, , , , , , , ,

This post, and this one here, are good required reading. Yes, AGI Therapeutics (AGI:ID/LN) was the Risk Arb investment to which I was referring.

This is the one Irish share I did not disclose owning during TGISVP. My apologies, readers – but AGI trading volumes were atrocious, and I was still building a position with great difficulty. However, when I got to covering AGI during TGISVP, I simply tagged its fair value as simply being equal to the Recommended Cash Offer – so no issues there, I believe. Now that I recently received my final batch of proceeds from the AGI takeover, I thought it might be useful/interesting to walk through my thinking and exact positioning throughout the process.

First, let’s moan about this chart a little. I was actually looking fairly closely at AGI last year, and thought it pretty reasonable from a valuation perspective (I’ll come back to this). Yes, it would have been sweet if I’d built up a decent position at EUR 0.03 or 0.04! I even discussed trading volumes etc. with my broker! In the end, I decided not to/wasn’t aggressive enough to invest in a small cap stock, with v poor trading volume, and an annual cash burn when I saw no visible catalyst to realize value. Of course, a pure value investor would point to AGI’s subsequent takeover and say who cares about catalysts…the value was there and bursting to get out! Sure, but that perhaps ignores the 9 other value stocks that one might be holding that are going nowhere slow for 3 years…

That being said, biotech, small pharm/medical devices & venture/university spin-out companies & funds (mostly in the US & UK) can sometimes be a fruitful sector to examine – stocks can pop up with net cash that actually exceeds their market cap! Of course, they may well suffer negative cash burn, so you need to to incorporate this into your assessment of value. Despite this, on occasion you’re offered a cheap stock that has its (potentially, v valuable) intellectual property thrown in for free! Ark Therapeutics (AKT:LN) is one interesting example to take a look at. I’m no expert at coming up with a fair value for such intangibles (and I struggle how the experts can either, if they only have the same public info. available to private investors..?), but I don’t really need to if I can buy the company near/less than balance sheet cash..! Incidentally, some very well respected value/activist investors regularly invest in this space: Carl Icahn, Dan Loeb of Third Point and Seth Klarman of Baupost.

Anyway, on Jan 9th, a Recommended Cash Offer was announced for AGI. Refer back to my ‘takeover as catalyst’ post for a risk spectrum of (the huge variety of) deal announcements you might see. This announcement was at the low end of the deal risk spectrum. In fact, there’s only one small kink in this announcement – but let’s run through all the key facts, with comments. Note: I want to be quite specific here, so I’ll focus on the usual UK/Irish takeover ‘process‘, but everything’s v relevant for the US also, for example, with minor tweaks:

Pre-Conditional:  This was an unusual kink, but a bit of a red herring. I guess there was a hiccup regarding irrevocable undertakings (which are always good to see from directors & major shareholders in any deal announcement), but these were received & the pre-condition satisfied later that day.

(Unanimously) Recommended:  The upside: V likely the deal will go through, but much less likely you’ll see a higher/another bid once a deal’s recommended. The downside: If it’s not recommended, don’t be surprised if the directors try to ignore, reject and/or sabotage any bid(s)…

Cash Offer:  Far better than a share/part share offer! Deal value’s fixed, funding availability’s generally been pre-confirmed, odds of success are far better, and there’s no difficult/impossible hedging to contemplate.

Offer Price:  $0.1171 per share. Shareholder can elect to receive USD or EUR. Important to track FX conversion protocol here, so that Price can be tracked accurately.

Offer Value:  This is important for valuation purposes. It (and ideally the Rule 2.10 announcement) will specify/imply the expected increase in the outstanding share count. Remember, a takeover will likely trigger an immediate vesting on all options/warrants, and could additionally trigger other incentive/termination/’golden parachute’ share issuance. This is especially true in management pork heaven – yes, the US! With AGI, it looks like about 39% of outstanding options will exercise, increasing the share count about 6%.

Deal Premium:  Closely examine stated deal ‘premiums‘, or the undisturbed share price (you’ll sometimes see obvious ‘news leakage‘ pre-announcement!). This offers a guide to your downside if the deal falls apart… I tend to see two extremes, however, upon deal failure: Share price settles at a decent premium to pre-takeover price due to hopes for another bid, or because investors take notice of highlighted intrinsic value. Or the share price just blows right through the prior price, under a deluge of disappointed sellers. There’s a 67% premium on the AGI deal, so this represents a higher level of price risk if the deal failed – calculating underlying instrinsic value will be an important reference point also.

Tracking premiums for all deals is definitely something you should do if you’re serious about doing some Risk Arb. It’s especially useful if you want to invest in situations where bid interest, or a company sale, has been announced but no deal/price has been confirmed. Tracking sector/market premiums will give you a good idea of remaining potential upside, vs. the risks involved. In some instances (small stocks!), it amazes me how excitable PIs will bid up & eliminate any likely premium when a takeover is still only a possibility… In general, I would peg the average deal premium at around 33-40%, but this average does expand and contract over time depending on sector & the general investment ‘climate‘.

Fair & Reasonable:  Huh? Surely Recommended includes the usual ‘fair & reasonable’ opinion from the board/advisers? Nope – I’ll name no names, but I’ve seen it missing on a few occasions. Which increases deal risk… Substituted will often be something like ‘we hate the offer, it’s far too low, but for various reasons we’re going to recommend it to our long suffering shareholders‘. Bizarre, I know, i) So, you’re basically telling me you can’t run the company well? Right, I already knew that, but now you’re telling me you can’t sell the company well either?! And why am I paying you exactly?, and ii) Just read/ponder it a little more, and a whopping great conflict of interest is sure to pop up..!

To be continued…