Point of sale consumer finance business, ThinkSmart, recently held an extraordinary general meeting in which shareholders approved a proposal to buy back up to 50% of TSM’s issued capital at between $0.31-$0.42 per share.
The buyback tender opened on December 23, 2014 and will run until January 23, 2015. Accordingly, shareholders need to consider whether or not to participate in the buy back.
With $0.245 per share of cash on the balance sheet, capital management is clearly appropriate. But, as we have previously written, we are not convinced that the buy back, in its current structure, is the best outcome for minority shareholders (see Time to think about ThinkSmart, December 17, 2014).
Outcome of extraordinary general meeting – seemingly little support
TSM held an EGM for shareholders to vote on the proposed 50% off-market buy back, arguably the most important vote in the company’s history, at 6pm (AEST) on Monday December 22. Somewhat unsurprisingly, considering the timing before Christmas, only 41% of issued capital voted.
The resolution was carried, with 39.3m shares (of a 146.9m share base) voting in favour. We note that the board controls 35.9m shares, 31.1m of which are controlled by the executive chairman.
If the board abstained from voting then the motion was carried with 27% of independent shareholder interests voting in favour. If the board did indeed vote in favour, then the motion was carried with only 1.5% of independent shareholder interests voting in favour.
How does an off-market buy back work?
ThinkSmart shareholders have the option to tender any or all of their TSM shares into the off-market buy back.
Shareholders that decide not to participate in the buy back do not need to do anything.
Shareholders that decide to participate in the buy back need to return their tender form and nominate:
1. The number of shares that they wish to tender – this can be some or all of their holding; and
2. The price at which they would like to tender their shares (at $0.01 increments between $0.31-$0.42, or at final price).
It is important to note that the independent expert’s (IE’s) valuation range, on a non-controlling basis, is $0.33-$0.39. It would seem unlikely that the board will pay above this range.
Tender pricing and scale backs
It is worth noting that TSM has absolute discretion to buy back any number of shares (between 0% and 50%), at any price level between $0.31-$0.42. This has some important implications:
· Tenders below the buyback price will be accepted in full and will receive the buyback price, even if the buyback price is above the price tendered by the shareholder.
· Final price tenders and tenders at the buyback price will be scaled back if required.
· Tenders above the buyback price will be rejected in full
Off-market buy backs are structured this way to minimise the price at which the company buys back it stock.
Key issues to consider
Valuation: What is the right price to tender shares? Adjusting for the company’s $36m net cash holdings, the implied price-earnings ratio, based on management earnings expectations, at the lower end of the buy back range is 3-4x FY15 earnings, while the top end of the range is 8-9x FY15 earnings. However, it would seem unlikely that the board will pay above the IE’s valuation range which is $0.33-$0.39. The upper end of this range is 7-7.5x FY15 earnings.
As we have previously written, we have some concerns about the IE’s valuation and highlight that the top end of this range certainly doesn’t account for the potential transfer of control to executive chairman Ned Monterello.
Considering the above, it wouldn’t appear sensible to tender stock within the IE’s valuation range on valuation grounds and tenders above this level are unlikely to be accepted.
Risks: While participating in the buy back doesn’t seem like a sensible idea, there are three key issues facing shareholders if they remain a minority holder of ThinkSmart.
· Reduced liquidity: ThinkSmart already has limited liquidity. With a 10% on-market buy back currently underway and a 50% off-market buy back now approved, the prospect of a significant reduction in liquidity is highly likely.
· A potential, effectively controlling shareholder: Ned Montarello founded ThinkSmart in 1996, is the executive chairman and currently controls 21.1% of TSM. He has indicated that he will not tender his shares into the off-market buy back which may result in an effective increase in his proportional ownership of the company. If both the on-market and off-market buy backs are completed in full, Ned Montarello’s voting power could increase to 45.9%. This is an important point as under an ordinary resolution (which requires 50% shareholder approval), if less than 91.8% of votes were tendered, Mr Montarello could carry a motion even if all other shareholders voted against the proposal.
· Propsect of delisting: Without an operating business in Australia and a management team based in the UK continuing shareholders face the prospect of the company being delisted in Australia.
Limited ability for favourable tax treatment? The company has noted that if the full 64.5m shares are bought back at a price of $0.36, then ~$1m of franking credits are expected to be distributed. This translates to a capital component of $0.32 and a fully franked dividend of $0.04 per share and highlights the limited franking credits available.
So what does this all mean?
It would seem that minority shareholders have been placed in a position where they are being given an option to tender their stock at below its intrinsic value in order to avoid being stuck in an investment that has limited liquidity, could have an effectively controlling shareholder and may be delisted. In our view this is not a great outcome for minority shareholders and a very disappointing strategy by the ThinkSmart board.
Nevertheless, we would be surprised if a significant portion of stock gets bought back via the off-market buy back considering the pricing range on offer and the number of shareholders that voted in favour at the EGM. If this transpires, the board will be presented with the question as to how to undertake any further capital management. What the board decides to do in the event that the off-market buyback is largely unsuccessful in returning capital to shareholders is the key unknown.
This process has highlighted some meaningful corporate governance issues and accordingly, despite the apparent attractive diversion between the current share price and underlying value, we would be reticent buying the stock.
We have downgraded our recommendation from Buy to Hold and revised our price target from A$0.50 to $0.41. Our revised price target is based on a 20% discount to consumer finance business Flexigroup, reflecting a number of investment risks outlined above and our concerns around corporate governance.
To see ThinkSmart's forecasts and financial summary, click here.