February 19, 2019 - 5:48am EST by
2019 2020
Price: 4.74 EPS 0 0
Shares Out. (in M): 46 P/E 0 0
Market Cap (in $M): 220 P/FCF 0 0
Net Debt (in $M): -12 EBIT 0 0
TEV (in $M): 208 TEV/EBIT 0 0
Borrow Cost: Available 0-15% cost

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Thesis Summary: Maxwell Technologies (MXWL) last traded at $4.74, just one penny (or 0.2% of your capital outlay) below the announced bid price from Tesla (TSLA). While borrow costs (1.8% at IB at the moment) will marginally increase your cost of carrying this position for the next 3-4 months (at maximum), barring an overbid (which I view as incredibly unlikely), essentially you risk next to nothing (less than 1% all in) to make a potentially exponential return if the TSLA deal breaks (since this price represented a 55% premium to MXWL's pre-merger price); additionally, MXWL is a dumpster-fire of a company with nary enough cash left to sustain another year of operations, and a host of accounting issues past and present, so fundamental downside is perhaps a lot lower than to the pre-deal price. But it gets even better. MXWL shareholders get $4.75 in new TSLA shares, capped to the upside, but not on the downside (beyond a buffer zone). In other words, you don't even really need the TSLA deal to break: if TSLA stock trades below $246 in the 5 days prior to deal closing - that is, just 20% lower than spot - MXWL shareholders will receive only 0.0193 TSLA shares per MXWL share, providing synthetic exposure to a collapse in TSLA's stock price on or before this spurious deal closes (sometime in the next 3-4 months, apparently).

While this is clearly a small-cap company, volume is adequate for most small funds (>$5mm ADV of late), and borrow is surprisingly available, making this highly actionable. Given the small market cap and irregular nature of the idea, this will be a short writeup - happy to answer any follow-ups in the questions.


Introduction: 'Take care of the downside, and the upside will take care of itself,' my Pops used to say, as he bounced me gently on his knee when I was a bub. Well, no, not really - I must have heard it somewhere else along the way. But I have always been attracted to massively asymmetric bets (and I guess by extension the value investing philosophy in general), and the current situation in MXWL seems almost too good to be true in this regard. Let me caveat at the outset by saying I am neither a merger arb expert, nor a battery technology expert, and while I have made investments in both fields in the past, I am approaching this very much from a generalist perspective. Please note also that I am short TSLA, both stock and via derivatives.

Let me start with a quick summary of recent events. MXWL is a crappy, small, battery/energy storage company that has historically been, as a Texan would say, 'all hat, no cattle'. They have accumulated a deficit of $283mm over their history; have burnt cash in 5 of the last 6 years (including >$60mm last yr); have progressively sold off their profitable businesses to sustain their money-losing Ultracapacitor/Dry Electrode businesses; have repeatedly run afoul of regulators (restating 2011/2012 financials a few years ago, and violating the FCPA a few yrs ago for which they are still being sued by the Swiss). As with many dodgy small-caps, they have funded the promise of a revolutionary future with frequent stock issuance and, more recently debt issuance (hmm, this pattern rings a bell...). Despite all this, the recent 10-K makes it quite clear that the company, as currently capitalized, had perhaps another year of runway before more capital is needed (burning $11mm cash per Q, no backlog, ongoing high R&D needs, and only $58mm cash post the most recent asset sale), and they only cured a much more dire going concern qualification in the Sep'18 accounts by selling their only profitable business, High-Voltage, for an immediate cash injection in December. They freely admit throughout their documentation that commercializing Dry Electrode tech - the big technological promise they are developing - would require a boatload more capital, as well.

Enter TSLA with a rescue bid on Feb 4, valuing MXWL at $4.75 per share in new TSLA shares. There were a few odd things about the bid from the outset. Firstly, this is a very small acquisition that - for most large cap companies - would be consummated in cash. Secondly, as recently as last August, MXWL had issued stock at $3.25, and business had clearly deteriorated since then; furthermore the stock was trading around $3 at time, providing perhaps an unnecessarily large premium for a company with going concern issues. More worryingly, despite the prompt filing by MXWL of the relevant 8-K and standard merger documentation, there was not even a press release issued by TSLA, let alone an 8-K, regarding the acquisition. We have now gone two weeks since the Merger Agreement was apparently signed (Feb 3 per MXWL documents) and there is still no formal or informal acknowledgement of the deal by the acquiring party...strange, to say the least (frankly I have never seen this kind of delay in my investing career). These events prompt questions, which it would be natural to ask the acquiree...unfortunately however MXWL canceled their year-end call in light of the pending acquisition, so no dice there either.

Without going too much into TSLA's supposed rationale for the purchase, some online commentators have highlighted the clear link between TSLA's China Gigafactory investment, and bailing out the Chinese government for its loss-making investment in MXWL a couple of years ago ( Others on the sell-side have opined that MXWL's tech may actually make sense in helping maintain TSLA's apparent lead on battery technology (I believe Jefferies). Whatever - I want to focus on deal mechanics, and what could happen to derail the bid from here.

Deal Mechanics: The MXWL 8-K makes the terms quite clear. Providing the deal conditions are met (see below), MXWL shareholders will receive $4.75 in TSLA shares providing the 5-day average TSLA trading price prior to the close of the transaction (presumably in the next 3-4 months, maximum) is >$246. If TSLA is <$246, then MXWL shareholders get 0.0193 TSLA shares per MXWL share. Essentially then MXWL shareholders are short a TSLA put that knocks in at $246. Thus, for example, if TSLA shares fall to $225, MXWL shareholders would get 0.0193*225 = 4.35; at $200 per TSLA share this falls to $3.86; and so on.

So, what then are the closing conditions? These are mostly boilerplate (anti-trust provisions; majority of votes support the merger; etc) but one in particular is of consequence: TSLA needs to file an S-4 to register the new shares for sale with the SEC, and this has to be deemed effective. This is the KEY issue - without an effective S-4, TSLA cannot issue the shares and thus the merger could not happen as contemplated. Feel free to mosey on over to the TSLA board here for a more fulsome discussion of doubt regarding TSLA's ability to issue publicly tradeable stock at the moment (there is also a huge amount on Twitter), but suffice to say that:

a) TSLA has not issued public stock or debt for well over 12mos now and is thus not a 'well-known seasoned issuer', the result of which is that any prospectus filing for new issuances (on form S-3 or S-4) are particularly onerous;

b) it is unlikely/perhaps impossible for TSLA to file the needed S-4 without an audited, signed off 10-K; as we know TSLA still hasn't filed this.

Frankly, I don't pretend to have all the answers, nor is this situation large/liquid enough to dedicate a huge amount more time than this. But the point is at the current price, merger arb guys (or retail punters) are so asleep at the wheel as to provide a hugely asymmetric payoff where we lose next to nothing in the base-case outcome but make out like bandits if the wheels fall off suddenly. And it doesn't stop here. Even if the deal goes ahead as planned with no hiccups, but TSLA stock takes a tumble before the deal closes for unrelated reasons like US sales falling off a cliff, or tepid European demand, or Musk overdosing live on a podcast or something - we still have a strong chance at a positive return. I like these kinds of trades.


Why there won't be an overbid: Clearly the biggest risk for the trade. However I sleep pretty easily on this one, because:

- the premium paid was already massive and beyong what a dumpster fire of a co with <1yr of cash runway would expect;

- anyone who wanted to buy the tech could have had the company last summer when they did another dilutive offering at $3.25;

- they have already sold their only profitable business (High Voltage), meaning the co has presumably already shopped part/most of the business;

- there was no go-shop provision in the agreement, suggesting MXWL management knows this deal, such as it is, is the best they can hope for.


What happens if the deal breaks? Well, the stock should clearly go back to where it was, at a minimum (ie, $3), so call it 38% downside. However, in this scenario, I think it is a matter of time before a further massive dilutive offering, or worse, because:

- as mentioned the co is burning cash at the rate of $10-11mm/qtr and has maybe enough for 5qtrs of life at current rates (but has highlighted a need for substantial additional capital);

- there are a number of accounting red flags that, because MXWL canceled the year end call, no one could really focus on. For example, inventories ballooned in the recent reported period (155 days vs 102 days in 2017), despite sales on a like-for-like basis being essentially flat. The company mentioned transitioning to a new contract manufacturer that demanded consigned inventory held on site and quarterly purchase commitments...even so these are historically high levels of inventory for this company and recall it has sold its only profitable businesses so there is large writedown risk here;

- payables contracted massively, trade payables fell to just 23 days in 2018 (versus 80 in 2017, and 40-50 4-5yrs ago), suggesting an unwillingness to accept MXWL credit;

- ongoing legal risk from Swiss enforcement of prior FCPA breaches that the company admitted to a few years back.


All in all this is very much a 'heads I win, tails I don't lose' type situation - very much to my liking given my underlying bearish view of TSLA.

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.


- Deal break

- Tesla blowup


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