Description

Thesis summary: Metlifecare (MET), a New Zealand-listed retirement village operator, is a highly attractive, 'heads I win big, tails I don't lose' type of investment. EQT, the Swedish private equity powerhouse, is attempting to reneg on a recently-agreed takeover of MET at $7/share - a 68% premium to the current quote ($4.16) - by claiming the onset of COVID was a 'material adverse change' (MAC). I believe it will be very difficult to prove a MAC occurred, and that EQT may well be compelled to complete the acquisition by the New Zealand courts, likely in the near-term (3-4 months). An alternate outcome is a renegotiated transaction, lower than $7, but still a substantial premium to the current price (I think in the $6-6.5 range) - still a highly palatable outcome with deep upside. And even in the most bearish scenario - that is, EQT is legally able to walk away with no consequences and MET remains independent - you are buying an attractive long-term asset at 0.6x tangible book value, with very low leverage (for this type of business), at a sizeable discount to competitors, and with management likely to initiate a substantial repurchase program to drive the stock back closer to book value (indeed such a plan was enacted just before EQT offered to acquire the company).

MET is listed in New Zealand, and trades $500k USD a day, so this is only for small/mid-sized funds. Given the time sensitivity this write-up will be brief. I will happily engage with any questions in the comments.

Company background: Metlifecare operates 25 retirement villages in the North Island of New Zealand (most situated around key population centers in Auckland and Tauranga), with another 10 under construction. A number of the larger operators - Ryman and Summerset - have been written up on VIC; please read in particular the writeup by rajpgokul as it gives an excellent summary of the business and in particular the accounting around Occupational Right Agreements (ORAs). The business has attractive long-term fundamentals, underpinned by the progressive ageing of NZ society (in particular, the population of >75yr olds will increase substantially over the next 15yrs); the capital-light nature of the business model, since through the ORA mechanism developers are able to generate float to fund new developments at low cost; and the secular growth in New Zealand property values over the long term. 

There are a number of larger names in the industry; MET has historically been one of the laggards, for a couple of main reasons: execution and lack of leverage. Simply put, MET has not been able to execute as successfully as some of its better-managed peers (Ryman and Summerset) and so has grown much more slowly; management historically has also been more conservative regarding expansion, again in contrast to its competitors. As a result, MET has suffered lower growth, lower margins, and a lower rating in the market.

Recent events: EQT no doubt saw this underperformance along with the attractive long-term secular growth trend driven by demographics and decided they could 1) fix the operating model; 2) increase financial leverage; and therefore 3) earn superior long-term returns from turning MET into the next Ryman/Summerset. A scheme of arrangement was agreed (after some negotiation and a rejection of a $6.5 cash bid) for a $7 all cash transaction in late December 2019. 

You can see the merger announcement and Scheme Implementation Agreement (SIA) - the key document governing the merger - here:

https://www.metlifecare.co.nz/scheme-asia-pacific

You can see how a typical Scheme of Arrangement transaction would proceed in New Zealand here:

https://minterellison.co.nz/our-view/how-a-scheme-of-arrangement-works 

You can read the correspondence between MET and EQT encapsulated in the announcements on MET's investor relations page here:

https://www.metlifecare.co.nz/investor-centre/market-releases

Since COVID, EQT has obviously had a change of heart and is trying to invoke the MAC clause in the SIA to wriggle out of the deal. It is worth including the entire clause here. I have highlighted the key parts directly from the SIA:

Thus, in order to satisfy the MAC test, EQT has to prove EITHER 1) the impact of the event was significant enough as to cut at least $100mm from net tangible assets, or 10% of estimated annual earnings (which has subsequently been disclosed to be $88mm for the Jun-20 fiscal year) in 'any financial year'; OR 2) that even if the event was the result of a change in general economic conditions, or a change in law BUT THAT the impact upon MET was 'materially disproportionate' and thus constitutes a MAC.

There are a number of different threads here, but the first principle of the dispute seems to reside around whether the Specified Event is 'the onset and spread of the COVID virus' itself (as EQT is claiming); or whether it is 'the general lockdown and consequences therein' (which is what MET is claiming). EQT is arguing that COVID is the Event and that all that followed (the forced lockdown and its economic effects) are all consequences; MET is arguing that the lockdown itself - a function clearly of a change in New Zealand law as passed by the Government, as well as general economic conditions - is the Event and thus all the discussion of financial impacts of the lockdown upon MET are moot AS LONG AS the impacts upon MET were not 'materially disproportionate.'

Scenario 1) Deal closes per the Scheme: 68% upside

I am NOT a lawyer, but I feel strongly that it will be very difficult to prove a MAC has occurred in this specific situation, for the following reasons:

1) MACs are very difficult to prove in the courts. The history of case law on both sides of the Atlantic (UK and US) throws up only a handful of MAC claims where the claimant successfully convinced the courts that a MAC had occurred. This is because overwhelmingly the courts don't like to tear up contracts, and generally precedent has suggested that for a MAC to be deemed to have occurred, there is a high bar determining 'materiality' and a component of durational significance (that is, the effects of the MAC generally need to be observed in terms of years, not months). This discussion from Harvard gives a good summation of the issues: https://corpgov.law.harvard.edu/2020/04/04/covid-19-as-a-material-adverse-effect-mac-under-ma-and-financing-agreements/. It seems reasonable to expect EQT to have to convince a court that the impacts of COVID would last years - even though the lockdown itself in NZ lasted 6 weeks...

2) Is this Event really material enough?: it is entirely unclear if there is any material financial impact on MET's business at all, COVID or otherwise. COVID has essentially already been beaten in NZ, and the economic impact upon MET has seemed minimal so far (less new sales/less showings, but only over a very short period of time, basically 1+ months). MET has already suggested June'20 earnings will be essentially inline with prior guidance (maybe -5% versus expectations); and that there has been as yet no observable impact on NTA since CBRE - the third-party appraiser who values the underlying land and property that constitutes essentially all of MET's book value - won't be revaluing the book until June, and in any case uses a long-term DCF model to value the book, suggesting 1-2 months of shutdown would in no way meet the materiality test needed to get to a large restatement of book value. EQT has claimed that NTA will fall by $200mm in the coming year (pointing to sell-side reports, etc) but that seems flimsy given this will likely be litigated/discussed well before any writedowns are actually contemplated let alone made, and that presupposes New Zealand property trades off significantly even though they have beaten the virus and are one of the first societies likely to normalize. Even if this point is not made moot, again, it seems quite difficult for EQT to prove to a court that MET will have to write down its NTA by $100mm+ a year from today/near-term, when it hasnt happened yet and given that the virus has been beaten and society is already reopening.

3) Was the effect on MET 'materially disproportionate'? This, again, seems difficult to conclusively prove. EQT is suggesting that - as a retirement village operator - MET is more affected than other businesses (given the higher risk to the elderly and the occurrence of COVID in nursing homes around the world); but MET has suggested that is irrelevant to NZ (where there were basically no COVID cases generally and no hotspots in nursing homes); and in any case MET centres remained open and operational. It seems hard to me to prove a materially disproportionate impact on MET's business when the average business in NZ clearly suffered more.

4) This case will be litigated in New Zealand courts (if it gets that far). Per the SIA, EQT has submitted to New Zealand courts as the governing jurisdiction. This is intriguing since I don't believe there has ever been a MAC clause litigated in NZ corporate history; I would expect therefore a reliance on past Western case law, in particular that of the UK - where the definition of MAC has historically been held to an EXTREMELY high materiality standard. It is also worth noting that the principal shareholder here is the New Zealand Pension Fund, with 20% of the float (who had supported the bid). In general I am not one for jingoism, but no doubt having NZ pensioners at risk of taking loses because a foreign acquirer is trying to wriggle out of a contract is probably a tough putt in a local court of law.

5) This deal was structured as a Scheme of Arrangement, not under the NZ Takeover Code. The Scheme is a relatively novel structure in NZ (only been around for a few years), but the basic concept is it is a more consensual, joint approach to crafting an agreement (between buyer and seller) to achieve a higher likelihood and certainty of closing for the transaction. The fact that this is a Scheme, and one entered into barely 4 months ago, is, in my view, likely to play against EQT in any courtroom since the very terms of the agreement were largely drafted by EQT.

So, I believe - in my non-lawyerly reading of the documents and understanding of the situation - that the bar for EQT to jump over to prove a MAC in a New Zealand court of law is incredibly high. Frankly I don't think they would win that legal case - assuming it actually went to the courts...

Scenario 2) A renegotiation: 20-50% upside

Perhaps a more likely outcome than a proper legal stoush is a renegotiated transaction, or some kind of settlement (this has been the outcome historically of many MAC invocations). Here, though, it is tricky to see how EQT really saves much money. They originally bid $6.5/share, but were rebuffed because that amount represented a ~10% discount to tangible book value; the company was not in distress; and core shareholders like the New Zealand Pension fund would not back a deal below tangible book. Of course, post COVID, attitudes have likely changed, and all parties would probably take $6.5/share now (even if MET still thinks book would be unimpaired mid-term), but it is hard to see how a negotiated price goes much lower than that, since key comps in the market all trade at least at >0.7x tangible book without a control premium, whilst the better operators (Ryman and Summerset) still trade well north of book value. Thus, even in a renegotiation, I still think there's substantial upside from current - let's say at least $6/share, or 44% upside from current. This would constitute 0.85x book, still a very skinny control premium versus comps and maybe not palatable to key holders; it would also leave a disgruntled EQT having to operate the asset after a very public disagreement.

Another, perhaps more realistic option, would be to negotiate a one-time settlement where both parties can walk away 'happy.' But what is the right amount? If you're EQT and you don't want to step in to a $1.8bn NZD EV transaction, how big a check do you write to walk away? $100mm? $200mm? Given the mechanics of PE and this transaction, they were probably only looking to put in $400-500mm of equity into the deal...would you be happy to take a 20-25% loss without even giving it a try (and taking a big hit to your reputation in the process); or would you push for a discounted purchase price and run the business plan you had envisaged?

These are not easy questions to answer but I find it hard to see how MET would settle for less than a meaningful check in compensation, given the strength of their legal position as discussed. To me this means $100-200mm - that is, 70c per share of value at mid-point - which would constitute 17% windfall versus the stock price today if consummated. However I still view this outcome as less likely than a renegotiated whole transaction (with more upside).

Scenario 3) No deal, full break: limited downside-15% upside

Of course the worst scenario is some kind of legal loss/abandonment by MET (or minimal won damages that don't amount to much); and MET thus continuing as an independent listed company. But even then, I am not too bearish, because today's price - 0.6x P/B, and ~10x underlying EPS pre COVID - is still a discounted level versus very similar comps for an underlevered name exposed to strong long-term secular growth (despite the near-term COVID headwinds). Oceania Healthcare (which I think is an inferior operator since it is smaller and 3x more levered than MET, for starters) trades at 0.75x tangible book, for example, and has no deal-related intrigue. Yes, you are explicitly betting on NZ (and in particular, Auckland) property prices as these are all essentially derivatives on underlying property demand. That may weaken in the very near-term but given the particularly effective handling of COVID, and the immutable demographic trend at play, I don't mind owning this under-levered asset at a low multiple of tangible book on a 2yr view if this deal breaks. Furthermore I fully expect management to turn the buyback back on - which had been instituted late last year and drove the stock initially, only to be turned off once EQT made their approach in November - if this downside case occurs.

Next steps

According to the Scheme, the original shareholders' vote - the penultimate step before the courts typically approve a transaction - was meant to be held in May; this has been pushed back to June. The long-stop date is in September so we still have plenty of time. At the moment I believe EQT is arguing with MET, trying to prevent the mailing out to shareholders of the Scheme Booklet (needs to be done before the Shareholder Vote). I believe the company is pressing ahead, however, with the steps to get the shareholder vote done.

Once that happens and presuming they all vote for the deal (management still recommends the deal, clearly), then the only other obstacle is a Foreign Investor approval (OIO approval), which you would think is not an issue for a small deal of this type and a Swedish buyer. Thus, assuming that is approved, after the shareholder vote, the deal would go to the courts for judge's approval - at which point I believe EQT would be legally compelled to 'perform under the contract' - that is, the close the deal.

Catalyst

Shareholders vote goes ahead

OIO approval received

Courts compel EQT to close