Apex/Lexmark: US$3.5 Billion, 29% Potential Return


On April 19, 2016, Apex  (SHE:002180) and Lexmark (NYSE:LXK) announced that they had come to an agreement where Lexmark will be acquired for $40.50/share in cash, valuing it at US$3.5 billion

In a world going more and more digital, printers OEM have been struggling for a while with lackluster performance. Take Lexmark for instance: over the last twelve months, operating margin of -3%, return on equity of -9%… you could probably have better metrics opening a lemonade stand for the summer. Therefore, it doesn’t come as a big surprise that the smaller players in the industry are starting to consolidate together in an effort to get more scale and cut costs.

However, the Lexmark acquisition is also part of the latest effort by Chinese companies to acquire US companies, assets or technologies as the Communist Party has made increasing China’s high tech capabilities and market share a priority. This, of course, has consequences on the deal’s risk profile, but overall I believe the spread remains attractive and here is why:

There is little competitive/antitrust risk – Lexmark and Apex are not (by far) the largest players in the printer industry and the acquisition will have virtually no impact on competitive dynamics. For fiscal 2015, Lexmark had ~US$3.5 billion of revenue, vs. a tiny ~US$300 million for Apex. In fact, Lexmark does not even reference Apex as a competitor in its annual report. Reinforcing that point, the transaction has already received the green light from US antitrust regulators. The same now needs to happen in China, Austria, Germany, Mexico, Poland, Russia and Turkey, which should not be too problematic.

Financing is in place – the equity portion contributed by Apex and its financials backers acting as a consortium and the debt portion contributed by the lenders are supported by letters of commitment and will be provided as long as the merger receives stockholders and regulators approval.

Shareholders should approve as any potential additional upside in the stock is unclear – one can tell from reading the merger agreement proxy that Goldman Sachs ran an extensive sale process that resulted in the consortium emerging as the most attractive bidder. Lexmark has announced since October ’15 that it was exploring strategic alternatives and any interested party has had time to come forward to participate in the auction. The company has some large institutional shareholders such as Vanguard, BlackRock, Fidelity and First Eagle Investment Management, and although First Eagle has engaged in shareholder activism in the past, I was not able to find any comment from them since the announcement of the transaction back in April ’16. With the shareholder vote approaching on July 22, time is running out and anyone wanting to argue against the transaction would have already done so. Finally, Lexmark’s share price is down ~30% over the next 10 years, so it’s not really what you could call the best long term investment. Finally, like most of the transactions analyzed on this blog, the acquisition has been approved by the Board of Directors of the target, who is recommending shareholders to vote in favor of it. 50% of the shares outstanding are required to warrant approval.

Additional regulatory approvals may create timing risk – I believe the biggest risk in this deal to be the additional regulatory approvals that pertain to China buying foreign assets, both from China’s and the United States’ perspective. It is well known that China is very careful with capital controls (to keep the yuan afloat), and the flurry of acquisitions undertaken by Chinese entities over the last couple of years has started to raise the eyebrows of local regulators, who are concerned that M&A is used as a way to get capital out of the mainland. This risk is somewhat offset by the fact that China is very keen to acquire foreign technology assets and Lexmark belongs to that category, but the country may still take time to approve the outflows of currencies needed to consummate the deal. The local authority on the matter is the SAFE (State Administration of Foreign Exchange) and it may ask that the funds are sent in several batches, as it’s done in the past.
From the United States’ perspective, the main risk is the approval from the CFIUS (Committee on Foreign Investment in the United States), which reviews all transactions that are filed with it, and then decides whether it wants to investigate further. Ultimately, a recommendation is made to the President if the committee decides the deal needs to be blocked. While the CFIUS is mostly concerned with strategic assets and national security (it doesn’t seem that printer manufacturers check these boxes), Lexmark holds ~2,000 patents (ironically, Apex and Lexmark previously went to court over a patent dispute), which in certain cases could lead to a more formal investigation. The voluntary application with the CFIUS was filed on June 13, 2016, and the committee should say within 30 days whether it wants to extend that review to conduct a 45-day investigation. While I believe that it should give the nod within 30 days or less, I can’t be sure and it’s just one of those external factors that can’t be controlled.

The ~29% annualized spread is attractive for a transaction of this size – investors have recently been warier of deals involving China for the reasons I mention above, which I think account for most of the existing spread. I don’t think the market is pricing in the fact that the deal might be blocked, but rather the possibility that closing could drag on. Under normal circumstances, it would be fair to assume a close by the end of September ’16, but the deadline in the legal documents for the merger to be consummated is December ’16, with a possible extension to April ’17, which would take the return down to ~15% and ~10%, respectively.

All things considered, I believe this transaction to be one that’s worth a try. I am initiating a position and will add to it as more information surfaces on the progress of the regulatory approvals process. I would be surprised if the deal gets killed, but when it comes to regulatory hurdles, you never really know what you’re in for. Check the current status of this transaction and others by looking at the portfolio.

Disclosure: Long Lexmark.

This article expresses an opinion and the author does not receive compensation for it and has no business relationship with any company whose stock is mentioned in this article; do your own due diligence before making investment decisions.

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