Friday, November 6, 2020

LGL Group: Warrant Dividend, SPAC Sponsor

LGL Group is an illiquid small (~$55MM market cap) aerospace and defense parts maker I covered once before in 2017 when they did a rights offering while at the same time an acquisition offer was outstanding for their operating business.  That thesis didn't quite work out as planned, the acquisition offer never materialized into a deal, but maybe for the best, the operating business has performed quite well over the last three years, growing revenue 50% (total, not annualized) and EBITDA has jumped by 300%.

The company is effectively controlled by the Gabelli family, they own/manage the top three spots on the shareholder register:

source: tikr.com
Mario's son, Marc, is the chairman of the board and steering the ship here, although his father hasn't been shy about expressing his views in the past.  The Gabelli's have done a number of corporate actions in the last decade to increase their investment in LGL, the stock is illiquid, so in order to meaningfully increase their exposure to the business, they do things like rights offerings and backstop them.  Back in 2013, the company issued a warrant dividend with a 5 year term and a $7.50 exercise price, despite the stock trading below the exercise price on expiration, Mario exercised the warrant and added to his position.  So clearly they want more of it and are up to a similar transaction announcing a new warrant dividend to shareholders.  Here are the details from the press release, the stock trades at ~$10 as I type this:

The LGL Group, Inc. Declares a Warrant Dividend

 

ORLANDO, FL, October 29, 2020 – The LGL Group, Inc. (NYSE American: LGL) (the "Company") today announced that on October 27, 2020 the Board of Directors declared a dividend of warrants to purchase shares of its common stock to holders of record of its common stock as of November 9, 2020, the record date set by the Board of Directors for the dividend. Each holder of the Company’s common stock as of the record date will receive one warrant for each share of common stock owned. Five warrants will entitle their holder to purchase one share of the Company's common stock at an exercise price of $12.50. The warrants will be "European style warrants" and will be exercisable on the earlier of (i) their expiration date, which will be the fifth anniversary of their issuance, and (ii) such date that the 30-day volume weighted average price per share, or VWAP, of the Company's common stock is greater than or equal to $17.50. The warrants are expected to be issued on or around November 16, 2020, and the Company intends for the warrants to be listed and traded on the NYSE American on or around such date, subject to NYSE American approval.

Part of LGL's stated strategy is to be an acquisition vehicle, but since that 2017 rights offering the company hasn't made a significant deal and has mostly let cash pile up on the balance sheet, currently at $22MM (including marketable securities which is in a Gabelli fund and can swing net income around a bit).  Thus another rights offering probably doesn't make sense, but a warrant dividend could as a way to get more exposure to the company, either through adding in the secondary market if the warrant trades poorly or just in another five years, exercise the warrant again.

LGL has two main operating businesses, MtronPTI and Precise Time and Frequency, both sell highly engineered products into the aerospace and defense sectors.  The operations did about $4MM in EBITDA in 2019, with a market cap of $55MM and $22MM in net cash, you're paying about 8.25x EBITDA for the business today.  They do other things to signal the operating businesses might be undervalued, like break out the accumulated depreciation of their PPE which is multiples of the carrying value of the assets on the balance sheet.  But the most interesting asset inside LGL is an ownership stake in a SPAC sponsor, its 2020 after all, the SPAC is LGL Systems Acquisition Holdings (DFNS) which is targeting a defense business, thus the ticker.  

Being the SPAC sponsor is a great deal, depending on the final details of the deal, but often the sponsor ends up with ownership in the proforma company worth 20% of the SPAC trust fund.  If DFNS does an attractive deal and doesn't negotiate a discount of the sponsor shares, the result could be a material asset for LGL.  DFNS raised $172.5 million and trades at a 1.7% discount to the net asset value of the trust.   DFNS has about another year to find a merger, the deadline is 11/12/21, otherwise they'll send the money back to the SPAC shareholders and the sponsor is out of luck.  Here are the details on the SPAC investment:

In November 2019, we invested $3.35 million into LGL Systems Acquisition Holdings Company, LLC, a subsidiary that serves as the Sponsor of LGL Systems Acquisition Corp (NYSE: DFNS), a special purpose acquisition company, commonly referred to as a “SPAC” or a blank check company, formed for the purpose of effecting a business combination in the aerospace, defense and communications industries. Prior to a business combination, the Sponsor holds 100% of the shares of Class B convertible common stock outstanding of DFNS (the “B shares”) along with 5,200,000 private warrants at a strike price of $11.50. The B shares equal 20% of the outstanding common stock of the SPAC. Upon the successful completion of an acquisition the proforma ownership of the new company will vary depending on the business combination terms.

The Company is expected to own approximately a 43.57% interest in the Sponsor through its direct investment. Assuming the terms of the business combination are identical in capital structure as that of DFNS, the Company anticipates its economic interest will include approximately 8.7% of the SPAC’s pro-forma equity immediately following a successful business combination. There can be no assurances that this scenario and the resulting ownership will occur, as changes may be made depending upon business combination terms.

If DFNS is able to come to a deal, the value of the shares attributable to LGL could be worth ~$15MM, certainly material for a company of this size.  A couple of the DFNS executives joined the LGL board in August, possibly signaling that being a SPAC sponsor isn't a one-time affair (the mania is showing signs of cooling, so maybe that's a bit of a stretch).  Either way, it is some built in optionality inside of LGL, and could have a bit of double leverage, the SPAC shares and warrants inside of LGL and then the LGL shares and warrants.

Even though I play around with options quite a bit, not an expert at valuing the warrant itself, but if you plug in terms of the warrant into a calculator and use a 50% implied volatility, spits out about a $0.75 per warrant (need 5 of them for one share of stock).  Could trade a bit like a spinoff and certain shareholders might be inclined to sell it immediately.

Disclosure: I own shares of LGL

8 comments:

  1. Pretty funny to come across this name here since I went through all the steps you did above a few months ago (I bought then), and just went back to value the warrant this past week. Nice to be fishing in the same waters...

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  2. Is it still possible to get the warrant if you buy the stock now on Monday 11/09/20'?

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    1. I believe so, the record date is 11/9. But if you want the warrants, might be easier just to buy them in the secondary market, they'll be tradeable.

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  3. Hey, great idea. One thing: The 43.57% share in the SPAC was reported in Q1, however, in Q2 the share in the sponsor was 62.2%, which is even higher. My calculation goes as: (4.3M shares x$10 + 5M warrantsx$1)*0.622 = $30M. Where am I wrong?

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    1. I think it's 62.2% of the "initial at risk capital" but a lower percentage of the proforma company after, I pulled the language in the post from the Q2 10-Q, 8.7% of the deSPACed company.

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  4. What is the number of the warrant on the market, thank's

    A french guy

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  5. When calculating the value via the volatility, do you account for the $17.50 cap?

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    1. Good catch, I didn't, no. More just threw that in there as a reference point for when it starts trading, but my preference would be more to think of it from a fundamental point of view.

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