Jaclyn: Arbitrage for the Little Guys
Arbitrage is as time-old as any market “technique” out there. When we talk about arbitrage spreads, we are speaking of two companies merging, a large tender offer, or other “workout” situations with a defined shareholder payout and a (relatively) defined time period. There are also defined reasons why our investment won’t work out. Buffett called it “upsetting the applecart.”
Introduction
When these events are announced, there is always a “spread” between the market price and the price shareholders will receive at the end of time period X, which represents doubt that the transaction will be completed. In these arbitrage situations, what can kill our investment is not market movement or changing valuation ratios, but rather corporate and legal events such as failed regulatory approval, shareholder approval, and financing commitment.
If you are new to arbitrage, I’d suggest reading Joe Ponzio’s post here. (As an aside, I participated successfully in the Tribune Co. going-private transaction late last year as well.)
In general, I can’t say arbitrage gets me psyched up in this day and age. There is a great deal of brainpower and computer power out there that can efficiently price arbitrage spreads, so it’s generally a waste of time. When you are talking about a little old individual investor such as myself, the odds of outsmarting the market plummet. For those reasons, merger arbitrage isn’t something I spend much time on.
Of course, for every rule there is an exception. When the arbitrage situations arise in small companies, we’re talking companies with sub $500mm market caps, they tend to be much less heavily analyzed by institutional “arbitrageurs.” That creates opportunity for those of us running smaller portfolios.
Jaclyn, Inc.
On that note, Jaclyn Inc. (JLN) announced last year that they’d decided to reduce their shareholder count below 300, and delist from the AMEX stock exchange to reduce costs. They decided the best way to complete this would be to pay every shareholder with 250 shares or less $10.21 a share, a sizeable premium to the then-stock price of about $7/share. The SEC filing with all of the information is here.
When I found this transaction, the shares were still around $7.50, early this year. With an offer of $10.21, the arbitrage spread was about 35%, which is a huge spread. However, if you do the math, the maximum amount of capital you could possibly put to work here is 250*$7.50 or $1,875. For anyone with a portfolio north of about $35,000, this arbitrage won’t help you much, sorry!
Luckily for me, I’m not running any sizeable portion of money, so I could participate here and it would be well worth my time. The next step was to go ahead and look at what might upset my applecart. What I found was delightful: there was really nothing!
What might upset the applecart?
One general worry in arbitrage is regulatory approval- take for example the potential merger of XM and Sirius Satellite. Regulators might say, geez guys if the only satellite radio providers out there merge, won’t there be a monopoly? Of course, Jaclyn merely wants to cease having to file with the SEC, so there is no regulatory approval needed.
The second thing that might upset our applecart is shareholder approval. While the premium was sizable enough that I didn’t think that’d be much of a problem, I looked in the proxy filed for the event anyways. I found this terrific nugget:
“ At the close of business on the Record Date, 1,257,643 of our outstanding shares of common stock (approximately 50.9%) were held by signatories to the Stockholders Agreement. As we noted above, the Stockholders Agreement entitles a four-person stockholders committee (presently consisting of Abe Ginsburg, Robert Chestnov, Allan Ginsburg, and Howard Ginsburg) to direct the voting of the shares of our common stock now or in the future owned by certain parties to that agreement, or as to which they have or may have voting power. The stockholders committee has indicated that it intends to direct the voting of these shares of our common stock “FOR” the Transaction. Accordingly, if all of the shares subject to the Stockholders Agreement are voted in favor of the Transaction, the Transaction will be approved.”
Insiders own 51% of the outstanding shares, and they will obviously be voting “yes” for the transaction, which means shareholder approval isn’t going to upset our applecart.
The last worry would be financing issues, and the relevant section of the proxy statement is thus:
“We expect that the consideration to be paid to the Cashed Out Stockholders and the costs of the Transaction will be paid from cash on hand and from funds under our existing revolving loan agreement with TD Banknorth, N.A. The revolving loan agreement provides for short-term loans and the issuance of letters of credit in an aggregate amount not to exceed $50,000,000. Based on a borrowing formula, we may borrow up to $30,000,000 in short-term loans and up to $50,000,000 including letters of credit. Substantially all of our personal property assets are pledged to the bank as collateral. The revolving loan agreement requires that we maintain a minimum tangible net worth, as defined, and imposes certain debt to equity ratio requirements. We were in compliance with all applicable financial covenants as of December 31, 2007. As long as no default or event of default under the revolving loan agreement exists, we may repurchase, and we may use the proceeds of loans we borrow under that agreement to repurchase , our shares of common stock in the Transaction in an aggregate amount not to exceed $3,000,000. In the event that the total cost of repurchases of our shares of common stock in the Transaction exceeds $3,000,000, we have been advised by TD Banknorth that it will work with us to enter into a mutually agreeable amendment to our revolving loan agreement so that we may complete the Transaction.”
So there are two sources Jaclyn plans to use to fund the transaction: cash on hand and $3,000,000 from their existing line of credit. According to the proxy, the bank has already effectively said “Yes, you can use $3m of your line of credit to purchase shares, and if it ends up being more, we’ll help.” The company has already updated the proxy several times, and they were well within their financial covenants on the line of credit as of the end of last year.
Will that $3m from the bank be enough? Well, the proxy says that the total cost of the transaction will be approximately $3.7mm:
“We estimate that the total funds required to pay the consideration to record holders who are entitled to receive cash for their shares, holders of shares in street name, and other costs of the Transaction will be approximately $3,728,000”
Thus, as long as the company has more than $728,000 in the bank, complete financing should be in place. Luckily for us, at the end of last year, the company reported $1.5mm in cash on their balance sheet, an increase from the previous quarter.
Conclusion
So what does this all mean? There is financing in place, stockholder approval in place, and the risk of regulatory approval is nil. The next step right now is for the matter to be voted on by shareholders at the annual meeting on May 7. At that point, the transaction will be approved, and they should set an effective date to pay out the $10.21 and receive the shares. Another piece of information that looks great is the 8-k filing JLN reported last week notifying AMEX that they plan to delist. That means the train is still moving forward.
The price has crept up to around $8.50 at today’s market price, which has brought the spread down to 20%. But for what shouldn’t take longer than another 2-3 months to complete, and probably less, that’s an annualized return of 80-120%, which sounds pretty darn good to me. There is no such thing as a riskless investment, and something could always come up, but I like our odds in this transaction.
Always do your own homework, and make sure to keep on top of any new developments in any investment. Sometimes being the “little guy” in the market can have its advantages.
Disclosure: I hold a position in JLN.
Hey Jeff,
Thanks for the post. I love your straigh forward and plain english description. Where do you get your arbitrage ideas from? For me it is hard to search through all the possibilties out there. Do you have a opinion on why there is still such a big spread on the JLN deal?
Thanks again
Mark
Mark,
Thanks for the kind words!
If you go to http://www.fatpitchfinancials.com, George runs a “Contributor’s Corner” where he keeps track of arbitrage situations for smaller investors. He charges an annual fee but one good situation can pay for it easily. That’s where I found JLN. Otherwise, you just need to keep your eyes and ears open for corporate restructurings, mergers, etc. announced. Read a ton (news, blogs, magazines).
As for JLN’s spread….its mostly due to the fact that only shareholders with <250 shares are being cashed out. Its such a small company, and such a small deal, that 99% of investors have no use in closing the spread.
Good Luck!
Thanks for your quick and direct answers. Jeff,
That is what I thought, but being new to this myself it is hard to have confidence in my own analysis but I am getting there. I will keep ejoying your blog!
Any thoughts on BDK. I have done a f wall street style owner earnings analysis and to me is seems to be trading at around a 60% discount.
Mark,
Glad you like the blog.
As for BDK, I haven’t analyzed the company in the past but here’s a very quick and dirty take:
Strong and stable free cash flows, which look like they have been growing over time. Their debt load looks high but managable (7x coverage is nice). They have a nice returns on capital(looks like >20%), and a strong brand name (Black and Decker is well known, obviously).
The shares also look rather cheap at 8x EV/free cash flow. The real question is if you see any significant growth. If you think the company can grow FCF at 5-6% or greater for the foreseeable future, while retaining their competitive advantages, the share are probably a real bargain.
Looks like they had a tough quarter, and you’d need to look at how strong their competitive advantages are, how they’ll perform in different environment, and quality of management. The shares are cheap but not cheap enough to buy purely because the multiple is low.
At first glance, though, BDK looks like it could be a terrific investment. Dig deeper.
Thanks for pointing out Jaclyn. I am seriously looking into it and wrote up my thoughts.
Good luck with your position…
Hey Mark and Jeff,
I came across another site that tracks arbitrage opportunities. I am not sure how current it is and how often it is updated, but it does provide a good list of announced buyouts/mergers:
http://www.arbitrageview.com/riskarb.htm
I don’t think JLN shows up on here (haven’t scanned the list for it yet) due to the fact it is going private by itself.
Any knowledge of how these transactions are handled when someone owns shares in street name? For instance, if I did do this through a brokerage such as Zecco, is there usually a fee associated with this or do you just see a cas deposit in your account one day and the shares gone? I realize that it may be tough to make generalizations since each brokerage is unique, but I was interested in anyone’s experience.
Thanks and keep up the good work!
You really can’t generalize on how street name holders will be treated. There is a section in every proxy released for these events that states how they intend to treat street name holders.
In the case of JLN, they intend to treat street name holders the same as record holders, which is great for us. You should contact Zecco and ask them about the transaction, and be positive they intend to follow through.
The only time you should be charged a fee is if you participate in a “voluntary reorganization,” generally a tender offer. In this case, if you hold <250 shares you'll be participating in an "involuntary reorganization" and as such there should be no charge.
Hope that helps.
-Jeff
Hi Jeff,
Nice post. Interesting to see how this works out.
Another good source of information is http://www.mergerinvesting.com which gets updated daily and lists all pending mergers. Although you have pay to see detailed information, the basic stuff is free and the rest people can find in the filings anyways.
Nice work.
Thanks Jae, the site looks great.
Like I said, I don’t do much risk arb stuff, but when something obvious like JLN comes along I don’t mind participating.
Not bad analysis, but somehow the trading in this bothers me,
Looks like every wanna be arb is in on this.
So why such a wide spread so late in the game?
The only good reason would be if there was a large seller that still needs to unwind.
Looks suspicious to my eye, but it could still be good.
Procol,
There are no “arbs” in this transaction- it’s just to small. The company has a market cap of $21 million. The whole deal, if you wanted to participate, the maximum capital you could put to work is around $2000 right now. The rest of the holders of the stock have no reason to bid it up and close the gap. It’s just too small. 250 shares or less.
Small areas of the market are illiquid and tend to be more prone to mispricing.
There market is there to serve you, not instruct you. The facts are laid out for all to see….nothing hidden.
-Jeff
Hey,
When would the payout be made? At the end of the quarter or immediately after the approval?
Great post and blog!
Nick
Nick,
Glad you like the blog.
The payout date will be (hopefully) set sometime after tomorrow’s special meeting. They will update the proxy with an effective date, assuming the meeting goes smoothly.
I’m hoping that in a week or two a date will have been set. I’ll give you guys an update on the situation then.
-Jeff
Jeff,
Nice in-depth post on JLN. I purchased my shares for $7.60 in early april. I have done many similar arbitrage plays over the last 2+ years (most have worked out very well). My blog, ryanhegs.com outlines each investment. Whenver I come across a new arbitrage opportunity I try to post quickly. I plan to continue visiting your blog to get your insight.
Thanks!
Thanks Ryan. I looked at your blog and it looks tremendous, I’ll add it to my RSS feed and keep up!
I see that you mentioned on your blog about JLN rumors on message boards and such. My advice? Don’t bother reading them. If the facts say yes, the facts say yes. The market should serve you, not guide you.
Thanks
-Jeff
Great blog, I’m really enjoying it!
I went long JLN 4/30 at 8.50.
Had a few observations on the situation…
– JLN says there are around 1M shares held in street name in total. They’ve assumed that 30% of these shares will be odd lots less than 250 shares. This may prove to be a low estimate.
– TD Banknorth has allowed borrow up to $3M. Based on their assumptions, they believe the total cost of this would come to $3.7M. If an extra 300k shares end up as odd lots, that would imply total incremental costs of perhaps $3.5M. This isn’t permitted under the terms of the current revolver, but TD Banknorth says they’ll work with JLN to work something out.
So… my questions are these:
–To delist, when exactly do they need to have less than 300 recordholders? My understanding is that it’s *after* the transaction, and not before.
–What will JLN do if the % of total street name shares in small lots goes to 60%?
–Will they buy everyone out prior to the Effective Date, or the Record Date? They say the Effective Date, but this seems a little unclear.
Curt-
Great questions. I’ll answer them under my knowledge.
1. They will need less than 300 record shareholders after the completion of the reverse split.
2. I don’t see any reason for their estimates to be wildly off. This is a simple part of their due diligence before agreeing to the reverse split, so I would be very very surprised if the costs suddenly doubled as you imply could happen.
If the costs do go up, they have more available cash on their balance sheet, number 1; about 750k worth. After that, their revolver with TD is a $12.5b line. They have only agreed to use $3m for this purpose so far, but made it clear that TD will work with them if it goes higher (as you mentioned). They’ll still have $9.25b of untapped credit on that line, so I don’t think TD would be opposed to them using another million or so if needed. From the 10-Q:
“As of December 31, 2007, borrowing on the short-term line of credit was
$2,905,000, and at that date the Company had $12,250,000 of additional
availability (based on the borrowing formula) under the credit facility.”
3. I’d look for the Effective Date. That’s when the transaction is “in effect”
” Stockholders owning less than 250 shares on the effective date of the Transaction will receive $10.21 for each pre-split share of common stock, without interest.”
Thanks!
-Jeff
[...] do little arbitrage situations, I mean like 3 of them ever. I think my best post was one called Jaclyn: Arbitrage for the Little Guys. I like it because I got to go, point by point, through the relevant materials in their filings, [...]