"Under the terms of the agreement, RealD shareholders will receive $11.00 in cash for each share of RealD’s common stock. This represents a premium of approximately 19% to RealD’s closing stock price on October 1, 2014, the last unaffected trading day prior to the announcement from Starboard Value LP of its non-binding indication of interest to purchase all outstanding shares of RealD’s common stock."
So the 19% is the price before Starboard came along. The actual premium on the closing price on Friday is less than 5%.
In connection with the merger agreement, Mr. Lewis intends to reinvest his equity into the transaction and has signed customary support agreements pursuant to which he has agreed to vote his shares in favor of the merger. Mr. Lewis will continue to serve in the role of Chairman and Chief Executive Officer of RealD."
So the CEO is rolling his equity and he owns 10%.
We think there is a very low probability this ends up being the price they are taken out at. Our reasons for this are:
Starboard offered to take them out at $12/share last year. The business has not gotten worse since then...in fact with Star Wars coming soon it has gotten better. All estimates point to at least $70M of EBITDA this year. The Company has already done $31.8m in Adjusted EBITDA in the first six months. There is almost no chance the second half of the year is worse with Star Wars and rest of the slate.
The Company is going to cash flow the majority of its EBITDA going forward because the majority of the installs are done and maintenance CAPEX is low. In addition there is minimal interest expense due to net cash on the balance sheet and minimal taxes due to a large depreciation shield.
The CEO obviously wants to hold onto the Company (this is his baby) and will do whatever it takes to do so. This feels like a lowball offer they know will be rejected or fought and from $11 they can easily move the price up ~20% to $13 and get a deal done (i.e. there is room on the offer because they know shareholders won't take a deal below the $12 Starboard offered in October 2014)
If Starboard offers $12/share that will certainly win over an $11/offer...the CEO knows this and if Starboard wins he is likely going to be ousted. While he has significant share ownership, we believe the majority of shareholders would vote to oust him without a materially reduced cost structure. We would think Starboard has a reputation to protect and while this is a relatively small investment ($55M) they won't want to be seen as being pushed around by RLD.
Even at $13 everyone knows the cost structure is ridiculously bloated and Rizvi can make a very large return simply by working with the CEO to cut expenses. If they have to pay more, Rizvi can just cut custs more to make their return. It really shouldn't be that complicated. It also appears they were trying to get this deal done ahead of potentially the largest 3D movie ever (Star Wars) before the numbers make it obvious to everyone the company is worth substantially more.
We think this is a heads I win, tails I don't lose because if Rizvi/Lewis win, you get $11/shr. If Starboard fights it, you likely get a higher price. There is a very high likelihood Starboard is going to raise a stink which should move the stock up. There is a low probability that Rizvi walks away (we would guess CEO likely found them to help finance the MBO) unless Starboard is willing to actually take the company private at a higher price (which Lewis would not be supportive up). Therefore, Lewis is going to have to convince Rizvi to match or exceed any price Starboard willing to pay. Even if Rizvi eventually walks away, Star Wars numbers should be clear by then and the substantial undervaluation should be clear to the market and the downside still is minimal.
We have had no contact with Bares Capital Management (largest shareholder) but based on our understanding of their investment strategy and style, a takeout of RLD at $11/shr is not something they would vote for (highly concentrated portfolio with extremely low turnover), meaning we need to see a higher price to get this deal passed.
So, our downside should be around $11 and the upside one would think is at least 10%-20% higher. There would appear to be a high probability of a successful path here to a solid return in a reasonable timeframe.
I do not hold a position with the issuer such as employment, directorship, or consultancy. I and/or others I advise hold a material investment in the issuer's securities.
1. Starboard steps in and starts a fight
2. Shareholders reject the deal for what it is and EBITDA growth jumps with Star Wars and the rest of the current quarter's slate.