AMS AG (OTCPK:AUKUF;OTCPK:AMSSY) has acquired a majority interest in Osram Licht AG (OTCPK:OSAGF;OTC:OSAGY). In order to succeed, the company had previously lowered the minimum acceptance to 55 percent (from the prior 62.5 percent). Following an extended offer period until Christmas, AMS now owns 59.9 percent. That is only a minuscule increase compared with the 59.3 percent it already secured during the initial duration of its offer.
As I have explained in more detail before, I doubt that the deal will create value for AMS’ shareholders. The debt-fueled acquisition added substantial pressure to the company’s balance sheet. In the long run, AMS needs Osram’s cash to make the deal work financially. Yet in order to gain full access, it will need to further increase its ownership. That perspective adds upside potential to the stock of Osram. Investors who are willing to take a certain degree of risk may position themselves to capitalize on this situation. In this article, I will discuss why AMS will be under pressure to increase its stake and how investors may take advantage.
AMS Needs Osram’s Cash
AMS’ main weakness is its debt load. AMS already reported net debt of $1.95 billion as of September 30th. The entirely debt-financed acquisition of close to 60 percent of Osram at a share price of €41 adds another €2.4 billion. Net debt hence should now be well above €4 billion. But this is only a momentary picture.
That figure will be reduced soon. The company’s executive management and supervisory board propose a €1.65 billion (€1,649 million, precisely speaking) capital increase. If the general meeting approves the plan, that would already dilute existing shareholders by about a third, depending on how the share price develops until January 24th. Yet the debt load would shrink considerably in return. AMS also sold its MEMS microphone design activities to Knowles Corp. (KN) for $58 million.
Still, AMS will most likely have net debt somewhere in the range of at least €2.5 billion. And another capital increase would most likely be the least favorable option, as shareholders already face a significant dilution as it stands. Yet another round would probably be more than many investors would be willing to swallow.
Theoretically, AMS’ own profits would probably be enough to service those levels. But this would not be a good deal for shareholders, as it would leave them worse off than if Osram had not been acquired. Osram in turn is profitable but lacks growth. In fact, it is losing both revenue and profitability at a fast pace (annual revenue – 8.6 percent YoY; adjusted EBITDA – 50.6 percent YoY). On top of that, AMS already overpaid for the company, valuing it at a total of €4.6 billion. So from my point of view, it does not look as if value appreciation was going to pay for the acquisition.
If the transaction is to make any sense from a financial point of view, AMS will need access to Osram’s cash and its profits. Based on unaudited preliminary figures for the fourth quarter, Osram reported a 2019 EBITDA of €176 million (€307million adjusted for special items). As of September 30th, the company also had cash and equivalents of €310 million on its books.
In order to gain access to these funds, AMS would have to reach a threshold of at least 75 percent ownership of Osram. Notably, this would also put AMS in a position to be able to conduct a formal merger with Osram if it wishes to. 75 percent of voting rights is also the threshold that needs to be met in order to force a formal merger. A squeeze-out would require a 90 percent majority of voting rights, yet given AMS’s debt load and the fact that a capital raise will be necessary either way, a forced merger – in which minority shareholders would be compensated in the new parent’s equity and not in cash (a cash-based squeeze-out would require at least 95 percent of voting rights) – would probably be the preferred option anyway.
AMS Will Inevitably Have To Overpay
In order to increase its stake to 75 percent, AMS would have to buy out a minimum of slightly above 15 percent of outstanding shares. Considering that AMS already offered to buy out Osram at €41 per share twice (and even extended the second offer), and still was not able to even meet 60 percent acceptance, I am quite sure that it will have to pay even more. In fact, Osram currently (as of January 16th) trades slightly above €45 per share. And again: €41 per share already was quite a price tag.
Since AMS already owns nearly 60 percent of the company, another 15 percent equal about 37.5 percent of the remaining Osram shares. And a good portion of those shares is most likely still owned by investors who refused the previous offer, among them hedge funds which I suppose are aware of AMS’ dilemma and plan to capitalize on it. Investors willing to take a certain risk may do essentially the same.
And there certainly is a risk to an investment in Osram. If AMS is unable or unwilling to come up with the necessary financing to increase its stake, both shares might tumble. As Osram already trades significantly above its fair value, the stock price will surely take a rather hard hit if and once AMS as a potential buyer of additional shares is taken out of the equation. In the worst case, AMS might even be forced to conduct a firesale of its Osram shares.
But also in a scenario where AMS makes another offer, another risk could arise. If investors are holding on long, hoping for a better price, while a sufficient number of others decides to sell, they might end up with AMS equity if AMS decides to force a merger. And if you share my view of the company, this is not really something you would want.
AMS is under some pressure to increase its stake in Osram to 75 percent if it wants to make the deal work out for its own shareholders. If it does not, it faces the prospective of having massively overpaid for Osram, while unnecessarily increasing its own already significant debt load and diluting its shareholders in the process. Also, AMS would most likely only get one shot (reaching 65 or 70 percent would not materially improve its situation while nonetheless further adding to the debt load), which could increase its willingness to pay a high premium in order to secure a 75 percent majority.
While I do not envy AMS for the position it finds itself in, I believe that investors may have a chance here to take advantage of the situation. Yet one should be aware of the risk of such an investment which is not based on Osram’s fair value as a business, but almost entirely on AMS’ pressure to gain a supermajority.
Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Disclaimer: All research contained in this article was done with the utmost care. However, I cannot guarantee accuracy. Every reader is advised to conduct his or her own due diligence and research.