Description

Investment Thesis

Ideation Acquisition Corp. ("IDI") is a SPAC created by Dr. Phillip Frost, founder of IVAX Corporation with a net worth of roughly $1.5B.  He lives in Miami and is still very active in pharma/med tech investments.  This is an opportunity for him to invest and diversify away from medical and into China urbanization and advertising growth.  I believe if the shareholders vote for the acquisition of SearchMedia International Ltd ("SM") on 10/26 that the IDI equity offers 50-200% upside over the next 2 years as IDI is purchasing a growing media platform business at roughly 7x earnings, 40% of peers average.  The warrants offer much more upside (and downside) and have recently rallied, which typically signals a positive shareholder vote for SPACs.  I typically am skeptical of new China listings or reverse mergers, but I trust Dr. Frost and he is buying more stock in the company upon the merger being completed, which gives me more conviction.  If deal doesn't go through, you lose nothing, but if it does I believe the risk reward is very skewed in our favor. 

Business

SM operates a large advertising network in China, consisting of in-elevator, billboard and transportation advertising.  It was formed in 2005 and has grown both organically and through small acquisitions.  Currently it has over 1500 billboards representing 500k sq ft of display space in 16 cities, 175k frames in elevators across China and lightboxes in eight major subway lines in Shanghai.  It has a very impressive list of clients across all platforms, including Toyota, Mercedes, KFC, P&G, Pepsi, Lenove, HSBC, Bank of China, Adidas and Samsung.  SM is nearing 1000 advertisers across their platforms. 

SM is #1 in market share for in-elevator displays in 13 of the 26 richest China cities.  It has grown by acquiring 12 media businesses in China and HK as well as building all 3 platforms organically, offering a one stop offering to clients for outdoor/indoor advertising.  It is a very light capex business with huge incremental returns upon launching a new site. 

Billboards - SM has over 1500 large format billboards and lightboxes in 16 cities throughout China, including main business areas of Beijing, Shanghai and Shenyang. 

In-elevator - SM has over 175k poster frames, both print and digital, delivering targeted messages inside elevators of both residential and commercial high-rise elevators.  It has done 6 acquisitions in 2008 to build this #2 overall market share business.   Biggest competitor is Framedia of Focus Media (FMCN), and SM is narrowing the gap quickly to only a few % difference.

Subway - SM leases the rights to lightboxes on 8 subway lines in Shanghai.  Daily traffic on these lines of 3mm per day and zero capex required.  It continues to grow # of lines in Shanghai and is the process of building in other cities.  Subway lines are being built all over China and this is a great growth market.

Even with the Olympics one time growth complete (which I am still trying to estimate), this business should still grow in 2009 and rapidly in 2010-2020 given improving revenue per contract and # of sites and contracts, as well as general demographic and urbanization growth.  YoY growth in 2008 vs. 2007 was 53% in revenue per contract and 700% in # of contracts.  As SM grows, its brand and reputation does as well, providing more pricing power and deeper client relationships.

SM has done a good job of integrating acquisitions as far as I can tell.  Margins have improved and their process of integration seems sound.  Their standardized IT platform and financial management processes have really helped them integrate deals efficiently. 

Lastly, they have a really strong network of premium locations, which helps with barriers to entry and pricing.  Their ability to offer a diversified platform and group pricing has allowed them to continue to have a very high renewal rate. 

Management

Crystal Liu, an advertising entrepreneur who has effectively handed over leadership to new management, founded the company.  She raised venture capital from Deutsche Bank and China Seed Ventures.   Garbo Lee is the CEO, who seems pretty impressive and has only been there a little over a year.  She was previously with Ogilvy and Bates Advertising, as well as WPP and Omnicom.  Jennifer Huang, the CFO, is ex Wall Street at Lehman and Merrill.  Earl Yen is Vice Chairman - he has been very successful in China as founder of CSV Capital and was a senior banker in China for Citi and Bear. 

Robert Fried is CEO of Ideation and will be actively involved in SM.  He has been in movie production and media for 25 years and is the main driver behind this transaction.

Transaction Overview

After IDI completed its $80mm IPO (10mm shares at $8 plus 1:1 warrant) as a typical SPAC in Nov 07, on 4/1/09 IDI announced the proposed acquisition of SM for 9.9mm shares minimum, and up to another 10.2mm shares based on a 2009 GAAP net income earnout.  Could be a total of $158mm based upon today's closing price of $7.87.  Given 12.5mm shares outstanding today (2.5mm founder shares that have no redemption rights), not including the 12.4mm warrants, this will represent 44-62% ownership of SM by SM purchased holders.  Dr. Frost will buy another $18.25mm of IDI shares in the open market or through private transaction to show further support of the deal.  He has already bought over $2mm in open market.  No debt will be outstanding post deal, a substantial cash balance will remain ($50-75mm roughly based on redemption possibilities) and 99% of SM holders have approved deal.  SM has earnouts outstanding from its acquisitions to date, which will be funded by its free cash flow or in stock (still waiting on this #).   The deal has to be approved by a majority of IDI stockholders and less than 30% of holders must not exercise their redemption rights to receive the trust account per share amount, roughly $7.80/share today.  Given Dr. Frost ownership and recent market move, it appears deal will be completed.  The pricing of the transaction for a 4/1/09 announcement date was fortunate to say the least for IDI...

The SM deal earnout is based upon the following: 

If 2009 US GAAP Net Income is greater than $25.7mm, which would be 65% YoY growth, SM holders will get an additional 1mm shares for each additional $1.25mm of net income produced over $25.7mm, up to a maximum of 10.2mm shares.  So > than $38.4mm of net income, would be gravy to IDI holders.  No indication has been given yet on YTD 09 results but projected financials given on deal announcement were for $123mm in revenue, $49mm in EBITDA and $29.7mm in net income. 

Assuming $25.7mm of net income and therefore no earnout shares, IDI would have proforma shares of 22.4mm shares and an equity value after closing of $176.3mm based upon today's close of $7.87/share.   Enterprise value would be roughly $100mm for a 2.5x EV/09 EBITDA (roughly $42mm of EBITDA) proforma value and 7x P/E.  Again, this assumes no warrant dilution, which is unlikely given the valuation and in-the-$ stock price.  Adding full warrant dilution, $60mm of cash will be received and there will be 34.8mm shares outstanding, yielding a $274mm equity value and $140mm EV, for a 3.3x EV/09 EBITDA multiple.  Please see below for comps and why this is so cheap. 

The SM holders are locked for 2 years with only 10% of holdings available to sell within 1 year and a total of 25% of shares between 18 -24 months and then 100% after 24 months. 

The 10mm IPO warrants are struck at $6/share, expire 11/19/11 and are exercisable once the deal is completed.  The company can redeem them as long as IDI stock is above $11.50/share for 20 of 30 trading days.  Therefore, at $11.50, IDI stock could see some resistance and selling pressure from warrant holders.   Insiders also bought 2.4mm warrants at $1 each simultaneous with IPO and have same features as the other warrants, so there are a total of 12.4mm warrant shares outstanding. 

Insider ownership

Dr. Phillip Frost owns 16.3% and HBK, a TX based investment firm, owns 10%.  Robert Fried, CEO, owns 5%.  Seems highly likely the deal gets done, especially if Frost buys more.     

Valuation

Clearly the equity is very cheap if the deal gets done, given both cheap multiples, low capex requirements and high FCF.  The comps below reinforce this view and why the deal price is very attractive.  Only one analyst, Gilford Securities, covers the stock.  I should note that the author's hedge fund has Frost as an investor so clearly his report needs to be discounted, although it appears conservative anyhow.   In 2008, SM did $85mm in revenue and only had $3.4mm in capex.  Expectations for 2009 are for growth given their projections but peers are struggling with higher concession fees and hangover from Olympic growth, both of which SM management say they have been able to offset.  We shall see with 09 #s but on 08 alone, stock is still cheap as seen below.

Catalyst

- deal is approved by shareholders on 10/26

- additional accretive acquisitions

- continued growth in contracts and sites and scalability of margins

- additional analyst coverage