Disclosures / Disclaimers
We have a small portfolio position in this entity and may add further / decrease the position at our discretion depending on future events
Please read this note in its entirety, and conduct your own due-diligence prior to investing
Summary
CETV, a media and entertainment company majority-owned by AT&T (75% ownership), is being acquired by PPF for $4.58 in cash per class A share.
Transaction is expected to close before Oct 27, 2020, which at current price ($3.98 at close on 7/31) implies ~15% return in < 3 months (though a delay is possible)
Primary risk is that the acquisition falls through - but we think this is unlikely (> 80% probability of closing, BUT this does mean there is a 20% risk of not closing)
In any case, make your decision on portfolio allocation taking this risk into account (as noted in disclosures, we have a small portfolio position)
Given AT&T's substantial ownership stake and the resulting reduced float, this stock can tend to be volatile and patience may provide better accumulation price points
Discovery & Due-Diligence
We came across CETV, when searching for the cheapest 10% of stock (using EBIT/EV) that were in the top 30% of high-quality stocks without any concentration risks.
CETV (also often referred to as CME) is a media and entertainment company that has operations in Bulgaria, the Czech Republic, Romania, the Slovak Republic, and Slovenia. CETV owns 94% of its Bulgarian operations and 100% of operations in other countries. The Czech Republic and Romania together contribute most to its revenues (~60%) and OIBDA (~70%).
A quick review of our checklist showed a serious bankruptcy risk warning and we were about to drop it - but then noticed the near-term acquisition catalyst. CETV entered into a merger agreement in Oct 2019 with an affiliate of PPF (an investment firm majority-owned by Czech businessman Petr Kellner) for a cash consideration of $4.58 per class A share (subject to closing) which per recent CETV 10-Q is expected to close before Oct 27, 2020.
Bankruptcy Risk Assessment:
Given the biggest concern as an ongoing firm is Bankruptcy Risk, we wanted to investigate this further (because if the acquisition does not close, one would not want to be left holding a financially fragile firm). From our analysis, we see that despite Z-Score being in 'high risk' territory - rest of financial health & return metrics are quite healthy and improving.
The company paid off $169 M in debt in 2019 (per SEC filing) and next debt maturity of ~$68 M is due only in November 2021
Interest expense has declined substantially & is estimated to be $22 M in 2020
Net Debt/Equity reduced from > 200% in 2014 to < 50% currently
And, very reassuringly it has $176 M in Cash&Eq. as of 6/30/2020
Also, ROIC improved to 40% and there were substantial improvements in CFO, interest coverage, FCF/Revenue over this time period
Summarizing, the probability of bankruptcy seems almost nil currently. This shows the benefit of digging deeper into the numerical data. Part of the reason Z-Score is so bleak is because of the retained earnings deficits that the company racked up in prior years.
Risk Assessment of Acquisition not closing:
This is always a possibility and a few acquisitions did get disbanded because of the uncertainty/impacts arising from COVID-19. So let's hypothesize what could be some likely causes for the acquisition falling through:
Change in strategic direction for one or both companies
Likely negative earnings impact (either expected/real)
Lack of funding
Not receiving regulatory approval
US government intervention to block sale (Senator Rubio requested CFIUS review)
Why we think the acquisition is more likely to go through than fall apart:
Change in Strategic Direction
CETV is currently majority-owned by AT&T (from their Warner acquisition). It is a very small part of AT&T business and as AT&T is trying to pay down its debt, it is highly unlikely AT&T will change its mind
PPF Group has significant telco and other interests in Central & Eastern Europe and they have tried in the past to acquire media assets. As such, CETV is a good complement to their existing telco business.
This article provides some insight into their interest in media assets and plans to integrate them into their existing telco businesses
Expected / Real Negative Earnings Impact
CETV has held up reasonably well in the current environment and even though revenues declined significantly in Q2, they managed to grow their cash flow from operations by 11% and unlevered FCF by 8%
In addition, our view is that a temporary pandemic impact is unlikely to cause PPF to change its direction given their significant interest in media assets as well as alignment with their geographic interests as noted above
Funding
€1.15 B acquisition specific financing is already in place
PPF group seems quite well-capitalized, it had > €9 B in Cash&Eq. per their recent annual accounts report
So all said, funding is not likely to be an issue
Regulatory Approvals
CETV shareholders approved the merger overwhelmingly (>99%) in Feb, 2020
Regulatory approval required for Romania and Slovenia have already been obtained. These two national regulator approvals were listed as required in the proxy agreement
Also, as noted above, Romania is a major contributor to CETV revenues and OIBDA and so this was an important regulatory approval to receive
In addition, TV Bidco - the PPF affiliate which would be executing the merger, filed and received merger approval from the Serbian competition commission
European Commission (Competition) approval is pending: This is the core risk to monitor as CETV does have substantial TV Ad market share and PPF has leading positions in telecom markets in their respective operating regions (some of which are common and thus could give rise to technically vertically affected markets)
Uncertainty - Part 1: PPF was expected to file notification with European Commission (EC) in Q1, 2020 which was then shifted to Q2, 2020
The notification is now expected in Q3, 2020 and merger is expected to close before Oct 27, 2020 per CETV 10-Q filing (though it is subject to extension by either party in certain circumstances to January 27, 2021)
This lack of notification likely explains part of the spread we are seeing in the market - with a reasonable interpretation that the delay might be because PPF is perhaps having second thoughts regarding the merger
We think this is likely not the case for a few reasons:
PPF's media and geographic interests as discussed above
PPF's 2019 annual accounts report (released in June 2020) mentions that they expect the transaction to close in a few months
And finally, because they responded to our query with the info that PPF is "currently in pre-notification stage at the European Commission and part of the delay has been caused by the COVID-19 pandemic"
Uncertainty - Part 2: The second uncertainty arises from not knowing whether or not EC will approve the acquisition because of competition concerns
In our view, there are two precedents worth considering in this case:
Fox - Sky : See summary press release on merger decision
PPF - Nova (Bulgaria) : See addendum on PPF - Telenor merger decision
The conclusion we draw from both of the above cases is that it is more likely than not that the EC would approve this merger. The following paragraph from the addendum above is especially pertinent in our view "The combination of NBG and Telenor Bulgaria in PPF’s portfolio would give rise to technically vertically affected markets in connection with the market for wholesale supply of TV channels in Bulgaria, the market for retail supply of TV services to end users in Bulgaria and the market for the sale of TV advertising space in Bulgaria. However, given the lack of circumstances which would allow the Parties to engage in market foreclosure, there arise no competition concerns in this respect". (NBG = Nova Broadcasting Group)
However, despite the EC approval, the Bulgarian Commission on Protection of Competition (CPC) asked PPF to divest NBG (although it drew flak for what was seen as a political decision especially because they seemed to apply a different standard for Nova's acquisition by another company)
This is still possible in the case of CETV with regard to its Bulgarian operations. However, in our view, this is not very likely/material because CPC would likely not want to be seen as changing the rules again and besides, bTV is one of the smallest contributors to CETV business. As such, if this were to happen, PPF would most likely just divest bTV and move on as before
CFIUS (The Committee on Foreign Investment in the United States) Review
This is largely irrelevant in our point of view, BUT as a US Senator did send a letter asking for review, we wanted to assess this aspect for completeness
Since the creation of CFIUS, only 6 transactions (as of July 2020) have been blocked by presidential action based on CFIUS recommendations, these were:
1990: China National Aero-Technology Import and Export Corporation (CATIC) was asked to divest its acquisition of MAMCO Manufacturing
2012: Ralls Corporation (US firm owned by Chinese nationals) was asked to divest itself of an Oregon wind farm project
2016: Chinese firm Fujian Grand Chip Investment Fund was blocked from acquiring Aixtron, a German-based semiconductor firm with U.S. assets
2017: Canyon Bridge Capital Partners, a Chinese investment firm, was blocked from acquiring Lattice Semiconductor Corp. of Portland, OR
2018: Singapore-based Broadcom was blocked from acquiring semiconductor chip maker Qualcomm
2020: Chinese company Shiji Group was asked to divest its acquisition of StayNTouch - an American mobile property management system company
Now, there have been cases where the merger/acquisition was dropped because the acquiring party expected the CFIUS to block the transaction
However, from our review of the 6 cases above and of some of the other cases that were dropped before being blocked, we observed that those involved concerns regarding US physical / real-estate / intellectual property / personal identity assets
As the above factors do not apply in the case of CETV, our view is that it is highly unlikely that CFIUS would recommend blocking the acquisition by PPF - but we grant that stranger things have happened.
Which leads to the question why CETV is only a small part of our portfolio, if we have high confidence that the acquisition is more likely to close than not:
A few reasons:
Our primary investing approach is to invest in high-quality companies with strong balance sheets and robust business models
The company's precedent transaction analysis places CETV's value between $3.70 - $5.10. Our valuation also comes roughly around this range (i.e., there is limited margin of safety should the acquisition fall through). For example, here are two likely valuation scenarios from the platform:
As such, and given our risk tolerance, we are comfortable with it being only a small part of our portfolio (as 80% probability of closing implies 20% probability of not closing)
Also, we can make a reasonable assumption that several merger arbitrage entities are invested in CETV and they may sell the shares immediately if the acquisition falls through which could cause a steep decline in price (given the reduced float as noted earlier)
How to keep track of this acquisition:
Links to background press releases/reports/articles:
You can read more about our platform and philosophy in an earlier post.
