drawn CAD 450 of total CAD 650.
See here: https://www.newswire.ca/news-releases/neighbourly-extends-exclusivity-and-provides-update-on-letter-of-intent-with-persistence-capital-partners-840130035.html#:~:text=The%20Company%20has%20agreed%20to,arrangements%20for%20the%20Proposed%20Transaction.
– As far as I can see: No opposing minority shareholders at the moment.
– No regulatory risk since market share is 2.5% in Canada.
– They own already 50%, so buyer walking away seems to be minimal here
– Upside / Downside of the trade: Upside: +18%, Downside: -28% (to CAD 12.50 preanouncement price). This translates to only 60% implied probabilty of closing which I consider too low given the facts above.
I have the feeling that I am missing something. Comments welcome.
(PS: Sorry for my bad English but I am not native speaker)
Cerberus, good catch, I kind of liked the situation before, but, as you say, the idea has become more interesting now. I’m considering taking a small position in this. A couple of thoughts, some may repeat:
1) The upside has now increased to 18.4% while the downside to pre-announcement prices stands at around 30%.
2) Recent quarterly results (came out after the write-up) were pretty decent with a 4% increase in same-store sales and adj. EBITDA up 8% primarily due to incremental contributions from previous M&A (over the last 12 months). NBLY now trades at 11x pro forma TTM adjusted EBITDA.
3) As Cerberus pointed out, the buyer has now secured a C$650m credit facility, out of which, C$450m would be used for the transaction. The buyer noted that it is continuing to advance equity financing and expects to conclude those arrangements over the near term. So it seems that we are now waiting for equity financing to be done for a definitive agreement to be reached.
4) NBLY has extended the exclusivity period till January 15. The timeline is still on track based on the original letter of intent document (late 2023 – Q1 2024) as management reiterated an expected Q1 2024 close.
Overall, I don’t see why the spread has increased as mostly positive developments have happened so far. The controlling shareholder is now closer to getting financing than before and the target’s financials were pretty good/were not bad.
However, there is one aspect that I don’t understand. We know that the buyer owns 50.2% of NBLY and the offer price is C$20.5/share. Therefore, based on 44.722m shares outstanding, the buyer needs C$460m to buy the remaining shareholders out. The buyer now has a C$650m credit facility, out of which, C$450m will be used to fund the transaction. My questions are:
1) why leave only C$10m for the equity financing? This looks like an immaterial amount to the total consideration being paid. They could easily cover that C$10m with the credit facility instead.
2) are there any issues to be expected with this C$10m in equity financing? I don’t see how there could be, when C$650m of debt financing is already on the table. So why the market (spread) has reacted in such a way then?
Would appreciate any thoughts on this.
I would not read much into the spreads. have some experience here working on L/MFT and market microstructures – some of the inventory models make it such that often there exists a slight pullback before a pop; similarly every risk arb deal also usually pops followed by a minor pullback – which often translates into a short term drift – unless its a deal with a very short duration or water tight.
Think of it from the point of a supply-demand model which is also self-reinforcing towards an up/down trend. not sure i make a lot of sense, but the TLDR = I wouldn’t read much into the spreads unless its a big gap up / down or a large correction
Would financing be easier now given the rate expectations next year?
I don’t think rate expectations play any role here and I do not think these have changed materially from when the transaction was announced anyways. The buyer has already secured a C$650m credit facility, out of which, C$450m would be used for the transaction when roughly C$460m is needed to complete the deal. Only C$10m of equity financing is needed. The newest press release also mentioned that “PCP has continued to advance with its sources of equity financing and expects to conclude those arrangements over the near term.”
There is now a revised offer of $18.50 with financing in place. Since PCP owns 50%, how much of a majority is needed for shareholders to approve the transaction? The current spread stands at ~20% after falling 13% today
Why would the special committee of NBLY agree to this lower offer?
I’m not clear what Persistence’s intentions are.
“Why would the special committee of NBLY agree to this lower offer?”
Probably because the alternative is no offer at all?
exactly – and rejection of an offer must take into account that it was $12 before the offer came in. PCP also owns 50% and would know the company intricately.
And will likely block any competing offer.
That is not how DentalCorp played out.
https://www.theglobeandmail.com/business/article-dentalcorp-share-buyback/
Why wouldn’t this Special Committee use the same logic the DentalCorp Special Commitee did?
Well, they could. In fact, the market seems to be pricing in that something like that could happen. Note that PCP is pretty explicit about this being the only option available to the company:
“PCP [..] has reaffirmed to the Transaction Committee that it does not have any interest in selling the Common Shares that it owns to any third party and that it would not support any alternative transaction involving the Company and a third party. ”
So if the board shoots down this offer, well, I guess in the short run you’d rather not own any shares.
On the other hand, while the lower offered price is disappointing, there is now a fully financed bid on the table from a majority holder at a huge premium to the undisturbed price. Yet shares now trade at an almost 20% discount to the offer price, which is huge and wider than it ever was before. Consider me surprised, I expected shares to trade around C$16 / C$17 instead on this news.
I own a few shares. Not sure what my edge is here, keeping it small.
Another example would be Startek’s (SRT) takeout saga that was covered on SSI in 2022 – controlling shareholder lowered the initial offer price and then special committee rejected the reduced bid. A year later the same controlling shareholder came back with an even lower offer, this time definitive agreement was signed. Different buyers and different targets, so very hard to draw any insightful inferences from this aside from that there are precedents of special committees rejecting lowered bids from controlling shareholders.
I am guessing it all boils down to how independent the special committee really is and how much value they see in the business.
To that end, at the beginning of October, when the initial PCP bid was announced, NBLY’s financial advisor issued a fairness opinion that:
PCP’s bid was already at the low end of what TD considered to be a fair value. if the special committee wants to support the new lowered C$18.5 bid, I am sure TD will find a way to justify an even lower fair value (there are always ways to work around this – change in market/business conditions, etc). But this gives the special committee an easy way out.
I do not think PCP will walk away or lower the bid further. PCP’s excuse for the lower bid seems lame considering that C$450m of debt financing for this transaction has already been secured earlier and the still pending equity financing amounted to a mere C$10m. But given the efforts invested into this deal over the last three months (an potentially even longer before te initial proposal), PCP seems to be pretty committed.
22% spread to the reduced offer price seems quite enticing.
Market prices this roughly 50% to fail here. Given that this is a $0.8-1 EPS business a few years out (after all restructuring expenses are digested and after a few more acquisitions), I don’t see why a $18.5 bid would be declined. Not like there will be another bidder coming along. And not like PCP are getting an insane bargain here. If anything a valuation of $25 seems a bit rich for a business that will barely hit $1 in adjusted EPS 2-3 years out, with single digit growth that is mostly non-organic (unless I am missing a lot of synergies here).
If bid is declined, shares fall back to $12-13. Then best case scenario PCP comes back with another similar bid a few years out. Which then puts the board and special committee in the awkward position of having to decline it again? They would irritate PCP and probably a lot of minority holders. So whose interests are they really sticking up for then?
18,25 now :-)
The definitive agreement with Persistence Capital Partners (PCP) has finally been signed. The offer price has been adjusted once more, but this time upwards to C$18.50 in cash plus a non-tradeable contingent value right (CVR) that may pay out up to C$0.61/CVR, subject to achieving specific forward adjusted EBITDA targets. NBLY shares surged by 15% today and trade at a 2% discount to the cash consideration ascribing no value to the CVR. The buyout seems like a done deal now and should close by March 2024. Minority shareholder approval will be required, but I find it hard to believe that shareholders would attempt to block this offer and risk a massive downside (34% from the pre-announcement price).
Investors currently get the CVR portion for free (aside from the small risk of the deal falling apart). The CVR will pay out if NBLY’s adjusted EBITDA for fiscal year 2026 is at or above C$128m. The pro forma (for recent acquisitions) adjusted EBITDA run rate as of September 2023 was C$97 million. To achieve the CVR target, earnings would need to compound at 15% over the next two years. This seems entirely achievable for a rapidly expanding roll-up that has been growing its adjusted EBITDA at a CAGR of 45% over the previous two years. The Canadian pharmacy market is undergoing consolidation and remains highly fragmented, which should pose no obstacles to NBLY’s further expansion. However, PCP will be in full control of NBLY, which has incentives not to pay out on CVR and which, I imagine, has some freedom of shifting the ‘adjusted EBITDA’ around to ensure profitability stays below the C$128m threshold. So I am staying on the sidelines with regards to the CVR.
By the way, it appears that PCP has now secured a $320m equity financing commitment from BAM, which makes the previous C$10m equity financing “hurdle” and subsequent price cut even funnier.
I know the deal has been completed, but I would like to add my two cents that may be useful in the future in similar situations.
PCP actually needed more than C$10m in equity financing.
PCP first invested in NBLY in 2015 via a fund raised in 2013, which like most PE funds has a 10 year life and was near the end of its life last year.
So they also needed to take some money off the table to return significant amount of capital to LPs, and without getting diluted too much.
BAM’s structured equity investment of $320 helped PCP achieve that goal.
Interestingly, had PCP used plain equity financing (by having to sell some of their shares to other co-investors at the same privatization price ), they would probably have less incentive to lower the offer price.
BAM’s solution, which I guess was more like preferred equity, solved the problem. The offer price became less relevant, PCP got to send back up to C$320M to LPs, and remained in control of NBLY and most of its future upside.
The arithmetic in the initial write-up was wrong . You don’t just add up the debt financing and plug the remainder as equity. They had told you how much they were planning to draw from the debt facilities – from that you could back out that they needed ~ C$300m in equity.
Hi @aviva, the arithmetic in the write-up seemed correct. C$460m equity is needed (if buyer kept their already owned 50.2%) , and the correct c$450m debt financing number ( the amount they were planning to draw) instead of the total available amount of the facility (C$650m ) was used in the calculation. Additional c$320m hybrid equity was eventually needed because buyer would like to partially cash out too.
“PCP has now received commitments for a fully underwritten credit facility in an amount of $650 million co-led by The Bank of Nova Scotia and RBC Capital Markets. PCP expects to use approximately $450 million of such amount to finance the Proposed Transaction. “