GCAP - Gain Capital

[JayGatsby]

So Gain Capital owns Forex.com and a bunch of other forex trading sites. The sites basically make money on volatility. The wider the spreads the more profit they make. Last year they got crushed, because there was no volatility.

 

If February they announced a deal with INTL FCStone (INTL) at $6 a share. They hold a lot of cash for liquidity purposes, and tangible book is $5.60 per share. The deal was a big premium to where the shares had traded, because GCAP kept printing losses

 

In today's environment profitability should have exploded ($100M+ of EBITDA, minimal capex). So I think as a shareholder you actually want the deal to fall apart. Expected to close Q2 (44% of shareholders voted to approve). So you have a wide spread (currently 5.32), backstopped by TBV, and a deal you arguably don't even want to go through anymore.

 

 

[Foreign Tuffett]

This is a really interesting idea. One thing that makes me cautious is that GCAP was trading @ ~$3.50 before the deal was announced, so if the deal breaks one would need to have a great deal of confidence in the business performance.

 

Can you share how you get to the $100M+ EBITDA number?

[JayGatsby]

Page 7: http://ir.intlfcstone.com/static-files/7f55d3d7-99ef-4f46-a37c-c7a4764c8879

 

They sold their institutional division, so earnings power is a little less. Volatility is also higher though.

[samaniv]

This seems like a great idea. Its hard to know where the EBITDA numbers will shake out if the deal doesn't close, though.

[samaniv]

Hi Jay,

 

Any thoughts on the release today? I feel it should be pretty much meaningless given the spoke in vol subsequent to quarter-end.  The gap to acquisition value is widening. Also, are you at all concerned about their ability to manage their net exposure through these patches of extreme volatility?

[JayGatsby]

It was the 10-K right? They'd already announced the results. 2019 results were horrible, which was shy it was trading so low.

 

The volatility so far seems pretty manageable. The volatility that has caught these companies in the past is things like the swiss franc peg, when currencies move 20% overnight. In those cases they have margin calls that they can't recover. As long as they're able to adjust, vol is their friend.

[DW1234]

I like this deal. Both companies thrive in this current environment, which makes it less risky that the deal gets terminated. Also downside price might move a bit upwards due to this. On top of this INTL has a rich history of succesful mergers.

 

This is not the only merger down a substantial amount. I'm always worried about missing something. But in this case I think that the combination of a market looking for liquidity ASAP + panic is more of an explanation for the current price than assuming the market has carefully weighted the impact of corona wrt the odds of this merger succeeding. All in all, I like the risk-reward here.

 

 

[samaniv]

Jay,

 

Do you know why they had relatively strong EBITDA in 2018 despite the CVIX being at such low levels?

 

Thanks,

Viraj

[DeepValuePlay]

When is the deal expected to close?

[writser]

I don't know. Wouldn't surprise me if a close is announced today .. Up 6% intraday and now trading at a ~2% spread. Had a small position but sold just now. Price movement seems a bit suspicious if there's no news. I'm probably at the stupid end of the transaction selling right now, it's very possible I'm missing something, but in this market I'm not holding for such a tiny upside if I don't see any news.

 

Lots of mergers traded at crazy levels in March. This too, I managed to scoop up some shares at $4.70 on March, 23 or a 20%+ spread. Not that I want to pat myself on the back - it was easy only in hindsight.  I spent too much of my dry powder way too early and when the shit really hit the fan mid-March I didn't have that much cash to deploy. Not to mention that I was scared.

 

Anyway, some normalcy returning in the market. Covid-19 is a real risk for merger deals (already a few have been cancelled or delayed) but this situation seems relatively Corona-proof and a 20% spread seemed somewhat overdone. On the other hand, right now, at a 2% spread I don't think it is particularly attractive. Not even when I completely ignore the whole Corona-thing ..

 

Finally: interesting idea, thanks all for bringing it up and the subsequent discussion.

[Jurgis]

I don't know. Wouldn't surprise me if a close is announced today .. Up 6% intraday and now trading at a ~2% spread. Had a small position but sold just now. Price movement seems a bit suspicious if there's no news. I'm probably at the stupid end of the transaction selling right now, it's very possible I'm missing something, but in this market I'm not holding for such a tiny upside if I don't see any news.

 

Likely it went up just because all market was going up and merger spreads were closing too.

[JayGatsby]

Glad it worked out for you. I've held the company for a few years now and would actually love to see the deal fall apart, but expect it to close. Not a bad outcome for me overall, but unlikely timing for them to ink a deal right before vol exploded.

[Hielko]

I don't know. Wouldn't surprise me if a close is announced today .. Up 6% intraday and now trading at a ~2% spread. Had a small position but sold just now. Price movement seems a bit suspicious if there's no news. I'm probably at the stupid end of the transaction selling right now, it's very possible I'm missing something, but in this market I'm not holding for such a tiny upside if I don't see any news.

 

Likely it went up just because all market was going up and merger spreads were closing too.

Now explain today's move down to me ;)

[Jurgis]

I don't know. Wouldn't surprise me if a close is announced today .. Up 6% intraday and now trading at a ~2% spread. Had a small position but sold just now. Price movement seems a bit suspicious if there's no news. I'm probably at the stupid end of the transaction selling right now, it's very possible I'm missing something, but in this market I'm not holding for such a tiny upside if I don't see any news.

 

Likely it went up just because all market was going up and merger spreads were closing too.

Now explain today's move down to me ;)

I should be paid for this.  :P  8)

[writser]

GCAP had a very good quarter with an expected net income of ~80m usd (vs. a 222m market cap). April probably won't be too bad either.

 

Also a preliminary proxy was filed. I especially recommend reading pages 40 - 43. Interestingly one director is consistently against the deal (and already was so before the Covid-19 outbreak:

 

Mr. Goor continues to be opposed to the merger, as, in his view, the basis for his previous dissent – that the merger consideration did not reflect the long term value of the company – has become significantly more pronounced, and, on March 31, 2020 the valuation of GAIN implied by the merger consideration of $6.00 per share was 19% below GAIN’s adjusted tangible book value.

 

In view of current events the board is "continuing to review its recommendation". Some snippets:

 

+ the fact that if the GAIN board were to make an adverse recommendation change involving or relating to a company intervening event, INTL would be entitled to terminate the merger agreement and, in connection with such termination, GAIN would be required pay INTL a termination fee in the amount of $9 million.

 

+ the fact that the significant improvement in GAIN’s financial performance in the first fiscal quarter of 2020 (as compared to the same fiscal quarter in 2019) was primarily due to the extraordinary developments resulting from the COVID-19 global pandemic, including significant increases in ADV and RPM, and there can be no assurance that such improvements in financial performance would continue or be maintained

 

+ the fact that GAIN’s exploration of strategic alternatives involved a lengthy and thorough auction process involving 108 potential bidders, in addition to INTL, which included both strategic and financial potential acquirers, eight of which, in addition to INTL, entered into mutual confidentiality agreements with GAIN and received information related to GAIN, but none of which resulted in a credible, financed alternative transaction other than the merger, and as a result, if the merger agreement were to be terminated, there was a considerable risk that no credible, financeable alternative transaction would be available, and

 

+ the fact that stockholders of GAIN who comply with the requirements of the Delaware General Corporation Law will have appraisal rights in respect of their shares and will be able to seek such appraisal if they believe that $6.00 per share in cash does not represent a fair value for their shares.

 

- any increase in the tangible book value or cash position of GAIN resulting from the developments described above cannot be distributed to GAIN’s stockholders as a result of the restrictions on dividends in the merger agreement.

 

At this point there is basically no spread left. But there seems to be a non-zero chance of the board changing recommendations. Maybe a small price bump is in the cards? Not sure what to think about it at this point. Interesting situation, at the very least.

[JayGatsby]

Wow. What's nuts about the $80M is January and February were still fairly subdued. Volatility didn't really hit until a week into March. The company has some NOLs, so the change in cash will really be closer to the $100M EBITDA. Far better than I expected. Vol is down, but still quite elevated, and seems unlikely it goes back to really low in the near term.

 

I don't know enough of the law to be confident, but seems like a higher value is a real possibility. Am I understanding Delaware law correctly that a company basically has to pay fair value for what they're acquiring regardless of what was signed? So you have the money losing $3.50 company as of late Feb, balanced with a massively profitable company in March?

[Hielko]

I assume you are referring to the appraisal rights. It's a costly procedure for shareholders to take since lawyers aren't cheap in the US, and it's only possible if you have followed all the rights steps in the process (voting against the merger, not sell/buy your shares in the process, notify the company that you want to exercise your appraisal rights in the right way etc). But for large holders it could be an option.

 

But and this is a big BUT: I believe that it is still about the value of the company the date the merger agreement was signed. It doesn't really matter that the company won a lottery ticket after the deal was signed. Furthermore, in case of GCAP, they did run a very competitive process to find the acquiring party, so it's tough to argue that this was not a fair transaction that was at arms length etc. Seems pretty questionable to me.

 

If the company/shareholders think that the deal is no longer attractive the way out is just voting against the merger. Will cost them a few million for the termination fee, but think that's really the only option. And if enough shareholders are happy with $6 nothing can stop this deal.

[writser]

Up ~7% today after an activist disclosed an 8% stake and pushes for a price increase to $8 (https://www.sec.gov/Archives/edgar/data/1138532/000114036120009470/formsc13d.htm)