Thursday, October 26, 2017

LGL Group: Gabelli, Rights Offering, Acquisition Proposal

LGL Group (LGL) is a micro-cap ($15MM market cap with a vintage space age logo) that makes frequency control components for the defense, aerospace and electronics industries.  Their market is mostly a commoditized industry but they've been shifting towards higher margin offerings in recent years with some success.  LGL Group has about $10MM in federal NOLs plus some other state and research credits, but this isn't a typical patent troll type NOL shell.  Mario Gabelli is a significant shareholder, not via his GAMCO mutual funds but directly in his/his family's names and his son Marc is on the board.  LGL is a very small holding in comparison to his net worth in GAMCO but like Carl Icahn's involvement similarly small companies, Gabelli has a lot of energy, loves the investment game and especially taking advantage of tax assets.  I think its clear based on the type of business this isn't a vanity project, he owns LGL to make money even if it's small in comparison to his net worth.  I've seen him speak on several occasions and he's always mentioning the tax disadvantages faced by old fashion open ended mutual funds compared to ETFs or especially real estate held for investment.  Plus he loves boring small industrial companies (where he started his career as an analyst), so his investment in LGL Group makes perfect sense.

This is another simple thesis with a near term catalyst, LGL announced a rights offering beginning on 9/5/17 to raise a little more than $11MM to pursue acquisitions, likely to monetize their NOLs without creating an "ownership change", the offering was expected to close on 10/10/17.  The rights offering was a little unconventional because it was announced at a small premium ($5.50 exercise price) to the share price at the time of the announcement and it was going to be tradeable, at a premium, what value would the rights have if you could just buy the shares directly for cheaper?  I looked at it then, as I try to look at all rights offerings, and passed.  But on 10/5, they issued a press release announcing the rights offering would be pushed back until 10/25 because they received a non-binding cash offer for their two operating businesses making the situation a lot more interesting.  Then on 10/23 they pushed the rights offering expiration back again to 11/13, likely to give both sides more time to agree on a deal?

The shares today trade for $5.66, we know that Gabelli was a buyer at the rights offering price of $5.50 as he's essentially backstopping the rights offering and along with the current CEO will have effective control of the company after the rights offering settles.  With the potential cash offer on the table, I think it significantly de-risks the situation:
  • On the upside, we could either get straight taken out at a premium or receive a significant cash infusion to the holding company.
  • On the downside, the two sides can't come to a deal, you still have an improving operating business, the rights offering closes and the company receives a cash infusion for additional acquisitions knowing that a proven capital allocator is effectively in control of the company.
The company has $6MM in cash and marketable securities on the balance sheet, no debt, and the operating businesses did about $1MM in EBITDA over the trailing twelve months ended 6/30 (but EBITDA for the first six months of '17 was about double '16, so there's some ramp to the business happening), putting the EV/EBITDA at approximately ~10x, not on the surface particularly cheap.  But several things strike me:
  1. The investment group submitted their bid after the rights offering was announced so they must believe their offer is the superior path and has some urgency to it; 
  2. Gabelli likely can't buy significant amounts of shares on the public market, either for liquidity reasons, or because he has non-public material information, but he can have the company conduct a rights offering and acquire shares that way, oversubscribe, and gain control of the company; 
  3. The company is run by a 40+ year industry veteran in Michael Ferrantino, however he came to LGL in 2014 to spark a turnaround, he's 74 years old, the business trajectory is turning for the better, is now the time to cash out and retire?
It's worth noting that the company did receive a similar offer for parts of their operating business in June 2013 and turned it down, but the offer spurred strategic review that led them down their current positive path, so it's certainly possible the same thing happens again and a short term catalyst speculation turns into a longer term bet on the jockey type investment.

Disclosure: I own shares of LGL

29 comments:

  1. Thanks for the idea. Did you purchase your position above the rights offering price . Are the shares today trading with rights. Would you intend to exercise your rights. Thanks.

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    1. Sorry - completely whiffed on discussing the rights themselves. The rights are publicly traded under "LGL RT", it takes 4 rights to buy 1 share of LGL, 3 rights were distributed for every share, so they're no longer attached to the stock currently, you'd need to buy the rights separately. My average cost is just above the exercise price, don't own any of the rights themselves but I am looking to add if I can get filled, then would recommend oversubscribing.

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    2. thanks--unfortunately stock up a lot

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  2. An $11m rights offering on a $15m market cap won't trigger NOL limitations??

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    1. No, that's the entire reason for doing a rights offering - everyone has an equal opportunity to add to their position, maintain their % holding in the company, and still raise significant capital. It's been the playbook for anyone with significant NOLs.

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  3. Hmm so what happens to the currently tradable rights if the rights offer is cancelled and they pursue the merger instead? Or are those 2 events not mutually exclusive..

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    1. That's good point too. The rights offering can be cancelled and rights purchased on the secondary market would be worthless (I think), but I don't think they're necessarily mutually exclusive events. The investor group could buy the operating business for cash from LGL, LGL could pair that cash alongside the funds raised in the rights offering and go purchase another business? There are a few potential paths here. Thanks, good comment.

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    2. Raising more capital to acquire a larger earnings stream that can more quickly harvest the NOLs makes sense, particularly since those NOLs might be worth less farther out in time if Congress passes the tax cuts. I guess there's also no way Gabelli could "sell" those NOLs to a buyer without triggering limitations?
      The oversubscription play makes sense (particularly to smaller holders, since larger shareholders are limited in the extent to which they can participate in oversubscription), but factoring in the likelihood of this particularly rights offer not being cancelled into an expected value seems a tough exercise. Thoughts?

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    3. I think you're right on both your points, NOL rules used to be a lot looser but the IRS cramped down on that a while back. And yes, be careful about buying significant amounts of the rights on the secondary market to oversubscribe because there's a chance the rights offering gets cancelled, but hopefully that would be parallel with a buyout offer dulling same pain. I still just own the shares at this point.

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  4. MDC,
    Is it your understanding that if one buys say 12 shares of the LGL.r, one would be able to execise the rights for 3 shares of common at $5.50 each and still be able to oversubscribe for more shares of the common. Or, instead, would you be able to exercise the rights for shares but NOT be able to participate in the over-subscription because one was not a record holder on 9-5-2017. In other words, in transferring the rights from buyer to seller, do the rights also transfer the ability to oversubscibe?
    Thanks, Peter

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    1. I believe the oversubscription rights are attached to the rights themselves, you should be able to buy them on the secondary market and oversubscribe, the record date shouldn't matter here. Thanks.

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  5. Thanks for the idea. IMO the stock is fairly priced @ $6. Owners earning multiple seems in line with the stock price. I haven't studied the company in detail but based on the previous years earnings the company is trading over book. My guess is that it is b/c of Gabelli? The easy money would be if a take over occurs (but what would happen to the NOLs?) or if the business continues to report improving results (personally, I have no expertise in the industry). Hope to hear your thoughts...

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    1. I think you sum it up pretty well, there's a potential short term profit opportunity (that's what I view as the upside) and if not, a longer term opportunity to invest alongside Gabelli.

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  6. https://seekingalpha.com/pr/16997466-lgl-provides-update-non-binding-acquisition-proposal-lgl-reminds-shareholders-rights-offering

    Investment group's offer is $14MM for the operating assets. Plus $6MM in cash, the rights offering is still on which will raise $11MM in cash, new share count will be 4,682,063 shares. If the deal is consummated, I have the pro-forma company with $6.40/share in cash on the balance sheet?

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    1. Yes, I think that's accurate, plus whatever value one supposes the NOLs have. There might be some capital gains tax incorporated by the markets. But I think the spread is mainly there given the unsolicited + conditional nature of offer, relative to more uncertainty about going-concern value of the operating assets if the sale doesn't go through. On the other hand, if anyone has powers of analysis that materially derisk those concerns, then it's an inefficient price.

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  7. I am coming to the same value, weird that trades are happening lower?

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    1. plus the NOL is still intact...

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  8. Interesting to see the spread blow out here. Do we know what the deal terms were from 2014?

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    1. I don't know if its relevant here, hard to know if its the same party? Sounded like back then it was only for pieces of the business.

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  9. anyone look at the rights? trading at 1c

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    1. It's about fairly valued then, at least with the stock at $5.60, which seems very strange to me, can't come up with a reason why the shares would sell off given the news.

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    2. the only thing i can think of is it was misread as $14mm offer, including cash on balance sheet.

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    3. Rights -- selloff might be due to exercise expiry (broker notification period etc).

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  10. Did the rights expire worthless?

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    1. Sort of. They're worthless if you don't exercise them, so now that we're past the exercise date, they're worthless if that makes sense. The rights themselves don't have any value, but those who owned them should have exercised for the right to purchase the stock at $5.50 for a stock that's now trading at $5.54, a tiny discount. Still strange to me to see the stock trade down here, but I already own a full position in it.

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  11. Final results from the rights offering: they sold 1,698,983 shares for $9.4MM, since they sold less than excepted, the dilution is less than expected, by my math if the company takes the $14MM offer (assuming no taxes) they'd have $6.72/share in cash, ~$5.50 is really a silly price for it to be trading at now.

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  12. Is there a chance that sale would still trigger some amount of taxes? Any idea what tax basis could be?

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    1. I'm not sure, sounds like they're structuring the deal to keep the NOLs, any taxable gain would likely be offset by them.

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    2. NOLs offset gain on sale -- exactly, that's a great point. Even if they forfeit the remaining NOLs, stock's still trading below cash. There is the small matter, though, of what Gabelli's son does with all that capital, given his history (link below) and the fact that LGL's liquid investments are currently placed with mutual funds he controls. http://www.businessinsider.com/marc-gabelli-market-timing-lawsuit-reinstated-2011-8

      Thoughts? Do those red flags warrant this pro-forma "trapped cash" discount?

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