Description

Market America is an arbitrage opportunity. Current management has offered to pay $8.00 per share in cash for the shares they do not own. That corresponds to an approximate premium of 7.8% to the current price. The deal was announced on October 17, 2000 and management has indicated that they hope to have a shareholder meeting in February to vote on the proposal with a closing to take place shortly thereafter. Allowing for a slightly longer time frame, I am anticipating a closing in mid March to mid April. The proposal is subject to obtaining a majority vote for the transaction by the non-management held shares (50% plus one vote). The public owns approximately 20% of the shares. Financing is not an issue as the company has cash on its balance sheet to fund the acquisition.

Provided the deal closes within 2 to 5 months, the annualized return will range between 19.4% (based on a 5 month hold) and 55.8% (based on a 2 month hold) with an expected return of 28.8% (based on a 3.5 months hold which is my anticipated time frame). On a normalized return basis the corresponding annual returns would be 46.0%, 18.4% and 26.3% respectively.

If the deal does not close the share price will likely fall to $4.45, the pre-announcement trading price. As I will explain below, however, that may not be such a bad thing.

The shareholder vote is what will most likely determine the eventual outcome of the proposed merger. A simple majority of non-affiliated shareholders is required to approve the merger. As it has been expressed to me, current management’s most significant concern is that any shares not voted are counted as shares voted against the merger. There are no shareholders that own more than 5% of the stock that are non-affiliated and there are a large number of small shareholders.

Putting aside for the moment the issue of valuation, the stock has essentially not traded at or above the take-out price in five years. In my opinion a significant number of shareholders will vote in favor of the merger solely because the price is higher than it has been for a long time. Additionally, management has indicated that most shareholders with whom they have spoken have been in favor of the merger. Not withstanding those comments, there is one shareholder who has initiated a lawsuit against Market America and its directors. I believe the purpose of the lawsuit is to try to compel management to raise the merger price. The particular plaintiff and his attorneys have a long track record of filing similar suits. Whether or not they will succeed at getting the offer price raised I have no opinion. I do, however, believe that it will not jeopardize the proposed transaction.

Valuation Considerations:

Market America first came public through a reverse merger in 1994. The business, which is about 10 years old, is a multi-level marketing and distribution company. To save space I will refer readers to the company’s public filings and their web site for a full description.

The company’s sales have grown from $1,321,874 in 1993, $9,931,946 in 1994, 19,592,056 in 1995, $42,479,911 in 1996, $66,281,671 in 1997, $87,531,005 in 1998, $110,347,824 in 1999, $135,965,263 in 2000, $138,513,706 in 2001 to $77,191,194 for the first six months of 2002. When the company first came public there were essentially no retained earnings. As of the most recent 10-Q which was filed on December 17, 2001 the company had over $86,000,000 of retained earnings and $72,000,000 in cash. There are 19,420,000 shares outstanding. Accordingly, there is $3.70 cash per share as of October 31, 2001 and it is increasing by about $.20 to $.30 per quarter. The actual excess cash per share is more realistically about $3.00 per share.

Since there is $3.00 per share of excess cash management is effectively purchasing the business for $5.00 per share or approximately $97,000.000. The business is on target to have revenues in excess of $150,000,000 in 2002 and an operating profit of between $25,000,000 and $30,000,000 or more. Depreciation and amortization expenses have roughly approximated capital expenditures setting aside certain transactions such as the purchase of real estate or corporate yachts. Therefore, management is purchasing the business for 3 to 4 times EBIT (there is essentially no debt on the balance sheet). Assuming a 40% tax bracket the EPS (without accounting for interest income or expense) would be $0.77 to $0.93. Hence, the $5.00 per share equates to a PE ratio of 5.88 on the median EPS.

The 2001 10-K has a nice chart that sets forth five years of financial date including return on shareholders’ equity. That table shows the ROE declining from 81.4% in 1997 to 30.5% in 2001. Not that I am complaining about a 30% ROE but if you adjust those numbers for the excess cash you will see that the actual ROE of this business has been in excess of 60% for all five years. This business is a cash cow and I believe management is purchasing this company for a very favorable price.

However, there are some issues and reasons why the stock has languished at depressed levels. There are only three directors, none of whom are independent, James Ridinger, his wife Loren and Martin Weissman the company’s Executive VP. The founder and CEO James Ridinger has a history that is not without blemishes. The SEC details some of Ridinger’s history in its Litigation Release No. 16131A/May 4, 1999 whereby Ridinger paid $404,694 for certain violations of various SEC rules. Additionally, there exist numerous cases of related party transactions between the company and management. For example, various real estate transactions, corporate guarantees of personal loans and the purchase of a corporate yacht. The business is also very dependent on current management and would therefore be a difficult acquisition for any non-related party.

In summary, this opportunity has some interesting characteristics, some good and some bad. In my opinion, as an arbitrage opportunity I like the fact that the business is so profitable and the price appears cheap in relation to its value. There is little reason for Market America to be a public company and there are many reasons why it should not be one. Accordingly, if the minority shareholders do not approve the merger, management will have to decide between increasing their offer price now versus waiting until some time in the distant future. Considering management’s bullish views about Market America’s future business prospects, it seems that it would be in their best interest to take the company private sooner rather than later; and management seems to have a pretty good record of doing what is in their best interest too.

Catalyst

Management buyout at $8.00 per share