Monday, November 1, 2010

Risk Arb: Pre-Paid Legal Services (PPD)

On October 25, Pre-Paid Legal Services Inc (PPD) announced that it is evaluating strategic alternatives, including a possible sale of the company. The board established a special committee comprised of independent directors to lead the process. Also disclosed was that the committee has been evaluating an offer "from a well-known private equity firm to acquire all of the outstanding shares of the Company's common stock in a merger at a price of $60.00 cash per share. Among other terms, the proposal allows for the offeror to pay a to-be-determined amount to the Company as the offeror's sole recourse in the event that it is not able to obtain financing to complete the transaction." Let's take a closer look at this risk arb situation.

The vast majority of transactions are discovered by the public in the following ways: 1) The companies mutually announce a deal. 2) A press report relays what sources are saying. 3) A company announces a strategic alternative review. What is unusual about the PPD announcement is that it included the type of buyer (financial sponsor vs. strategic), the proposed price, and that it is contingent on financing. This last point should not go overlooked. At $60/share, PPD carries an enterprise value of $593 million. The announcement implies that the prospective buyer does not have committed financing. Assuming the numbers work (otherwise, why make the offer?), a "well-known private equity firm" should be able to easily secure financing for a deal this size.

Using the description from Bloomberg, PPD develops, underwrites, and markets legal service plans. PPD's plans provide for or reimburse legal service benefits, will preparation, traffic violation defense, automobile-related criminal charges, and letter writing, among other services. A $60/share takeout price values PPD at 4.9x LTM EBITDA. This multiple is noticeably below PPD's five-year average of 5.7x. The offer price was a 7% premium to the previous closing price. PPD closed as high as $67.67/ share on September 29. As expected, the shares closed with a negative spread the day of the announcement, at $62.74/share. On PPD's October 27 earnings call management said that the strategic review is a "process that will continue for the coming months".

In a letter to the special committee dated October 30, Thomas Smith (representing Prescott Investors, a 25.3% holder of PPD) gave his views on the proposal. Apart from being the largest shareholder, Mr. Smith was a board member of PPD from 2004 through February 2010, and has been a shareholder since 1996. Here is the relevant passage of that letter:
With that background, we commend the Special Committee for taking steps to evaluate strategic alternatives to enhance shareholder value, as noted in Pre-Paid’s press release on October 25, 2010. We do, however, strongly recommend that the Committee move expeditiously in its evaluation given the current fragility of the financing markets. We believe that the offer of the unidentified private equity firm that was noted in the company’s press release was appropriate in terms of price, and although the offer has since been withdrawn, we understand that the private equity firm remains interested in pursuing a transaction. The private equity firm’s offer has the added benefit of allowing Pre-Paid to reduce its exposure to any downward trend in financing markets, as we understand that the potential buyer has completed due diligence, is fully financed and prepared to negotiate a merger agreement immediately. In addition, we understand that the buyer would maintain Pre-Paid’s headquarters in Ada, OK, which would preserve the company’s strong ties within the local community.

The Prescott Investors will continue to be supportive and constructive shareholders of Pre-Paid, as we have been over the past 14 years. While we support the Committee’s plan to evaluate all viable strategic alternatives, we caution that time is of the essence and urge due consideration of the existing opportunity for value realization by Pre- Paid’s shareholders. In order to facilitate a transaction that is in the best interests of shareholders, the Prescott Investors are prepared to either sell all of our Pre-Paid stock or participate in the buyout offer, in either case, on terms that we deem to be appropriate.
There are several interesting things to note from this. The first is that the largest holder, and a former board member (who presumably knows the company) is willing to sell a stock at $60/share which was at $67.67/share one month before. The second noteworthy item is that “the offer has since been withdrawn”. Wait, where did they learn that information, and why hasn’t the company disclosed this? Another area of concern is “the potential buyer has completed due diligence, is fully financed and prepared to negotiate a merger agreement immediately”. Recall that the October 25 announcement says that financing is not secured, and now we are told it is. More importantly, call us crazy, but isn’t a withdrawn offer the opposite of standing ready to negotiate an agreement immediately? Too much uncertainty for us right now, though we await the next bit of news.

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About the Authors

Hunter is the founder of the Distressed Debt Investing Blog and the Distressed Debt Investors Club. He has worked on the buy side for the past 7 years in high yield and distressed debt investing.

Edward has been a professional investor for four years, focusing mainly on the event-driven space. His investment philosophy is value-based, and he spends the majority of his time identifying near-term catalyst based opportunities.

Email

hunter [at] distressed-debt-investing [dot] com