Description

SUMMARY

This is a small idea which might be interesting for PAs. It’s a short-term investment, small dollar amounts, with a high IRR if everything goes smoothly. You invest just over $1,100, make a profit of about $350 in a couple of weeks. If this is not worth your effort, you can stop reading here. But this could still be an opportunity to teach your children or grandchildren about analyzing investment opportunities and arbitrage.

Buy 999 (or fewer) shares of WSTL, which closed at $1.12 on Friday. Sit back and wait. Fairly soon, within two weeks I hope, you will be cashed out at $1.48 per share.

“GOING DARK” TRANSACTION

At its 2020 annual shareholders meeting, which is to be held at 11 a.m. EST on Tuesday September 29, shareholders will vote on a “going dark” proposal. Specifically, the plan is to reverse split the common stock 1000:1 (1,000 shares will become 1 share), immediately followed by a 1:1000 forward split (1 share becomes 1,000). Following the reverse split, any shareholder owning less than one share (i.e. less than 1,000 shares before the reverse split) will not be issued a fractional share; instead they will be cashed out at $1.48 for each share they owned before the reverse split. Following the forward split, all shareholders who owned 1,000 or more shares before this entire exercise will have the same number of shares they had previously. All of the “small” shareholders who owned less than 1,000 shares will have been eliminated.

The purpose of this transaction is to “go dark,” i.e. by reducing the number of shareholders of record to less than 300, Westell could deregister its shares under the 1934 Securities Exchange Act and eliminate the expense and effort of being a public reporting company. They will no longer have to file quarterly, annual, and other reports with the SEC, and shareholders will no longer get annual reports and proxy statements. The stock will no longer trade on NASDAQ and will be much less liquid than it is currently, but will continue to trade on the pink sheets and in private transactions. The one-time legal and other costs of the transaction are estimated at $300,000. Annual cost savings from going dark are expected to be $900,000, in addition to the management time and effort spent on being a public company.

I’ve found that there’s always some uncertainty in these transactions about whether street name odd-lot shareholders get cashed out. In the proxy statement, in a section titled “Treatment of Beneficial Holders (Stockholders Holding Shares in ‘Street Name’)” the language reads, in part: “We intend to treat stockholders holding our Class A Common Stock in ‘street name’ in the same manner as record holders.” Past experience suggests that street name shareholders will get cashed out, but this is one risk of the transaction.

There are two classes of common stock, Class A (which are publicly traded) and Class B. The two classes are identical, except that the A shares get one vote per share, the B shares get 4. There are 12.34 million A shares and 3.48 million B shares, a total of about 15.8 million common shares. The B shares thus have 53% of the votes. All the B shares and 4.8% of the A shares are owned by directors and officers, who have indicated that they will vote for the transaction. As a result, approval at the annual meeting is not expected to be a problem.

Interestingly, in the proxy, they expect the number of A shares to be reduced by 5.3 million, or about 43% of the outstanding A shares and about one-third of all of the common shares outstanding. At $1.48 per share, this would result in cash outflow of about $8 million, which they will pay from cash on hand.

I won’t spend time describing Westell Technologies’ business because it’s not relevant here, except to quote the company’s most recent 10-K, where it describes its business thus:

“The Company is a leading provider of high-performance network infrastructure solutions focused on innovation and differentiation at the edge of communication networks where end users connect. The Company’s portfolio of products and solutions enable service providers and network operators to improve performance and reduce operating expenses. With millions of products successfully deployed worldwide, the Company is a trusted partner for transforming networks into high-quality reliable systems.”

I don’t really know what this means, and I don’t really care except to the extent that it affects the outcome of this investment. I have no sense of Westell’s competitive position in its businesses. Its financial performance has been poor in recent years, with sales declining from $102 million in FY 2014 (FYE March 31) to $30 million in FY 2020. It has lost money in recent years, losing $10 to $11 million in each of the last two years. The first quarter of the current fiscal year showed some improvement – sales continue to drop, but the loss was much smaller.

The good news is that the balance sheet is strong, with cash of $21.9 million at 6/30/20. The only debt was $1.64 million of PPP loans. The net cash of $20.3 million translates to $1.28 per share, versus the current stock price of $1.12 and the cash-out price of $1.48 for the odd lot shareholders. The cash balance gives them a comfortable cushion to buy out the smaller shareholders in the transaction.

The $1.48 cash-out price is based on a fairness opinion. My guess is that the large shareholders and management believe that the company has the potential to be worth a lot more than this price, and have chosen to do a large stock buyback through this transaction, simultaneously going dark and saving themselves the headaches of being a public reporting company.

RISKS

• The transaction is cancelled. I think this is unlikely, but it could happen. One possibility is that too many people try to take advantage of the arbitrage, and the company does not want to use too much of its cash.

• The terms are changed. Parker Drilling, which was written up on VIC a year ago, subsequently announced that it was changing the terms of its transaction, strung the shareholders out for many months, and was eventually a disaster for many who participated in it. I think that this too is unlikely.

• The “street name” vs. “shareholder of record” issue discussed above.

Catalyst

Completion of the "going dark" transaction.