Description

Rarely do you get an opportunity to buy a great cash flow business at 1/3 of the price that management and smart investors are paying, but that is exactly the opportunity in the Key3Media ("KME") spinoff of Ziff-Davis, which should begin trading in a few weeks. KME does not trade publicly yet and to put on this position you will have to go through the trouble of artificially creating it.

Ziff Davis (ZD) is in the final stage of a series of complex transactions. I'll skip history and get to where we are today. Ziff Davis basically has 4 assets left. The first is 60mn shares in publicly traded ZDnet (ZDZ). The second is $75mn worth of other technology assets. The third is Key3Media, which will be distributed to ZD shareholders on a pro-rata basis via a spin-off (you will actually only receive .5 shares of Key3 per ZD, but for simplicity I will refer to all numbers in this ideas as per 1 ZD shares). The fourth is cash, which will be used to pay a dividend.

This morning ZD announced a transaction whereby CNET will purchase all of the shares of ZD for .3397 shares of ZD. CNET is purchasing ZD because of its interest in ZDZ and i, but prior to the merger, ZD intends to spin-off Key3Media and pay a dividend of $2.50.

Here is what you receive as a ZD shareholder

ZD price $13.50
- CNET stock of .3397 short at 1% risk arb discount for 1 mth $ 9.96
- Cash dividend to ZD shareholders $ 2.50
Implied price for Key3Media $ 1.04

What makes me think that it is worth it to create Key3Media for $1.04 per ZD Share. First of all, Key3Media has hired a new CEO named Fred Rosen, who had an enormously successful track record as the CEO of Ticketmaster for about 15 years, prior to selling to USA Networks. He basically built the company up from nothing to a national powerhouse. Mr. Rosen is buying stock in a private offering at $3 per ZD share. He will be incented through a large options grant of 12% of the equity, struck at 30% above the offering price. A private offering to friends and family of management, where past partners, which may include investors such as Paul Allen or the Pritzker family (both past partners of Rosen's) will buy an additional $60mn worth of stock.

Valuation - At the public offering price, Key3Media will have an Equity Value of $330mn and total debt outstanding of $430mn for a Total Enterprise Value of $760mn. Last years EBITDA was about $90mn and that is expected to rise this year. Previous management did little to manage the business. I believe that there are great opportunities to ramp up cash flow here through increase advertising, partnerships, web-site revenue and basic customer service. Recently the owner of PCExpo was sold for 11x 2000 EBITDA. Key3 requires only about $5mn per year in maintence capital expenditures, so I am comfortable using EBITDA-Cap-X as a cash flow number (the company won't pay a materail amount of taxes). If EBITDA has a modest increase to $100mn this year and you apply the same multiple as PCExpo, then TEV should be worth $1.1bn, with the equity worth $670mn or 2x the offering price and 6x times the price we are creating it for.

Risks - Comdex, their biggest trade show has been in decline for 3 years. Management feels that it can halt this trend. If they are wrong, then you have a leveraged company in decline. Also, there is a great deal of potential dilution from stock options and warrants issued to certain layers of the debt. And of course, it will be very leveraged. Finally, we are creating this stub via a risk arbitrage transaction, which requires a lot of capital to create a small stub. Deals sometimes break and spreads often change. I am expecting the implied risk arbitrage discount to move little in the next month at which time you can take off the risk arb position (deals don't usually break in the first few weeks). All in all, 3 times your capital at risk in a month isn't a bad return.

Catalyst

The spin-off will serve as the catalyst and that is expected in the next few weeks.