LON:PURE | Pure Circle - A Sweet Merger Arb Oportunity?

24th Apr '20 by Mark Simpson

3 comments 782 reads

The following is a detailed write-up of a trade idea that we covered on small caps live this morning and thought it would be of interest to readers here. It is takeover arbitrage on a company called Purecircle (LON:PURE).

For those who don't know we run Large Caps Live every Monday at 11am discussing large caps and macro, plus Small Caps Live every Wednesday and Friday at 11am covering smaller company news. They are text-based live discussions led by a couple of 'hosts' on a platform called discord. Everyone is welcome to join in and contribute:

https://discord.gg/nuFGaEc

With this trade idea I’m breaking two of my golden rules so this should come with a suitable health warning.

The first rule is not to get involved when you don’t entirely trust the management.

The back story:

I’ve been a long-time bear on Purecircle (LON:PURE) the provider of Stevia sweeteners to the food & beverage industry. They ticked all my short criteria, (and I have been short at various times depending on the availability of borrow and my risk appetite):

- Large Cap (They were over $1bn at one point.)

- Promotional management with lots of RNS-NON’s released.

- Over a year’s worth of inventory.

- Took them over 6 months to get paid by customers.

These suggested that either they were pretty bad business managers or they were being aggressive in their accounting.

It turned out to be the latter:

https://www.investegate.co.uk/...

During the course of the audit of the Group's financial statements for the year ended 30 June 2019, a potential issue relating to the classification and valuation of certain inventory items was identified by the Group's auditors, PricewaterhouseCoopers.

Leading to suspension a bit later:

https://www.investegate.co.uk/...

and Loss of CFO & CEO:

https://www.investegate.co.uk/...
https://www.investegate.co.uk/...

The inventory write-down was eventually finalised with the Final results:

The Group's gross profit has been further impacted by charges of $19.7m to write inventory down to its net realisable value and a further $14.8m to provide for slow-moving inventory, impairment on intangible assets of leaf & product developments of $15.7m and a further $6.8m one-off cost has been incurred in professional fees during the investigation.

They remained suspended pending interim results release on 9th April:

https://www.investegate.co.uk/...

Finally, suspension being lifted on 15th April:

https://www.investegate.co.uk/...

A tale of woe so far, but here is the interesting bit:

https://www.investegate.co.uk/...

Along with the interim results…

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Mark Simpson

21st May '20

Purecircle (LON:PURE) has found some strength this week, presumably due to the offer scheme docs being posted:

https://www.investegate.co.uk/ingredion-inc-/rns/publication-of-scheme-document/202005181745572631N/

Which shows that timetable has moved up quite a bit since our initial estimate. Scheme would complete 1st July with payments on the 15th July.

The shorter timeframe also reduces the risk. They would have to face FCA action or Patent Infringement cases in the next 6 weeks to throw a spanner in the works. With courts operating remotely and FCA probably not very active then this seems pretty low to me. Also the requirement to have $40m H2 revenue I think lapses since they won't have month-end-close and therefore management accounts prior to the scheme becoming effective.

Needs shareholders to vote in favour but they would be daft not to. So I think we have moved to a 90%+ chance of completion.

With the price at c87p to buy today we have 13p upside, 57p downside & 90% we have a probability adjusted risk-reward ratio of 2.05 so above the 2 that hedge funds would normally want for merger arb even after the recent move up.

I make the IRR 52% so again this exceeds the usual merger arb threshold that hedge funds use.

So the shorter timeframe and higher probability of success actually make this a better opportunity today than when I first raised this as an investment idea.

Metatron

I've held shares in Ingredion for over 9 years so certainly believe that for Purcircle shareholders getting some Ingredion shares would be a good thing .Basically corn prices are well below the average break even price to grow corn and have been for the last 12 years .If corn begins a long overdue bull market I believe Ingredion will be a major beneficiary of that and as there are not many other ways of investing in a rising corn price I expect investment money to flow into Ingredion.I have been waiting for corn to start a new bull market for 9 years though!

9th Jul '20

Just to cycle back on this - got the 100p/share cash from the takeover yesterday for a 32% return since I wrote about this. Not an amazing headline figure given some of the other moves in the market since then, but given that the risk was very low this was definitely a positive from the recent market weakness.

IRR is c.280% and shows the difference that getting your money quicker in these sort of situations makes.

Pure Circle - A Sweet Merger Arb Oportunity?

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Mark Simpson

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