NMKT: The Pros and Cons of NewMarket's New Deal
Wednesday, October 11, 2006 20:04ET
On Tuesday, 10/10/06, shares of NewMarket Technology (NMKT) jumped +13% after reporting the execution of a non-binding LOI to be acquired by Action Products (APII) in an all-stock transaction that...in reality, would result in a "reverse merger" with APII's toy business becoming an operating subsidiary of the parent...to be subsequently renamed "NewMarket Technology" and run by the current NMKT management team. Although the deal calls for NMKT's stock to be valued at $0.50/shr (or more), NMKT closed Wednesday's session at $0.30, down -7.6%. Whether the market is confused or skeptical is unclear, but the deal structure does deserve a little explanation.
So, what does a traditional toy-maker have to do with a technology incubator? At first glance, not much...but if the deal didn't benefit both sides it probably wouldn't have gotten this far. Let's take a look.
APII: This 30-year old, family-run toy business has recently struggled for profitability to no avail, and with little or no sales growth. This deal follows a 2-year, -50% stock price decline and a series of senior management departures. In Sep-06, the company's CFO resigned, and in Jul-06, APII dismissed Lawrence Bernstein, PR/COO, just months after the former Hasbro executive was brought on board to help turn around sales. APII might just be looking for a spark to help grow its business without the public company headaches. A quick glance at the deal details does show that APII hopes to use this transaction to protect and improve shareholder value.
NMKT: On the other hand, NMKT has been executing an aggressive "sales growth through acquisition" strategy. NMKT's sales have grown from $2.3M in 2003 to $63.7M for the trailing 12-months, and now, NMKT projects $100-120M in revenues for 2007. All along, NMKT has reported increasing net income and currently sports a low P/E ratio of 10. But here's the catch...NMKT has accomplished its acquisition growth through the issuance of stock and now sits below the Nasdaq $1 minimum share price listing requirement with over 200M fully diluted shares outstanding. CEO, Philip Verges, has indicated that NMKT can no longer afford to continue issuing its stock for acquisitions while the stock price lags its fundamental merits due to an "OTCBB listing stigma." Mr. Verges has also indicated that a Nasdaq (or AMEX) listing may help bring NMKT the valuations it "deserves."
So, who wins? Of course, only time will tell, but both sides probably feel that this deal is a "win-win". There are a lot of factors at work here, but the following bullet points represent just a few "pros and cons" as we see them.
APII - Pros and Cons:
PRO: APII becomes part of a larger, profitable and growing enterprise.
PRO: *Shareholders keep their $3.25 warrants (currently out-of-the-money).
PRO: Common shareholders have option to convert to a $6 par Preferred Stock.
PRO: Preferred converters will be entitled to a 5% dividend, or $0.30/shr.
CON: *Shareholders are diluted 80-90% and give up control to NMKT.
CON: *The new stock may never reach the $3.25 or $6.00 strikes (wts/pfd).
CON: Will NMKT be able to pay the $1.5M in annual preferred dividends?
CON: Without a quick turnaround, NMKT may cast-off an unprofitable toy biz.
NMKT - Pros and Cons:
PRO: NMKT gets (and hopefully maintains) a long awaited Nasdaq listing.
PRO: Shareholders get a +72% premium at $0.50 per share (in APII shares).
PRO: NMKT gets the "recap" they need without the dreaded reverse split.
PRO: *NMKT may reap a $17M+ cash infusion if APII exercises $3.25 warrants.
CON: *Depending on warrant exercises, NMKT may see dilution from 10-20%.
CON: APII's losses and dividend obligations may hurt NMKT's profitability.
CON: Toy making is a big diversion from NMKT's technology incubation model.
CON: Lot of hurdles ahead for a non-binding deal without market respect.
*Dilution Note: The actual dilution involved in this deal could vary due to a number of factors. Obviously the ensuing share prices of both stocks will impact final ownership percentages, but a big contributing factor is the APII warrants. Prior to this deal, APII shareholders were issued approx 5.2M 2-yr warrants exercisable up to $3.75/shr. At current share price levels and excluding the exercise of these warrants, NMKT would control approx 89.5% and APII would control approx 10.5% of the new company. Now, if the new company's share price gets above $3.25-3.75 and these warrants are exercised, NMKT would give up another 8.5%, BUT the company would receive a big cash infusion between $16.9-19.5M. Not a bad scenario.
So, what's next? For this deal to truly be a "win-win", the most important factor may be a sustained and elevated stock price for both APII and NMKT. Secondly, many hurdles exist including: APII shareholder approval (including a req'd increase in shares authorized to accommodate the near 50M share issuance); NMKT shareholder approval; and, Nasdaq listing scrutiny. If the recent NMKT "PR" activity is any indication, NMKT's management seems dead-set on getting this deal done. And if history is any indication, NMKT has completed many deals over the last few years and they just might pull this one off too...But to the satisfaction of everyone involved?
Knobias, Inc. has received monetary compensation from the above company for services rendered as part of the Knobias Media Package. Please refer to the "Media Package Disclaimer."
