Merger Arbitrage – 15% Upside
UK payments company Equals Group has received a non-binding takeover offer at £1.35/share from a consortium of PE firms and a fintech company. The “put up or shut up” deadline to place a formal offer is set for October 2. Negotiations are in the final stages. The buyer group has almost wrapped up the due diligence and secured financing a few weeks ago. All recent signs are pointing to an imminent announcement of a definitive agreement. Given the sale process history and the credibility of parties involved in the buyer group, I expect EQLS to trade with a minimal spread once binding papers are signed. This could be a timely opportunity to pocket a 13%-15% return in just a few weeks. The buyers have made several bids prior to the current one (which hasn’t been declared final), so a slight bump in the offer price could still be on the table.
In a no-deal scenario, a drop to pre-announcement levels would result in a 14% loss. However, since the sale process had been launched, EQLS posted solid interim H1 FY24 results and a very strong Q3 update. Somewhat comparable peers such as ALPH and WISE are up 42% and 12% since then, and broader UK indexes (FTSE 100 and FTSE AIM 100) have climbed around 13%. So the downside risk seems to be fairly limited.
The buyer consortium includes J.C. Flowers & Co. It’s a private equity firm ($5bn AUM) led by billionaire J.C. Flowers, renowned as a legendary investor and Wall Street wizard who became partner at Goldman at the age of 30. The other parties in consortium are TowerBrook Capital Partners, a PE firm with $14bn in AUM, and a privately held fintech player Embedded Finance (formerly known as Railsbank/Railsr).
There are a couple of reasons why this opportunity exists. EQLS is a London AIM-listed micro-cap (albeit with decent liquidity), so it’s flying under the radar for most arbitrageurs. Management has been in negotiations to sell the company for the whole year and the initial suitor (not the current buyer group) walked away after a lengthy due diligence process. So, it’s not surprising that investors have been frustrated and lost hope. However, as mentioned earlier, recent developments look very promising.
The sale process has been quite long so far. Here is a brief timeline of developments over the last year:
- Nov 1, 2023 – the company noted recent market speculation and confirmed the ongoing strategic review. As part of that process, the company reached out to a small group of potential suitors, including Fleetcor Europe and Madison Dearborn, both of whom are EQLS’ peers. Fleetcor is a $21bn payments giant (CPAY), while Madison Dearborn is a private equity firm, which had recently acquired MoneyGram.
- Nov 3 – Fleetcor confirmed that it had been contacted by EQLS, but said it had no intentions to make an offer.
- Nov 29 – it was announced that Madison Dearborn had started the due diligence (first PUSU date extension).
- Mar 20 – EQLS noted recent press speculation and confirmed that it had received a non-binding proposal from a consortium comprising Embedded Finance and TowerBrook Capital Partners. The offer price was not disclosed.
- Apr 17 – management published an update on the strategic review: “Having now received indicative non-binding proposals from both MDP and the Consortium, it considers it to be in the best interests of shareholders that the Strategic Review remains ongoing to allow further time for it to reach its conclusion.”
- Jun 12 – Madison Dearborn backed away from the takeover. However, it was noted that the parties continued discussing some commercial agreements between EQLS and MoneyGram.
- Jul 10 – a £1.35/share bid from Embedded Finance and ToweBrook Capital was publicly announced. The offer followed “a series of prior proposals” from the consortium.
- Aug 7 – EQLS noted that due diligence had been “substantially completed” and the buyer group was arranging financing;
- Sep 4 – J.C. Flowers joined the consortium. Management noted that discussions were at an advanced stage and the progress was being made to a fully equity financed bid, backed by TowerBrook and J.C. Flowers. PUSU date was extended to October 2.
If we trust managements word, the due diligence is nearly done and negotiations are in advanced stages. With J.C. Flowers stepping in to finance the deal after 6 months of due diligence, the buyer consortium is now fully committed and is very unlikely to back out (my humble opinion only).
There’s one more thing. On September 10, EQLS released interim results, which included this interesting language about the proposed 1p dividend (emphasis mine):
The Consortium has confirmed that it does not intend to invoke this right in relation to the interim dividend declared today meaning that, should it proceed to make a formal offer for Equals, shareholders will be entitled to receive the interim dividend in addition to any offer consideration payable by the Consortium should it proceed to make a formal offer for Equals.
The proposal for the interim dividend is being made with the consent of the Consortium.
I don’t think management would be phrasing it this way unless they felt really confident about the negotiations and expected a definitive agreement to be signed soon.
Some other details
EQLS was initially a B2C payments and FX exchange provider, struggling to keep up with larger competitors. In 2017, the company shifted focus and launched a new B2B channel targeting SMEs. However, the real growth engine kicked in with the launch of the Solutions segment in 2021, offering services to large corporates. This segment has been expanding rapidly (with sales up 82% YTD and 97% in FY23) and now accounts for 41% of EQLS’ total revenues. You can see the revenue segmentation below. All of this growth was achieved with very minimal contribution from acquisitions.
Recent results have been very strong. Interim report showed a 33% increase in revenue and a 30% rise in adj. EBITDA. In the same report, management also provided a partial Q3 update (covering July 1 to September 6), which showed revenues accelerating to 49% YoY during that timeframe.
EQLS is currently valued at 8.1x TTM adj. EBITDA. While there are no direct peers, two larger “somewhat comparable” comps – ALPH (similar growth, but higher margins) and WISE (faster growth and slightly better margins) – are trading at 15x and 17x adjusted EBITDA, respectively. Another peer, MoneyGram, was acquired at 5.5x LTM EBITDA last year, but it was a troubled company dealing with regulatory issues and messy financials.
This is likely an incredibly obvious question to most of you who know about all of this stuff, but I don’t understand it and I’m looking for some help and would be much appreciated for any help that you can provide. When I go to IB and search for Equals, this ticker comes up but the price is listed as 117. The price referred to above is in pounds as 1.35 per share. What is the relationship between that 117 and the 1.35? Is this a different listing for the company? Or said differently, why can I not find this on IB at the price referenced in this write up?
Again, I’m aware this is a dumb question, but I’d rather learn and ask and show my naive nature in this rather than simply go uninformed.
British stocks are quoted in pence so 117 = £1.17
Thank you!
EQLS is actually very illiquid.
Its situation and trading arrangement is similar to other AIM SETSqx small caps (e.g., MRL, also covered on SSI), with almost all of its reported volumes being off-book trades.
There is basically no continuous market and one has to find luck in one of the five auctions (8am, 9am, 11am, 2pm and 4:35pm)in each trading day.
Thanks for the write-up. I think it is worth pointing out the following:
“As stated in our interim trading statement, overall profitability is helped by our interest income, which is earned on client safeguarded funds. Equals allocates interest income to the product line that generates the balances. Whilst Equals does not expect interest rates to revert to near 0% levels, some retracing of interest rates is likely. Equals expects to be able to offset this with continued growth in balances combined with extracting better rates from our banking partners.”
Interest income for H1 was 9.6m (11.2m for entire 2023). That makes the adjusted EBITDA growth a bit less impressive – they’re riding the high interest wave.
And it also makes the comparison with WISE a bit tricky: I believe you use their ‘Underlying adjusted EBITDA’ metric to calculate the EV/EBITDA ratio. But WISE backs away excess interest earnings there. Excluding that adjustment WISE is trading at a much lower multiple.
Still an interesting setup, but the quality of earnings was (for me at least) a bit less impressive than I initially thought.
There are two ways to look at this. The first one is as you suggest – they are riding the interest rate wave, which has pushed revenues and EBITDA higher, potentially temporarily.
The other way to look at this: interest rate income can be regarded as part of the total fee bucket that the company generates from its clients. I.e. other fees are lower because of this side-income from higher interest rates.
When management says that Equals expects to offset potential decrease in interest with continued growth in balances, I think there is strong justification for that as the balances have been expanding rapidly. From the latest earnings release:
“Interest earning balances have risen sharply from an average of £313 million in H1-2023 to £350 million in H2-2023, £438 million in Q1-2024 and £533 million in Q2-2024.”
That’s 55% growth in customer balances YoY, which kind of corresponds to strong revenue growth even excluding interest income.
In any case, I do not think it has any implications for the £1.35/share buyout, but I agree that this income muddles the comparison with peers.
Equals with an update on the strategic review:
– discussion with parties in an advanced stage, due dilligence almost completed
– 135p all cash offer still on the table
– PUSU deadline extended to Oct. 30
You can read it in full here: https://www.equalsplc.com/content/news/archive/2024/021024
I think it is positive, spread is just short of 20%
The deadline was pushed to the end of October and it was confirmed that the due diligence has substantially been completed (deja-vu!) :-D
Are the buyers trying to push the price down from 135 GBp or do you think this further delay is business as usual (from personal experience the work involved in taking over a small company is often the same as taking over a big one!)?
It’s hard to say. Negotiations with the consortium have definitely dragged on for quite a while now. I’m not sure what’s causing the delay in completing due diligence, especially since they claimed it was “substantially completed” back in August. That’s likely why the market is pricing in a very low chance for the deal to go through. Despite that, I still like the setup.
Hi DT,
With regard to this comment: “secured financing a few weeks ago” – I think I am/was missing something.
Would you please point to the source of this confirmation because in the release dated 4-Sep-24 they still said:
“In order to allow further time for the Consortium to complete its due diligence and agree acquisition financing arrangements…”
This, to me, implies financing was not secured then.
In the 2-Oct-2024 release (post idea publication) my inference based on the change in language relative to the 4-Sep-2024 release was that financing is no longer an outstanding issue, however, it was still not expressly stated, only implied.
By ‘secured financing’ I was referring to J.C. Flowers joining the consortium as well as equity financing discussions with TowerBrook and J.C. Flowers. Probably should not have called it ‘secured’, but that’s the impression I got from the press release at the time. The latest update on Oct 2 (where, as you suggest, the financing is no longer mentioned as an issue) seems to confirm that.
Out of interest is there a reason regulatory risk is not discussed in this pitch?
What regulatory issues do you see here?
I did not discuss these, as I did not foresee any.
I just asked because most merger arb pitches mention them, so I thought I’d ask. I personally have no idea.
In addition to competition authorities, banking regulators in UK, Belgium, and France have to approve the merger because Railsr (a smaller and less established player) and private equity firms (which tend to raise suspicions from regulators and the public) will gain access to EQLS’s licenses in these countries.
This may explain the more prolonged timeline (Shareholders should approve the merger on Jan 8, but closing is expected only in Q2).
Spread has now widened once again to around 20% – I haven’t seen any major updates, PUSU date remains October 30.
FWIW, here’s the current sentiment summarized in this comment from LSE forum:
“I did write to EQLS expressing my bitter disapointment. Long stor short – the length of time to conclude, the poor price offered based on where we are today, risk around IP etc.
EQLS response was nothing new as you would expect. Just an elaboration of the timeline needed for a consortium to all align”
https://www.lse.co.uk/SharePrice.html?shareprice=EQLS&share=Equals-Gp
advancing at snails pace – https://www.equalsplc.com/content/news/archive/2024/301024.
Another (last minute) PUSU extension (to Nov 20). Offer bumped by a 2c special div to be paid upon closing (they really hassle over every c and %).
due diligence completed.
still non binding phase.
consortium working on transaction documents.
Equals with an update:
– PUSU extented to Nov. 20th
– offer sweetened to 135p +2p special dividend
– DD completed by the consortium, transaction documentation progressing (whatever that is)
Looks good to me.
https://www.lse.co.uk/news/equals-group-says-takeover-tilt-sweetened-amid-deadline-extension-vnalxq3jyun13y6.html
Spread of 11% remains, which seems wide for a deal that has reached “transaction documentation” preparation stage.
Are there any other hurdles (e.g. regulatory) other than a binding offer and shareholder approval?
Spread does seem wide (at ~120p) but because it trades in the irritating auction system I’m not sure how easy it is to get a fill…. and then adjusting the price mid auction seem to knock the order out until the next auction (though I’m not sure if that’s how it actually works). It all seems so typically archaic.
Depending on how you structure the takeover, you can even get around shareholder approval at an AGM in the UK (scheme of arrangement vs. contractual offer).
Point 5 here:
https://www.burges-salmon.com/news-and-insight/publications/guide-to-public-takeovers-in-the-uk#offer-structures
Definitely a positive update, the increased price/DD being done implies buyer is still very much interested. I don’t see any other major conditions written. Remaining spread is around 12% as of now.
We got another PUSU extension till Dec 11.
On the previous PUSU extension it was reported:
“The Consortium has also confirmed it has completed its due diligence and is advancing necessary transaction documentation.”
Today’s extension reads (emphasis is mine):
“Whilst the Consortium has completed its due diligence in relation to Equals, the formal announcement of the Possible Offer under Rule 2.7 of the Takeover Code requires the Consortium partners to have concluded their own negotiations regarding the basis on which Railsr will be contributed in parallel with the Possible Offer.”
Any thoughts what the part in bold could mean?
Could that mean that the parties still have to agree how the entity that takes over Equals has to be set up? For example, is this takeover 50%/50% financed by TowerBrook/JCFlower or are they going for 60%/40% etc.? In that case it would be “internal” to the investors and nothing to do with Equals.
That would be my guess.
I don’t think Railsr (Embedded Finance) has much money. It was sold in a pre-packaged bankruptcy in 2023 for less than GBP 1 million.
My guess is that Railsr is contributing itself to the consortium, and they plan to merge Railsr with EQLS. So TowerBrook and JC Flowers (who are contributing cash) are trying to determine how much Railsr should be valued?
https://www.railsr.com/post/embedded-finance-secures-significant-new-funding-positioning-the-company-for-a-return-to-growth
Apparently Rails received $24m in funding roughly a year ago. It really looks like they are haggling about the valuation of Rails as part of the offer (like snowball suspected).
To me that does not look as bad as the share price suggests.
https://www.londonstockexchange.com/news-article/EQLS/rule-2-7-announcement/16807075
Took a while and shareholders were probably taking on some risk that did not materialize, but here we are. Even a small bump compared to the last proposal, if I’m not mistaken (135p + 5p dividend). Nice outcome.
Under the terms of the Acquisition, Equals Shareholders shall be entitled to receive:
140 pence in cash per Equals Share (the “Cash Value”),
comprising a cash consideration of 135 pence for each Equals Share (the “Cash Consideration”) plus a special dividend payment of 5 pence in cash per Equals Share that the board of directors of Equals intends to declare prior to completion of the Acquisition with the record and payment dates aligned with the corresponding dates for determining entitlements to, and payment of, the Cash Consideration due to Equal Shareholders under the terms of the Acquisition (the “Special Dividend”).
Closing expected in Q2 2025. Currently there is a 3.7% spread for 5-6 month holding period.
A solid outcome overall. The offer has been slightly improved with the dividend part increased from 2p to 5p, bringing the total offer price to 140p.
So far 15% return in under three months. While there’s some remaining upside (mainly from the dividend), I do not think 3-4% for a 5-6 month holding period is worth it.