Thursday, October 27, 2016 0 comments ++[ CLICK TO COMMENT ]++

Purchase (Special Situation): Ingram Micro

I'm continuing to expand into more risk arbitrage positions. This time, Ingram Micro (NYSE: IM). Unfortunately, all are Chinese deals and there is somewhat increased risk of some event derailing all of them at once so hopefully I find something completely unrelated soon.

Ingram Micro (IM) is a reseller/distributor of information technology products, with a few additional services. It is being bought out by Tianjin Tianhai, a Shangahi Exchange publicly-traded Chinese subsidiary (shipping/logistics) of the large HNA conglomerate (aviation/tourism/logistics). It makes sense from a strategic point of view since the logistics business can be utilized by the Ingram Micro IT distributor business.

Ingram Micro is not that good of a business so it isn't one that I would be pleased to hold if the deal fails (in contrast, recall that Syngenta is one that is a good one). However, the valuation for Ingram Micro is not that high so the stock likely won't fall too far if deal fails.

With my assumptions, the expected return is around 6.5% (you are looking at a raw return of around 8% if deal closes). If the deal closes within a few months, the return is pretty good. But if it drags on, then the return is just ok.

Anyway, here is my analysis of this deal...

Takeover price: $38.90

Deal closing: 2nd half 2016

Purchase price: $35.87

Prob (success) = 95%
Return  (success) = 8%
Prob (failure) = 5%
Return  (failure) = -30% (assume it drops to $25, about 10% below pre-takeover price)

Expected Return = 6.5%

Buffett's Four Key Questions

(1) How likely is it that the promised event will indeed occur?

I think the chance is very high and think it is about 95% of success. Shareholders have approved deal. Financing does not appear to be a risk with the Chinese firm already working to line up funding (the parent company is also very large and can likely source funds if necessary). Risk lies with CFIUS, which is the American government agency that evaluates foreign takeover where national security is a concern. This entity is politically motivated and it is impossible to be certain of any outcome (their decisions are generally not consistent). However, based on public analyst comments and my understanding of Ingram Micro's business, they don't really deal with any sensitive items and don't really have much intellectual property or proprietary products/services (Ingram Micro is essentially a reseller/distributor of IT products). The small amount of business involving the US government, and it does sell some security products, have several competitors that will offer the same products/services.

Initially, the deal was not going to be submitted to CFIUS (later, after some CFIUS consultations, they decided to submit an application) and this leads me to believe that the bidder and Ingram Micro management initially felt there was little national security or sensitive products/services involved. Their assessment is probably correct and gives an indication of how confident they were with regulatory issues.

(2) How long will your money be tied up?

Deal is expected to close by 2nd half of 2016. As soon as CFIUS ruling comes out, I expect the deal to close within a month. Initially the deal was not going to be submitted to CFIUS but on the July 21 press release they stated that they were going to submit. CFIUS has a 30 day review, optionally followed by a 45-day detailed investigation. It may have been submitted to CFIUS a bit after the July 21 press release so we should be getting a ruling in October. But this can probably drag on if there are further questions and actions the merger entities have to take. A reasonable worst case might be 1Q 2017.

(3) What chance is there that something still better will transpire - a competing takeover bid, for example?

Zero chance of something better. Ingram Micro doesn't have a great business that would interest many.

(4) What will happen if the event does not take place because of anti-trust action, financing glitches, etc.?

I am guessing that the stock will drop to around $25, which is about 10% below what it was trading at before takeover. Stock has been in a range between $23 and $30 for the last 3 years. The business isn't that great but the valuation isn't that high and makes up for it. Presently, it has a P/E around 21 (forward P/E according to Morningstar of 12), P/B of 1.3 and long-term P/FCF is probably in the 20s and ROE is around 7%. If it drops to pre-takeover price, it'll be trading around book value.

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