This company is currently in the process of selling its operating business. Management announced that it plans to liquidate the company in case the disposition is successful. So far, the stock price has not reacted due to a number of uncertainties. While I think that the downside risk is limited, I expect this investment to deliver an IRR of 10.7% over a holding period of 22 months.
UMS United Medical Systems International AG (UMS AG or company) is a German holding company. The company’s assets are almost entirely held by its 100% owned affiliate UMS (DE) Inc., which is incorporated in the US (more specifically in Delaware). The operational business is conducted in various affiliates of UMS (DE) in the US, Canada and South America.
On August 14, 2014, the company announced that it has entered in an SPA (Sales Purchase Agreement) to dispose UMS (DE) for a sales price of EUR 56.4 m. The current market cap of UMS AG is EUR 46.4 m based on a share price of EUR 9.75. Shareholders need to approve the disposal at an extraordinary general meeting to be held on September 25, 2014.
Provided that the deal will be completed, the company’s assets will almost exclusively be limited to the cash inflow from the sale of UMS (DE). Therefore, at the extraordinary general meeting, management also proposes to change the company’s purpose in the articles of associations. In case the transaction is successful, the sole purpose of the company will be the management of cash. In addition, management announced that with the following annual general meeting to be held in June 2015 a significant part of the profit portion from the sale of UMS (DE) will be distributed to shareholders. Thereafter, the company will be liquidated and the remaining cash will be distributed to shareholders.
Uncertainties reflected in the share price
The company has currently roughly 4.76 m shares outstanding. Based on a sales price of EUR 56.4 m for UMS (DE), this corresponds to EUR 11.85 per share of UMS AG. As far as I know, the company has no substantial liabilities. So why is the company’s share currently trading with a 17.7% discount compared to the sales price of UMS (DE)?
First, 75% of shareholders present at the general meeting need to approve the transaction. The board and management is holding 37.4% of the shares. At the last annual assembly roughly 50% attended the meeting. Shareholder attendance might be higher this time. While I believe the chances to be low, there is a risk that a group of shareholders representing at least 25% of the votes will break the deal at the meeting.
Second, financing for the deal is not in place yet. The investment firm New State Capital Partners committed to capitalize the buyer with equity in an amount of USD 23.37 m. The rest of the purchase price is planned to be financed with debt. Based on my knowledge, there has not been an announcement made that debt financing is in place. Based on the PSA, the deal has to close until November 22, 2014.
Third, the preferred transaction structure for minority shareholders would have been an offer for UMS AG instead of UMS (DE). However, based on information from the management, the company has been in negotiations with different parties regarding a disposition since 2006. One of the obstacles was to sell the German AG which is basically only holding a US entity. Given that it can be quite difficult for a buyer to gain a 100% share in a listed German entity, potential buyers refused to make a bid for UMS AG. So the structure of the transaction provides for complexity.
Fourth, the deal is not fully transparent. It is not clear, who is behind the acquiring entity. The official statement is that New State Capital is “advising” the buyer and provides equity financing. In addition, the company said that the current management of UMS AG plans to participate in the acquisition of UMS (DE). So it is not clear, whether there are conflicts of interest.
Fifth, the time frame of the liquidation is uncertain. As a consequence of the intransparency mentioned above, shareholders might take legal actions against the company. For instance, supposed that shareholders will approve the deal at the meeting, a shareholder could file a law suit against the resolution. Based on the SPA, this can be resolved with a legal opinion from the advising law firm and the transaction can be completed. Nevertheless, a pending law suit could delay the following liquidation of the company and therefore distributions to shareholders.
Sixth, after deal completion management could change their mind or the shareholder structure could change. As a consequence, a liquidation of the company might no longer be pursued.
Seventh, mutual funds have been reducing their shareholding over the last months, which weighs on the stock price. BayernInvest has reduced its holding from 5% to below 4% and Universal Investment from above 3% to below 3%. Perhaps they know more than I do. On the other hand it could just be position trimming due to expected lower trading volume as a consequence of the upcoming liquidation.
Apart from that, there will be substantial cash outflows including deal related costs, disposition taxes, operating costs and costs for liquidating the company.
Based on the SPA, the seller shall be responsible for all transaction expenses and costs incurred by UMS AG and UMS (DE) in connection with the consummation of the transaction. I think that it is conservative to estimate deal related costs for UMS AG to be 3.5% of the sales price. This is EUR 2.0 m or EUR 0.41 per share.
I am not a tax expert, but the way I am calculating disposition taxes to be paid by UMS AG is the following:
After deducting transaction costs and book value (I take the book value from the holding company) from the sales price, the estimated profit is EUR 35.5 m. Based on § 8b Abs. 2 KStG and § 8b Abs. 3 Satz 1 KStG, 95% of the profit is tax free. Hence, the taxable income is EUR 1.8 m (=5% x EUR 35.5 m).
In the latest annual report, management makes the following statement regarding accumulated tax losses:
“UMS AG has income tax losses of € 11.8 million (previous year: 11.6 million) and € 10.5 million in trade tax losses (previous year: € 10.3 million) that are available indefinitely for offset against the UMS AG’s future taxable profits, within the limits of § 10d (2) EStG and § 10a GewStG. No deferred tax assets have been recognized in respect of these losses as they cannot be used to offset taxable profits elsewhere in the group. As the holding company is not likely to generate future taxable profits, no deferred taxes have been recognized for timing differences for UMS AG.”
Therefore, it might be possible to further reduce the taxable profit by using accumulated income tax losses. As I am not sure, whether that is doable, I leave them out of the equation.
UMS AG has to pay corporate tax, solidarity surcharge and trade tax. Hence, I estimate the tax payment to be EUR 0.6 m (= (15% x (1+ 5.5%) + 16.4%) x EUR 1.8 m) or EUR 0.12 per share.
UMS AG receives an annual management fee of EUR 0.4 m from UMS (DE) and has annual holding costs of roughly EUR 0.5 m (excluding exceptional items). Expected closing date is November 22, 2014. So I assume that annualized operating costs will be EUR 0.5 m or EUR 0.11 per share from December 2014 until liquidation of the company.
In addition, there is a brief story to be mentioned. Recently, the company sued its tax advisor as management is of the opinion that it was wrongly advised. The background is the following: concerning the dividend distribution for the fiscal years 2009 and 2010, on the advice of its tax advisors, the company withheld taxes for their shareholder (which is the common way) and remitted them to the tax office. As it turned out, however, the company determined that the distributions would have been tax-exempt because these distributions could have been made from the contribution account for tax purposes. Based on my understanding, the company had to bear accumulated costs related to this issue of roughly EUR 0.8 m until the end of 2013. Legal proceedings against the tax advisor started in 2014. Management expects the chance to succeed as “very good”. Let’s keep it simple and assume that they will reach a settlement and that any inflow from the tax advisers will be offset by outflows to the company’s lawyers.
Apart from that, I assume that the costs of the liquidation (e.g. consulting fees, costs of lease termination) will be EUR 1.0 m or EUR 0.21 per share.
Estimated time frame of the liquidation and targeted return
My base case scenario for this investment is an orderly proceeding of the liquidation. In that case, after deal completion shareholders will decide about the dissolution of the company and the distribution of the profit share after tax payments and deal related costs (EUR 34.6 m or EUR 7.27 per share) at the general meeting in 2015. Thereafter, there will be a twelve month period, where creditors can demand outstanding liabilities from the company. Then, the company can be liquidated and the remaining cash (assuming that there are no unknown outstanding liabilities) of EUR 17.3 m or EUR 3.65 per share can be distributed to shareholders.
The calculation of the estimated liquidation value can be found in the following table:
I assume that the next general meeting after completion of the transaction will take place in June 2015 combined with a distribution of EUR 7.20 per share. An additional distribution of EUR 3.72 could then be made 13 months later in July 2016. Based on these assumptions an investment offers a total return of 12.0% and an IRR of 10.7% for a holding period of 22 months.
Consequences of a broken deal
If the deal fails, I will hold a company which is generating a steady and relatively predictable income stream of roughly EUR 2.5 m per annum. The stock has a dividend yield of 5.6%, which is tax free. I think there is a large number of market participants who are looking for this type of income generating stock. In addition, the market reaction to the announcement of the deal was rather negative. So disappointment in case the deal falls apart should be limited. Apart from that, there is still the possibility that another buyer turns up. So I believe that the downside risk is relatively limited here.
I think it is likely that shareholders will approve the deal. However, from the risks and uncertainties mentioned above, I suppose that a prolonged liquidation due to legal proceedings from minority shareholders against the company poses the biggest threat to my base case scenario (a liquidation of the company returning an IRR of 11%). On the other hand, I believe that management and the board representing a shareholder group holding 37.4% of the company are highly incentivized to cash out and to speed up the liquidation. There are a number of assumptions I have made. However, I think that the risk to lose money in this investment is relatively limited.
In my last post, I announced that I will start to accumulate a position in UMS AG. Based on the assumption that I trade one third of the daily volume, my target is to accumulate a 2.5% position for the virtual portfolio with a stock price limit of EUR 9.75 starting from September 8, 2014.
The content contained on this site represents only the opinions of its author(s). I may hold a position in securities mentioned on this site. In no way should anything on this website be considered investment advice and should never be relied on in making an investment decision. As always please do your own research!