Aim-traded shares in Constellation Healthcare Technologies (CHT:222p), a provider of outsourced medical billing services to US physicians, soared on Friday last week after the company announced a merger agreement with a vehicle backed by its chief executive, Paul Parmar, and CC Capital, a privately owned investment company. The offer consists of a cash payment of 293¢, equivalent to 235.5p at current exchange rates, and a promissory note worth 43¢, or 34.5p a share, which values the fully diluted equity of the company at $308m (£248m), representing a 45 per cent premium to Constellation's previous closing share price.
Analyst Guy Hewett at house broker FinnCap has suspended coverage after the announcement, but was previously forecasting a $10.2m increase in cash profit to $52.6m based on a $17.7m rise in revenue to $150.3m in 2017, reflecting the upside of acquisitions made in the past 12 months. On this basis, the exit multiple represents just under six times cash profit forecasts to enterprise value, and around 13 times adjusted EPS of 26.9¢ (21.6p).
Shares in Constellation initially surged pass the 250p target price I outlined when I initiated coverage at 178p last month ('Constellation's brightening prospects', 10 Oct 2016), but have since drifted back to a bid-offer spread of 215p to 222p. There are several reasons for this.
Firstly, the Parmar controlled entities holding 53.5 per cent of the shares will effectively take a 49.3 per cent economic interest in the new bid vehicle, and that's after banking profit on 38 per cent of its shareholding in Constellation, so the chief executive is keeping virtually all his skin in the game. That's not the case for minority shareholders, whose only interest in the new bid vehicle will be the payment-in-kind (PIK) promissory note, the terms of which are hardly overly generous: it's unsecured and unlisted; accrues interest at a paltry rate of 5 per cent a year and is repayable on or prior to the seventh anniversary of their issuance; and is denominated in US dollars, leaving UK holders exposed to currency risk.
Secondly, if the merger agreement is terminated then under certain circumstances, which in my view are not onerous, Constellation will be liable to pay CC Capital's expenses of up to $4m, and potentially is in hock for a further $10m in the event that fewer than 89 per cent of Constellation shareholders vote in favour of the merger agreement. Moreover, if a higher offer is received from a rival bidder, then Constellation will have to pay CC Capital $8m plus expenses. There is a chance that enough minority shareholders may decide not to accept the offer and that could cost the company millions.
Thirdly, the 293¢-a-share cash consideration being offered to buy out the issued share capital of Constellation's minority shareholders, who control 46.5 per cent of the shares, will cost the bid vehicle $115.6m, effectively all of which is being funded by a new Bank of America Merrill Lynch credit facility arranged by the bidder. Constellation has an ungeared balance sheet, and could just as easily return cash to shareholders by gearing it up rather than ceding control to another party. Moreover, the promissory note is funding a chunky 13 per cent of the total consideration being offered, so to place a value of 34.5p a share on this unlisted paper is unrealistic in my view given the yield being offered and the terms of issue.
Fourthly, although the 270p-a-share offer at current exchange rates is above my target price of 250p and is 51 per cent higher than the level at which I initiated coverage last month, it only represents a small bid premium above my fair value price when you value the PIK note using a more reasonable interest rate of 10 per cent. On this basis, I value the net present value of the note at only 25p in its current form and not 34.5p. Put simply, the cash consideration needs to be much higher than 235.5p a share, and the interest rate on the promissory substantially higher than 5 per cent for the offer to be worth backing. And that's why the shares are trading below the level of the 235.5p cash element of the offer, as investors are clearly disinterested in holding an unsecured low-yielding PIK promissory note in a privately owned Delaware bid vehicle.
Of course, shareholders are being given the opportunity to vote on the merger agreement at the forthcoming general meeting and it will only proceed if sanctioned by those controlling at least 89 per cent of the share capital; by a majority of the minority shareholders; and by a majority of the aggregate voting power. Frankly, there is no way I can possibly suggest voting in favour of the merger arrangement in its current form and I will only change that view if it is sweetened to include a higher cash consideration, and a considerably higher interest rate on the unsecured and unlisted PIK notes. This would act as a major incentive for the bid vehicle to redeem the PIK notes as soon as possible, and realign the interests of minority shareholders with those of the bid vehicle, including Constellation's chief executive Paul Parmar. Reject the offer.
Ensor plans an exit
Constellation Healthcare is not the only company on my watchlist that's planning a stock market exit. The same is true of Ensor (ESR:58p), a Manchester-based company focused on the manufacturing and supply of physical security products and packaging that has been selling off its divisions in trade sales. At the end of July, and following two major sales that completed at a significant premium to book value, the company had net assets of £17.5m, or 58p a share, including £10.8m of net cash, or 36p a share ('The inside track', 14 Sep 2016).
Ensor now has two remaining businesses for sale: Ellard, a supplier of electric motors and controls for the automation of doors and gates; and Wood Packaging, a specialist supplier of protective covers for furniture transportation, servicing major retail groups as well as the SME markets. The company's board is in advanced discussions for the sale of Ellard which has increased sales at a compound annual growth rate (CAGR) of 14 per cent in the past three years and lifted operating profit by 10 per cent to £890,000 on revenue up 15 per cent to £8.5m in the 12 months to the end of March 2016.
It is actively marketing Wood Packaging to potential buyers and once a sale of Ellard completes, it may consider an offer for this business from the founding Harrison family who control 54 per cent of Ensor's issued share capital "should a better, alternative offer not be forthcoming". Any offer will be "no less favourable than the best indicative offer previously received". Wood Packaging has increased sales at a CAGR of 17 per cent in the past three years and reported an operating profit of £628,000 on sales of £3.6m last financial year. Ensor releases its half-year results on Monday, 12 December, and trading in the first four months of the financial year was ahead of the same period in 2015.
The plan is to liquidate the company as soon as all the disposals complete, and return accumulated funds to shareholders net of professional expenses. Ensor has no pension liabilities, having already acquired an annuity to secure all the pension liabilities as a precursor to the wind-up of the company, so it should be a straight forward liquidation process. However, the regulatory requirement of maintaining a listing on the Alternative Investment Market (Aim), and the substantial costs involved including issuing a shareholder circular for the disposal of Ellard, and paying additional costs to its advisors, has led the board to conclude that a delisting of the shares would speed up the process, and be in the best financial interests of all shareholders.
So, in accordance with Rule 41 of the Aim Rules, Ensor has notified the London Stock Exchange of the intention to delist the shares subject to shareholder approval at the general meeting on 21 December 2016 and one that will require support of at least 75 per cent of the votes cast. It is anticipated that trading in the shares will cease at the close of business on Tuesday, 3 January 2017. The board plans to set up a matched bargain settlement facility to enable shareholders to trade their shares following the Aim delisting, and a further notification will be made once this is implemented.
Under this settlement facility, it is intended that both selling shareholders, and buyers, will be able to leave an indication that they are prepared to buy or sell shares at an agreed price to enable this matched bargain facility to work. The obvious downside is reduced liquidity in the shares after the delisting from Aim for investors who want to sell out before the company returns its cash. That may not be an issue for the directors and large shareholders, but it is an issue for smaller investors.
So is it still worth holding onto the shares?
Still, it seems sensible to save the company the substantial Aim-listing and compliance fees while the board executes the disposal of the remaining two businesses. Ensor also owns land with residential planning for seven homes in Brackley that's being marketed for sale at £750,000. Clearly, not all investors will want to hold shares in an unlisted company, which is why the shares have drifted from 66p at the time of my last update ('The inside track', 14 Sep 2016) to an offer price of 58p now. The lack of a timetable for the cash return has dampened interest too. But that doesn't mean to say there isn't potential upside if you are willing to hold on.
That's because at the current share price the company is being valued in line with book value of £17.5m, so net of the aforementioned £10.8m cash pile, and after accounting for the £750,000 land sale in Brackley, this implies a total valuation of £6m for Ellard and Wood Packaging, or a modest four times their combined operating profit last year. So, ahead of the next trading update at the time of the half-year results in a fortnight's time, and taking into consideration the potential for disposals to exceed book value, I rate Ensor's shares a hold at 58p.
Please note that in the event of Ensor’s shares delisting then they would no longer be traded on a recognisable exchange under HMRC rules, so will be taken out of an ISA if you hold them this way. Therefore, it’s worth contacting your broker to ascertain whether they will administer the holding for you outside an ISA. I understand that the unlisted shares can be held in a SIPP, so there should not be an issue here.
Finally, I plan to write updates on a number of companies on my watchlist that have reported results and trading statements recently including asset manager and stock broker Walker Crips (WCW), property company Palace Capital (PCA), asset manager Miton (MGR), student accommodation group Watkin Jones Group (WJG), car dealer Cambria Automobiles (CAMB), engineering support services group Renew Holdings (RNWH), and budget hotels group easyHotel (EZH). My next column will appear on my home page at 12pm on Monday, 5 December.
