Analysis

Background

On May 25, 2010, Emmis Communications Corporation announced that it signed a merger agreement with JS Acquisition, LLC, a company owned by EMMS’s Chairman and CEO, Jeffrey Smulyan, effectively taking the company private. Common stock holders will be cashed out at $2.40 per share in a deal worth approx. $90.2m. The deal has been in the works since late April, when the company received a letter of intent regarding the going private transaction.

Terms

Holders of Class A common stock will receive $2.40 for each share tendered. Other considerations are due to preferred stock holders.

Shareholder Complaint

As often happens in these transactions, several lawfirms are investing whether the board of directors breached its fiduciary duties to shareholders by accepting the going private offer. These lawsuits allege that the closing price of $2.40 is only 11% above the most recent closing price of $2.38.

However, I do not see this as being a major roadblock to the transaction. The only reason for the small premium was that a letter of intent was signed back in April. The $2.40 offer is 74% above the 30-day average trading price and 118% above the 180-day average trading price, a significant premium.

Board Approval

The board approved the transaction in conjunction with the merger announcement.

Shareholder Approval

In order to approve the transaction, a majority of common shareholders must tender their shares in favor of the merger. Since Jeffrey Smulyan owns 60% of outstanding Common Shares, this part of the approval is already assured.

In addition to the common shareholder approval, 2/3 of Preferred Stock holders must also vote to tender their shares. Alden Global Capital, the asset management company that is providing financing for the transaction, holds 41% of outstanding preferred shares and has voted to approve the merger.

This means only 25% of preferred stock holders must vote to approve the merger in order for the transaction to go through.

Timeline

The tender offer will commence on June 3, 2010 and will last at least 20 business days. Assuming preferred shareholders promptly tender their shares, the going private transaction should commence sometime around July 1, 2010.

Discussion

Unless something falls through with the financing, I don’t see very many risks with this transaction. Jeff Smulyan controls the majority of the company and seems to have the backing of the board and the largest preferred shareholder. I’m anticipating the merger will go through in July.

Shares can be picked up for $2.29 per share, resulting in a quick ~5% return in just over 30 days

Supporting Documents

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Disclosure

Long EMMS

Servotronics reported Q1 results two weeks ago, and the market certainly reacted favorably! Almost 44k shares traded hands – average volume is around 2k – and the stock jumped almost 30% during intraday trading before closing at $10.04, a 19.54% gain. The stock has dipped since then but it’s rising back towards $10.

Back in March, investors will remember that the stock took a 25% hit after reporting a large decrease in net income, as the Consumer Product division barely broke even for the year.  I certainly felt like the March drop was an overreaction and the company’s press release seemed to back up this sentiment:

Notwithstanding the reported reduction in year to year net income, the net income for 2009 was the 3rd highest net income reported by Servotronics during the past 25 years. Also, the 2009 reported net income was approximately 50% higher than the reported net income for the Company’s 4th best year during the same 25 year period. The Company’s 3 best years, as measured by net income during the past 25 years, occurred during the last 3 years (i.e., 2009, 2008 and 2007).

Q1 Financial Numbers

Total revenue increased by 4.6%, with a 13.2% increase in the Consumer Product division. Net income increased a staggering 397.6%, as margins improved across the board due to a better product mix. Although these are obviously very positive results, the company’s product mix constantly shifts from quarter to quarter, especially since a large percentage of sales come from governmental contracts, so it is important to keep these numbers in perspective.

Outlook

The most exciting part of this quarter is management’s cautiously optimistic report on the future of the aerospace industry. Several major aircraft manufacturers have announced plans to increase production in late 2010, 2011, and 2012. As a supplier of ‘servo-control components,’ a necessary part of airplane hydraulics, SVT is well positioned to capitalize on this growth.

I expect the company to continue to deliver impressive operating results as they ramp up production to meet this increased demand.

Valuation

I calculate an intrinsic value between $15 and $17 per share, providing substantial upside at the current price.

Disclosure

Long SVT

ELST filed its Q1 results on March 13th and reported a solid, if unspectacular, quarter. Total sales increased by 23% compared to the first quarter of 2009. Domestic sales were basically flat but foreign sales jumped almost 82%, due to higher demand for the company’s products from industrial automation projects in Chile, India, Colombia, and Peru. Operating margins are significantly higher on foreign sales – see chart below:

Foreign sales accounted for 34% of total sales in 2009, compared to 23% in the previous year. Hopefully management will continue to focus company sales efforts on this segment going forward.

Despite the improved results, management is still very cautious for the rest of 2010 –

“Management believes that the tenuous worldwide economic recovery makes sales revenues during 2010 difficult to predict and prone to potential fluctuation”

As a going concern, I think the business could be worth anywhere from $.75-$1 per share, substantially higher than the latest closing price. Barring a potential catalyst, it is very important to understand the downside risk as well:

Based on the company’s latest closing price of $0.45, the stock is trading for 10% less than the sum of its assets its liquidation value, providing a nice cushion to the downside.

Also, Paul Sonkin of Hummingbird Capital has increased his stake from to 16% to 21.1% of the company. Hummingbird Capital is a very successful hedge fund manager that focuses on nano-cap plays selling at a discount to their intrinsic value. Paul recently spoke at the Value Investing Congress (see a great writeup here: 2010 Value Investing Congress Notes by The Innoculated Investor)

It is always nice to have an expert on your side!

Disclosure

Long ELST