Description

Argosy Education – Arbitrage

ARGY – 10.35 offer
Deal price: $12 all cash
Deal closing: between Thanksgiving and year-end.
Simple return: 16.9%
Annualized: A BIG NUMBER

This is a small or micro cap arbitrage deal that has “opened up” in the last few days. I suspect many other arbitrage deals have opened up as a result of margin calls, arb funds getting out of their positions at any cost, and general fear that deals will be cancelled due to the “war clause” in most deal agreements. Buffett’s move regarding Finova put the fear of God in most people that play this risky game...

Argosy (target) is the leading for profit provider of graduate level degrees in the country. Education Management (EDMC) has a chain of art schools and is beginning to offer undergraduate degrees and to upgrade its accreditation in order to attract better students at higher tuition price points. EDMC is a growth company, with enrollment growth of 15% to 20% and revenue and EPS growth of 20% plus. EDMC is falling from a momentum valuation and has a ways to go before it reaches fair value. Fundamentals are very much intact. Education companies typically see a swell in their applications and enrollments during recessions.

The deal size is about $75 million for ARGY’s 7,450,000 shares outstanding (float is less than 1,500,000). Founder and chairman Dr. Markovitz has agreed to tender his shares and will continue with EDMC in an executive position. EDMC does $350m in revenues, $50m in EBITDA, and $28m in net income (trailing twelve months – EDMC grows at 15%+ so adjust upward for current numbers). Accoring to the proxy, EDMC anticipates needing to finance about $25m of the deal price. This should not pose a problem given the company’s revenues and profits – the financing could be paid off with one year’s net income, and the entire purchase price could be paid for with a little over 1 year’s EBITDA.

As of yesterday, officials at both companies say that the merger is progressing as originally anticipated. Major issues that could blow up the deal are:
1) financing – doesn’t look like it should be a problem.
2) “war clause” – EDMC does not appear to want out. ARGY is a good fit and will give them solid growth in revenues going forward, with the opportunity to improve ARGY’s depressed margins. Also, EDMC went ahead with 2 small deals on Sept. 17th, so they do not appear to be pulling in their horns in any way.
3) Regulatory approval – should not be a problem.

Finally, according to Dr. M at ARGY there were other parties interested in acquiring ARGY, and I think a deal should be forthcoming at a somewhat lower price (lower than $12) within the next 12 to 18 months if this deal falls through.

There are dramatic things going on in the markets - perhaps most of it is justified. The Bass brothers' Disney block (margin call on a "market neutral" fund?), etc. In the midst of all this, ARGY certainly looks like an inefficiently priced security. I know J.G.’s book says that the risk-reward of arbitrage is not favorable, but 16.9% in a few months is nothing to sneeze at.

Catalyst

$12 all cash deal price, 16.9% return by year-end.