Sepura PLC – LON:SEPU
Share Price – 15.5p
Market cap – £57.5mn
Anyone who is eagle-eyed and has been monitoring my portfolio would have spotted that I took a position in Sepura a few weeks back. Almost as soon as the position was opened and I finally got a chance to blog about it, it was closed resulting in an 11% loss including costs. Needless to say, I was deservedly punished for my hubris, and will recount the lessons here.
Sepura, the maker of professional radio equipment was once a high-flyer in the small cap world. From the depths of the recession in 2008, it had been growing consistently, increasing profits and generating dividends for shareholders. As you can clearly see, loyal shareholders with a long-term horizon were richly rewarded with the run up of the stock price until 2016.
Unfortunately for Sepura, a badly conceived and debt-fuelled acquisition made in May 2015 along with weakness in its core business generated crippling losses which the fragile balance sheet just could not sustain. Despite raising money through a rights issue in June 2016, profits collapsed further and the company was forced to put itself up for sale, only months later. With the liquidity position of the company in a critical position and a lack of incoming bids, the Board had to accept an offer of just 20p a share from a Chinese competitor called Hytera.
After watching the entire spectacle from the sidelines, it was at this point I stepped in thinking I could play the role of arbitrageur in order to pick up the spread between the current share price of about 19p and the offer price of 20p. The Scheme Document outlining the takeover proposal gave a timeline which suggested that anyone buying at 19p in January, would have to wait no more than 2 months to pocket the 20p offered when the deal was expected to close in March. Of course, there is no such thing as a free lunch – takeovers can and do break down, so it’s up to investors to do their due diligence in determining the likelihood of the takeover failing. This is where my hubris kicked in.
Before the takeover could be approved, it needed to be approved by shareholders, Spanish and German regulators. I deemed that Spanish and German regulatory approval should just be rubber stamping of the deal. If the British themselves can allow one of their own companies be taken over, there should be no such issue with German or Spanish regulators blocking the move. I thought that the possible spanner in the works would come from shareholders blocking the takeover. I knew from the takeover documentation that the Chinese company possessed a letter of undertaking from 38% of shareholders guaranteeing their votes in favour of the takeover. Having done some further due diligence telephoning up connections with other large shareholdings, I was confident that the other large institutional/individual shareholders would also approve the deal, thus giving the required 75% required to push the deal through. With another merger arbitrageur operation (Cigogne) having moved in with a 5% position, it looked like the stars had aligned and the shareholder vote would be a formality. Indeed, come the EGM the deal was approved by shareholders unanimously – it was time to pop the champagne corks.
Just four days later, Sepura then issued an RNS casting doubt that regulatory approval would be granted for the takeover. The share price plunged and I scrambled madly to try and learn about German competition and takeover rules. What I learned was not comforting. It seems that after a number of German companies had been acquired by the Chinese in 2014 and 2015, and now the German government was very concerned that further key European technologies relating to telecoms, robotics, and security were falling into Chinese hands. Indeed, it appears that the German government can (and have) blocked any such takeovers of such companies on national security grounds. With the takeover now under further investigation from the Germany competition authority for at least the next 3 months, I sold out my position and took my loss. With Sepura already in breach of banking covenants and the very real possibility of them taking control of the company and handing shareholders a zero, I just could not take the risk. Perhaps the deal will go through in three months time, perhaps not. If you wish to get involved and follow, you can track it here. For me though, I am out. A possible 100% loss for a 30% gain is just not a game I want to play.
- One of the justifications I used for this investment was that other large investment banks and hedge funds had been increasing positions in the company in the run up to the shareholder vote, presumably with the same intent as mine, hoping to arbitrage the deal. It was silly to automatically assume that they must know what they were doing.
- Thinking I knew all the answers when I quite clearly didn’t. What’s worse is that I had actually previously read about takeovers falling afoul of the German government – yet it was still a complete blind spot here.
- Getting involved with a debt zombie that had no future should the takeover fail. With net debt at £80M and free cash flow in £10M in a very good year, it was clear that Sepura has a high degree of failure without a takeover.