Nellore's Final Remarks: The Facts Just Don't Add Up, Vote AGAINST
PALO ALTO, Calif., March 17, 2023 /CNW/ - Nellore Capital Management LLC ("Nellore) today provided final commentary to explain its opposition to the proposed C$1.8 billion takeover of Magnet Forensics Inc. ("Magnet") (TSX: MAGT) by the private equity firm Thoma Bravo.
Sakya Duvvuru, Founder and Portfolio Manager of Nellore Capital, said "the Software PE market continues to be strong and Magnet stands out as an especially weak negotiation in comparison. The presentation put out today by Magnet is further proof that the Special Committee doesn't understand the value of the company, which continues to be justified by outdated and misleading information."
Ending Where We Started: Magnet is a Special Business Creating Continued Shareholder Wealth
Magnet's operating and financial model are such that roughly every 4 years, revenue converts into free cash flow ("FCF"). For instance, the company generated US$27mmof revenue in 2018 and generated US$33mmof FCF in 2022. The company generated US$50mmof revenue in 2020, and per Management Forecast, expects US$65mmof FCF in 2024. The company is expected to generate the equivalent of 2022 revenue, US$99mm, in 2026 FCF -> a compounding machine! Thus, one could pay up to 20x 2023 revenue (>100% above current offer price), and still earn a double digit return over 4 years.
Materiality of Q4 FCF on Realizing Fair Value
It seems like Magnet (and its Special Committee) are either not aware of, or don't appreciate, how FCF can drive returns for the buyer. Consider that by waiting for March 9th instead of January 19th, Magnet's Last Twelve Months ("LTM") FCF doubles, and at the offer price, is actually trading 13% below the average over the last twelve months!
This is especially significant because the last twelve months have been especially punitive toward high growth, technology companies. Yet, here we are with an offer price that is below the average in that punitive period. Applying the unaffected average of 43x on LTM FCF post Q4 results and Thoma Bravo's 37% median premium results in a offer price of C$60 per share. Or, using the unaffected stock price on January 19th of C$38.15, we derive a multiple of 32x LTM FCF. Using the same multiple on 2024 FCF and discounting back to today, we get to C$60 per share.
Further, using the same methodology Magnet uses on slide 3 of today's presentation to justify the transaction, we can see that not only is Magnet not trading at 56x estimated 2023 FCF, it is trading at just 38x twelve months trailing FCF and well below the peers:
Not only is there no control premium here, Magnet consideration is not even at the level of transaction unaffected, slower growing, lower margin public comps. Applying the median multiple of peer group results in a stock price of C$66. Applying a further control premium results in a price >C$80. The Special Committee should have understood this and negotiated using this information.
Four Software Takeovers at Higher Premiums
Since the Magnet transaction was announced on January 20th, takeovers by private equity ("PE") firms have been announced for four other public software companies with one-day unaffected premiums ranging from 29% to 62%. Clearly, the 15% premium for Magnet is far too low.
Notably, three of the takeovers were announced just this week, highlighting the underlying demand for recurring revenue and software business models even in the face of Silicon Valley Bank issues and general macro uncertainty. Further, the size of the deal values, the variety of players investing, and the unaffected premiums paid all highlight the vibrancy of the Software PE market.
Moreover, high growth, high quality software companies Kinaxis and Docebo have both reported strong earnings in the last two weeks and are both trading above their pre-earnings reports. Cellebrite is also trading up 15% since its strong Q4 report.
Don't fall for Magnet's downside risk scare tactic. To the contrary, Nellore believes the stock will start to price in US$65 million of FCF in CY'2024 and trade above the deal price.
Comments on ISS
We believe even the cautionary support recommendation from ISS is not warranted. We can just agree to disagree about the significance of Jim Balsillie choosing the Rolling Shareholder option, procedural depth of the market check of reaching out to just two financial sponsors, the differential consideration and the lack of value for Grayshift synergies for SV shareholders. But we will not let the following ISS assertions go unchallenged:
Share Price Volatility:
Comments on Research Analyst Commentary
The tone of the analyst community has moved significantly toward our favor since our initial press release on February 9th, the release of the management forecast on February 22nd, and finally the release of Q4 results on March 9th. Even so, Magnet again continues to highlight research reports from January 20th despite more recent commentary from the same institutions.
Nellore Capital Signing Off: Protect Your Interest, Vote AGAINST
Nellore is the only party that is 100% aligned with its fellow SV shareholders. We are sincerely trying to present the facts as they are and attain full value for all of our Magnet shares.
Nellore continues to urge shareholders to use to GOLD proxy to vote AGAINST the proposed takeover.
If you have already voted another proxy, you can still vote the GOLD proxy AGAINST the takeover. Only the later-dated vote will be counted. The voting deadline for the GOLD proxy is Monday, March 20 at 5pm Toronto time.
About Nellore Capital Management LLC
Nellore Capital Management invests in entrepreneurially managed, competitively advantaged technology businesses globally for the long term.
For further information:
Sakya Duvvuru, Founder & Portfolio Manager, Nellore Capital Management LLC, Ph: 501-551-0128, Email: [email protected]
If you require assistance with voting your shares, please contact Carson Proxy Advisors:
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SOURCE Nellore Capital Management LLC