[Member] Special Situation Opportunity with GSOL (Global Sources)

We have had a few special situations investment in the portfolio. EBIX last year worked out really well, while with MAXY we ended up getting our investment back with not much more. Global Sources (GSOL) presents another investment opportunity in the same vein, although the details are very different.

Opportunity in a Nutshell

The stock currently trades at $8.06/share. The management has issued a press release indicating they are going to spend $50 million repurchasing 14.4% of the outstanding shares for a consideration of $10/share in cash. This transaction is structured as a tender offer and will get under way before end of April to be completed before end of May.

What is Global Sources?

Global Sources is a Bermuda registered company that is in the business of bringing buyers and sellers together. Its main focus is Chinese sellers and the buyers are mostly Western European and American, including the likes of Best Buy, Sears, Samsung, etc. The company runs online marketplaces similar to Alibaba.com, and in addition it conducts trade shows, private sourcing events, publishes print and digital trade magazines, provides sourcing research reports, etc. Essentially, it helps market Chinese products to western markets and helps western companies to find Chinese suppliers.

The company has been doing this for the last 50 years and has been listed on Nasdaq since 2000. This is not one of those Chinese reverse merger companies that have popped up in the recent times that eventually turn out to be nothing more than a shell.

The Tender Offer Mechanics

This is not an open market purchase. When the tender offer becomes underway (sometime in April), a stock holder will receive a note from their broker asking if they want to tender a part or all of their GSOL holdings. Once the stock holders commit their shares to the tender, the company will then pick 5 million of the shares ($10/share, $50 million committed) to repurchase. If the tender is oversubscribed (meaning more shares are tendered than the company plans to purchase), the company may chose to follow a priority order for which shares are chosen.

Essentially, if we purchase the shares today paying around $8 per share and tender these shares to the offer, there is a good chance that a part of our holding will be purchased at 25% profit in 2 months. Ideally it should be 14.4% of our holdings, but it may depend on the priority order the company decides on.

It is also likely that for some of us, none of our shares may be chosen for the purchase. Because of this, we also need to make sure that the stock presents a good investment opportunity in its own right.

What Happens to the Market Price in the Next 2 Months?

The current price reflects the fact that this is not an open market purchase. However, as the tender is floated, I expect a large amount of stock will be tendered and be taken out of the circulation in the market. The resulting lack in the supply should make the stock price move higher. The stock price should be capped at $10/share in the next 2 months so in theory 25% or so is the maximum return we can expect till May.

The 3 month average volume of shares for GSOL is 32.5 thousand shares per day (the volume has predictably gone up to about 100K/day in the last few weeks since the PR). If the company were to decide to conduct an open market purchase, it will take them 5,000,000/32,500 = 153 trading days to complete the buyback and the buying pressure will guarantee the average cost per share of the purchase to move higher than $10/share. A tender at a premium does make sense for the company if this is taken into consideration.

The risk is that the market price does go above $10/share by May and investors who tendered their shares may have to settle for less. However, we should expect the bulk of our shares (86% on average, individual ratios will vary) to stay unbought after the buyback is complete and we should get an opportunity to sell these.

Fundamentals of the Business

This is rather uncharacteristic of a value investing site to start talking about the business fundamentals so late in the writeup Smile

The current market value of the company is $292 million and the stock trades at 1.43 times book value. There is no debt and the company has $144 million in cash and short term investments.

This is not a net-net or grahamian stock. However, when we look at the earnings, the stock appears to be at attractive valuation.

Pre-tender valuation:

This calculation is as of the quarter and year ending Dec 31, 2013.

Total earnings for 2013 were $30.17 million (adjusted for one off charges/gains, non-IFRS numbers on the financial reports) on revenues of $198 million (net margin: 15.24%). This gives it an adjusted P/E ratio of 292/30.17 = 9.68. Since the company has excess cash than is needed for their ongoing operations, it makes sense to look at the ex-cash P/E ratio. This assumes that the excess cash can be distributed to the shareholders without any effect on the business going forward.

Normally, the rule of the thumb is to use 2% of the revenue as maintenance cash, required to fund ongoing operation. We will be generous and assume 5% of the revenue. This is about $15 million.

This implies 144 – 15 = $129 million of the cash is unnecessary for the business. If this cash were distributed, the market cap of the company would be reduced to 292 – 129 = $163 million.

This gives it an ex-cash P/E ratio of 163/30.17 = 5.40.

This is very cheap. Ebay for example, sells at a 17 P/E ratio (ex cash does not make sense as it has debt to contend with) with a similar net profit margin.

Post-tender valuation (gut check):

For this purpose we will consider the potential ttm numbers that will be reported at the quarter ending Jun 2014. We will also revise the numbers to account for the reduced share counts after the tender is completed. We are doing this to get a sense of what the numbers look in June 2014, which is of interest to use due to the tender offer completing at the end of May.

Other thing to keep in mind is that this is by necessity a back of the envelope calculation and we are taking some minor liberties (I will call these out below).

Let’s start with the share count. The current number of shares outstanding is 36.1 million (2013 annual P&L, average number of shares outstanding for the year).

Post tender, the number of shares outstanding will be reduced by 5 million. So the number will be 31.1 million. Please note that when the quarterly numbers are reported, the average share count will be higher as these are averaged over the period in question. We are not accurate but we are better off than using the average number of shares reported on the financials for June 2014.

The company expects the 1st half 2014 adjusted earnings (adjusted to account for one off charges) to be between 0.18 to 0.22 per share based on the current share counts. This implies a range of $6.5 million to $7.9 million compared to $0.37/share (adjusted) or $13.36 million in 1st half last year

This implies a ttm adjusted non-IFRS earnings of 30.17 – 13.36 + 6.5 = $23.31 million

If the stock price is $10, this gives a P/E ratio of 10*31.1/23.31 = 13.34

To get the ex-cash adjusted P/E ratio, we will have to do a rough estimate of the cash position in June.

We know that the company started with $144 million in cash and they will use up $50 million in the tender. This gives up $94 million. The company recently closed on an office space in Singapore and another small acquisition amounting to $13.1 million. This was a leased office space they purchased in February for cash, so this will also result in reduced expenses going forward, but we will ignore this for the moment.

So we are currently at 94 – 13.1 = $81 million in cash.

In 2013, the company expanded it cash holdings by $27.5 million. Given the projected decline in revenues and assymetrical revenue over the course of the year, and keeping with the conservative outlook, I would expect the company to add $5 million or more in cash from operations in the first half of 2014. This gives us an expected cash level of $85 million or better in June 2014.

The projected ttm revenues is 192 (2013) – 92.7 (1st half of 2013) + 88 (lower end of company projection for 1st half of 2014) = $187.3 million. 5% maintenance revenue amounts to $9.37 m giving us an excess cash value of 85 – 9.37 = $75.64 million.

The projected ex-cash adjusted P/E at $10/share is therefore (311 – 75.64)/23.31 = 10.1

This looks very reasonable to me and leaves room for multiple expansion in the future if a catalyst appears.

We have only looked at the numbers already reported or what the management feels comfortable with and have not indulged in any future eps growth speculation on our own.

Another Possible Catalyst

Most value investors will end up selling the shares that remain unbought after the tender process is complete. I want to come back and reassess to see if it makes sense to purchase additional shares as the rest of the market is selling. The reason is the upcoming IPO of Alibaba.com, that I expect will generate tremendous interest in this space.

Given that the GSOL shares are cheap at the current prices, even if ignore the tender offer, any shares purchased now should give us the luxury of waiting to see if this catalyst plays out.

I have to believe that the management is timing this tender with the Alibaba IPO in mind and they expect the share price to be much higher in the future. Since the shares they purchase now will go in the treasury, this also gives them an option of reselling these shares back in the market later at better prices. Perhaps this is not the plan, but an option is nice to have.

Current expectation is that at the conclusion of the tender offer, we will see price decline that should give us an opportunity to buy more shares, depending on the valuation prevailing at that time. Alibaba ipo should help expand the multiples for related stocks including GSOL

Recommendation and Maximizing Your Chances of Successful Tender

I believe that a bird in hand is worth 2 in the bush. In that spirit, I would recommend tendering ALL your shares when the option becomes available. Whatever gains we get from this, we will keep and then we will act on the remaining shares later.

In the past similar tenders, the company has chosen to prioritize purchases of odd lots. So any one owning 100 shares is at a lower priority than someone owning 119 shares. If the past is any indication of what they might do in the future, it is reasonable to expect that a similar priority process may be followed. As they sweep up the odd lots, someone owning 119 shares might see 19 shares being purchased first (to round off their lot) and the remaining 100 shares go back in the priority queue.

The company defines the lot size as 50 shares. Therefore, to maximize chances of a successful tender, total number of shares you should buy should end in 49 or 99 (49 shares, 199 shares, 949 shares, etc). If you have multiple accounts, considering breaking up your holding across different accounts (so if you are considering 300 shares total and have 2 different brokerage accounts, you may want to buy 149 shares in one and 149 shares in the other). This is a little bit of extra work, but every incremental % of return compounds to a significant number over the years and is worth going after.

There are a lot on unknowns at this time on how exactly this will be executed and we can only look at the past to get some ideas. The time to move however is now as when more information is released, the window of opportunity will start closing.

Bottomline

I recommend purchasing GSOL shares as follows:

  • Buy upto 5% of your portfolio
  • Pay less than $8.25/share, lower the better. However, plan to complete your purchase in March 2014. If everything goes well, I expect the liquidity of the shares to dry up in April and May
  • Make sure your lot size ends in 49 or 99 and prepare to tender all your shares when the offer is extended
  • I will reassess in June to determine if the remaining shares should be sold or more shares purchased, depending on the price/valuation changes and progress on Alibaba ipo.
  • Tentative holding period: 2 – 3 months

Finally, due to the element of chance in what portion of our shares are repurchased in the tender offer, it is likely that our returns may differ at the conclusion of this round trip. I consider this a low risk investment.

Discuss GSOL in the forum here.

Note: Thanks to a member who brought GSOL to my attention.

IFRS is the International Financial Reporting Standards, similar to US GAAP but there are minor differences. US will eventually move to IFRS
Update (Mar 31, 2014): The buy price is raised to upto $8.50/share but I am unwilling to go any higher. If we miss the purchase prior to tender being started, we should stay with the limit order and wait patiently. I expect the price to come back within our range in the next few months and the appreciation potential post tender remains