Thesis:

I’m proposing going long the rights of Quartet Merger Corp (QTETR), a blank check company formed by Crescendo Capital’s Eric Rosenfeld and special advised by our own Joel Greenblatt.

Why QTETR? Because at the current quote of 72 cents, the rights offer one of the more attractive risk/reward equations of any special sit I've ever seen.

At its heart, the thesis for QTETR is a simple one. With QTET presently trading at $10.05 and set to merge with growth orientated private logistics company Pangaea in less than a month, the right’s price implied expectations are telling a much different tale, effectively discounting the opposite.

In other words, the rights are discounting a very high likelihood the Pangaea deal fails, an outcome that for various reasons I believe to be a highly unlikely.

Thus, assuming the deal closes as expected roughly one month from today, investors stand to generate an eye-popping 40% absolute return for an IRR approaching 5,569%.

Who know's, but for reason's articulated below I imagine this is exacly the type of market neutral “workout” that would have made even a young Buffett salivate. Which isn't something I'd ever say lightly. After all, we're talking about a world where he was digging up 50's equivalent micro caps like Sanborn Maps. So securities with simply mind boggling margins of safety and multiple ways to win. Regardless, to me QTETR feels a lot like that. 

“Buy All Right’s” SPAC Edition:  

Members of VIC know as well as anyone that participating in rights offerings can be a great way to maintain or increase exposure to an underappreciated asset chocked full of hidden value, where that value is set be unlocked in the near to medium term future. A fact illustrated most powerfully when rights offerings are used to execute spinoffs.

Typically though, in a plain vanilla rights offering, a company wants to raise fresh capital by selling new shares. Rather than issuing new stock and going through the standard process of engaging an investment bank to underwrite and sell the offering, a company distributes rights pro rata to shareholders to buy the stock, usually at a discount to the current price. The offering allows shareholders to maintain their proportional interest in the company by buying more stock. Often, the right is freely tradable for some period of a time, typically a month, and shareholders who don’t want to pony up more cash for stock can sell their rights at the going rate. Naturally then, tradable rights can be a particularly lucrative “secret hiding place of stock market profits” to dig for mispriced securities. Obviously this is a crowd that know's all that. 

Yet QTETR isn’t your run of the mill rights offering.  Indeed, it’s something entirely new and the type of delightfully innovative twist that could only hatch from the minds of opportunistic value investors. Anyhow, remember that SPAC units have historically been issued with warrants. What we have with QTETR then are rights associated with a SPAC deal that chose to offer rights instead of warrants - the first such deal of its kind.   

Understanding this is critical, if only because it explains how such an insane mispricing could exist in the first place. I mean between complete institutional and retail related ignorance, extremely limited liquidity and its tiny size, QTETR's “rub your eyes and check again” mis pricing starts to finally make sense. As far as the latter two points, note the size of the issue at current the quote amounts to a mere $6.9m, vs. ~ $10m at issuance (amounting to ~ 1/11 of the SPAC’s cap structure). Point being, there a number of good reasons rights holders aren't likely to be the Patsy at anyone's poker table. 

Regardless, while we can debate all day whether SPAC right's are as innovative as the ATM, fans like myself take solace in the fact that the setup with QTETR is relatively straightforward. And unless I miss something reading the cumbersome 438 page proxy (caveat emptor!), it appears this "too good to be true" lay up is exactly what I’d initially hoped. Namely, the chance for bargain hunting investors to generate an extraordinary absolute and relative return with minimal risk in a very short period of time.

(Naturally this trade is for PA accounts and tiny funds like my own only. That said, with tight limits and the patience to stay at it a surprisingly size chunk of capital can be put to work)

Situational Overview:

By purchasing QTETR at .72 cents investors are getting the right to participate in a Joel Greenblatt advised SPAC where each right converts to 1/10 of a share in blank check company Quartet Merger Corp (QTET) assuming the deal’s approved by SPAC shareholders on September 29, 2014 and closes shortly thereafter. 

Put another way, if 1) QTET holds in north of $10 - and I’d argue it should given the highly credible sponsorship, its strong shareholder base, and what by all rights (pardon the pun) appears to be a solid deal in light of the fact that investors are getting a dominant, high quality, owner operated, growth business on the cheap, and 2) the deal closes, rights holders stand to make ~ 40% in less than a month, which again, results in an IRR of 5,569%. On the first point, it's worth mentioning that the one firm covering QTET puts it's fair value at $16 using reasonable assumptions.    

Again, we're looking at a ~ 40% absolute return locked in 31 days from today (deal should close immediately thereafter), where the risk of the value realizing event not taking place seems slim to none. Better yet, in the unlikely event of a post close implosion in QTET’s share price, one can always short out QTET (the borrow is both cheap and available). Or one can just hold. After all, your buying QTET at an implied $7.20, which is dirt cheap on both an absolute and relative basis as you'll see below - so odds are actually quite good holding may offer the best path forward of all. The takeaway being there are multiple ways to win. A lot.

A couple of other high level points…

1. A colleague of mine who turned me on to the idea in the first place (hat tip Troy!) spoke to the CFO of the SPAC yesterday, who interestingly enough happened to be vacationing in St. Martens in what at the time was only 14 days before the deal closing. Perhaps I’m wrong, but gallivanting in the tropics so close to the shareholder vote indicates he is either grossly negligent or pretty confident all is as it should be.

Personally I'm going to go with the latter considering if they didn't have the requisite "Yes" votes I’d imagine they'd be scrambling to meet shareholders every day in order to doing everything in their power to get this thing over the line. Yet given he was sitting on a beach soaking in rays, tells me he views the odds of a no vote as about nil.

Of course with the rescheduling announced earlier today the signal value here isn’t as powerful as it was yesterday, so do with it what you will.     

2. This is obviously a very illiquid security, but I found it surprisingly doable with tight limits if you’re patient and stay at it. Hence my guess is small funds and especially individual investors should be able to put a worthwhile slug of capital to work without too much trouble.

3. At the end of the day, I find it hard to see how or why this deal wouldn’t close as expected given the sponsorship and shareholder dynamics involved.

After all, Pangaea’s shareholders have already approved the transaction and Management is converting 100% of their 60% equity stake in the offering. Better yet, they’ve agreed to lock it up for 12 months with the exception that the stock trades north of $12.50 for 20 consecutive days (at which point they’re free to sell as they wish).

Then there is the guy behind the SPAC, Eric Rosenfeld of Crescendo Capital. While I don’t know Eric, from what I can tell he appears to be a savvy guy focused on the right things and the simple fact that the undisputed master of the special situation universe is willing to rubber stamp his deals lends him a level of credibility typically unrivaled in the SPAC space (Wilbur Ross’s new SPAC comes to mind).

Of course Eric has done this a number of times successfully in the past, and each time with Greenblatt's help. Note his previous ventures received 99%, 98%, and 83% of the vote vs. the requisite 51% hurdle. Nuff said.   

Equally as interesting I think is that he's already started his next SPAC, so presumably he's quite confident as well vis a vi the deal closing. Perhaps I’m reading too much into this, but the above seems like a reasonable (if not exactly air tight) presumption given the poor optics that would result from starting your next venture before your previous commitment was wrapped up (on the off chance it blows up). That is unless he believes the vote is a slam-dunk.

So read into it what you will, just another arguably worthwhile data point to consider.

4. Last but not least the SPAC appears to be purchasing a high quality, rapidly growing logistics biz at ~ 11x '15 EPS (inclusive of earn-outs).

Call me crazy, but again, voting “no” to the purchase of what by all accounts appears to be a dominant, owner operated growth business on the cheap (both in the absolute and relative sense), one rubber stamped by Joel Greenblatt no less, seems like the definition of nonsensical. As an aside on this point, I just read a tweet earlier today by Cliff Asness where he rhetorically queried the twitter-verse on whether something can make “negative sense”. Well, if there is, voting no on QTETR appears to fit that definition to a T.  Actually, so does QTETR’s share price but I digress.

Of course that doesn’t mean it won’t happen (stranger things happen all the time), but regardless, I think a quick perusal of both Greenblatt’s recent thoughts on the attractiveness of the deal, along with the current shareholder base below, should help put you at ease.  

Oh ya, make sure to take a look at the second largest shareholder. Apparently Cliff agrees!! Lol!

Mirth filled amusement aside, see the quote/list below…

Joel Greenblatt, Quartet’s Special Advisor, said, “An attractive valuation, an experienced management team, and a global leader in its sector are some of the attributes that make this a unique investment opportunity. This is a quality company with significant growth prospects and I am excited about its future.”

If for some reason the shareholder image ceases to work, the top ten list is as follows: 

1. Polar Securities – 1.6m shares

2. AQR Capital Mgmt – 1.08m shares

3. Eric Rosenfeld – 1.02m shares

4. Fir Tree Partners – 991.8k shares

4. K2 Associates Investment Mgmt. - 883.5k shares

6. Davidson Kempner Capital Mgmt. – 810k shares

7. Bulldog Investors - 700k shares

8. DKU 2013 – 662.6k shares

9. Weiss Asset Mgmt. – 600k shares

10. Glazer Capital, LLC – 562k shares

QTET for the Long-Term?

One last point, according to the initial release the merger transaction allows shareholders to purchase Pangaea at an implied 30% discount to comps. 

While I haven’t personally re run the comp valuations since that release (guess is the relative valuation discount approximately the same), it’s worth noting that at .72 cents your creating Pangaea at $7.20 and hence, the implied discount to peers would be even more attractive. So assuming you’re a fan of the business and therefore decided to convert upon consummation, the implied purchase price is almost certainly unsustainably cheap.

Point being, while I’m not explicitly recommending that route, it definitely doesn’t seem like a bad way to go if you like the business and believe a combination of rapid earnings growth and sustained multiple expansion is a high probability. Of course the added tax benefits of a longer-term holding period is a huge plus as well.

Perhaps I’ll stick around awhile.

After all, with today’s delay I’ll have quite a bit more time to look under what looks like an interesting hood. At this point all I’ve done is look over the financials and created a few charts laid out in the section immediately. Note the merger presentation and a recent press release are pasted in the misc. section as well, both of which I found useful as far as getting a high level feel.

Which reminds me, if anyone has done the work feel free to chime in on the comments. I’d love to hear what people think.  

Pangaea Chart’s: Historical Financial & Operating Results

Risks:

While this entire write-up is basically one long ode to why I find it extremely unlikely the deal breaks, should it happen odds are the rights trade down to ~ 40 cents or the approximate level where they traded prior to the April 30^th announcement with Pangaea.

Yet it’s important to keep in mind that even after the proverbial “kick to the nuts” a no vote would deliver, all would not be lost, as QTET would still have till November of 2015 to do another deal.  Which brings me to the deathblow scenario, as the inability to find an acceptable replacement acquisition by November of ’15 would cause the rights to expire worthless. 

Another risk worth briefly discussing is the requirement that $25m remains in the trust at closing. Given the $98m balance at present, the nature of the shareholder base, along with the current unit price, the odds of any material % of QTET shareholders being involved for a quick arb seems minimal – at least to the point where cash is drained to a level that violates the $25m threshold. Remember too that the rights issue in total amounts to ~ $10m, so rights investors like myself who’s default plan is to exchange their rights for cash aren’t a threat. And finally, management at Pangaea reserves the right to wave the hurdle at their discretion, so even in the extremely unlikely event cash drops beneath the threshold it’s not automatically a deal breaker.  

Timeline of Events:

April 19^th, 2013 – Quartet incorporated in Delaware

November 1^st, 2013 – Quartet Merger Corp IPO

April 30^th, 2014 - Quartet and Pangaea Logistics announce merger agreement (http://www.marketwatch.com/story/quartet-merger-corp-and-pangaea-logistics-solutions-ltd-agree-to-merge-2014-04-30)

May 1^st, 2014 – Quartet files 8k with deck explaining transaction (solid read) (http://www.sec.gov/Archives/edgar/data/1581889/000114420414026889/v376863_425.htm)

August 13^th, 2014 - Quartet files definitive proxy for merger (http://www.sec.gov/Archives/edgar/data/1581889/000114420414049033/v386565_defm14a.htm)

August 14^th, 2014 - Quartet sets September 19^th as special shareholders meeting to approve merger (http://www.sec.gov/Archives/edgar/data/1581889/000114420414050249/v386803_ex99-1.htm)

August 28^th, 2014 – Quartet delays the special shareholder meeting to September 29^th (reason unknown to author currently) (http://finance.yahoo.com/news/quartet-merger-corp-amends-record-174800786.html)

Presentation Transaction Summary Slides:

Pangaea Press Release Investment Highlights/Commentary:

Pangaea is an established, growth-oriented global logistics company dedicated to providing seaborne dry bulk transportation services. Pangaea is headquartered in Newport, Rhode Island with offices in Copenhagen, Athens, Rio de Janeiro and Singapore.

• Global provider of comprehensive maritime logistics solutions

• Continuous market leadership for 18 years

• Value-added backhaul specialization and ice-class 1A dominance

• Embedded, loyal customer base

• Asset-light strategy ensures ownership only when needed based on demand

• Consistent, acyclical growth: 70%+ Net Income CAGR (‘10-’13)

• Attractive Return on Equity: 19.5% (3-year average)

• Close alignment of interests - Management owns approximately 60% of Pangaea before merger and will roll 100% of its equity into the merger

• After the merger, the resulting company intends to pay an annual cash dividend of 10 cents per share, payable quarterly

Pangaea provides logistics services to a broad base of industrial customers who require the transportation of a wide variety of dry bulk cargoes, including grains, pig iron, hot briquetted iron, bauxite, alumina, cement clinker, dolomite, and limestone. The Company addresses the transportation needs of its customers with a comprehensive set of services and activities, including cargo loading, cargo discharge, vessel chartering, and voyage planning.

The Company continues to innovate. In 2010, for example, Pangaea was the first non-Russian vessel operator to carry dry bulk cargoes from Europe to Asia via the Northern Sea Route. Similarly, in 2013, Pangaea was the first vessel operator to carry dry bulk cargo from the West Coast of Canada to Europe via the Northwest Passage. The Company’s experience in carrying a wide range of cargoes, pioneering new routes, and serving less common ports increases its opportunities to secure higher margins than in more commoditized cargoes and routes. Pangaea believes that providing such specialized transportation logistics services, together with its long-term commercial and contractual relationships and asset-light business strategy, makes the Company less sensitive to industrial and economic cycles as compared to other bulk-shipping operators.

Eric Rosenfeld, Chairman and CEO of Quartet, commented, “We are pleased that Quartet’s Board of Directors, as well as our Special Advisor, Joel Greenblatt, unanimously approved this transaction. We believe that Pangaea is without parallel in its sector, making it an extremely attractive merger partner. The Company has a very appealing growth profile and a compelling valuation, with a price to forward earnings multiple that is more than 30% below its publicly traded peers. We expect that its numerous competitive advantages will enable the company to continue to prosper.”

Mr. Rosenfeld continued, “We believe the dedicated management team and expertise that Pangaea has demonstrated, particularly in the ice-class trade and in backhaul, clearly indicate that this Company not only has the vision to be a global leader for years to come, but also maintains a worldwide network to execute in a way its peers cannot. As a result, it is our belief that Pangaea is well-positioned to provide long-term value to stockholders.”

Joel Greenblatt, Quartet’s Special Advisor, said, “An attractive valuation, an experienced management team, and a global leader in its sector are some of the attributes that make this a unique investment opportunity. This is a quality company with significant growth prospects and I am excited about its future.”

Peter Yu, Managing Partner of Cartesian Capital Group, a significant Pangaea stockholder, stated, “This is a defining moment in Pangaea’s evolution and we are proud of our involvement in helping the company reach this critical milestone. Management has positioned the company for long-term sustained growth by becoming the leader in several key areas with limited competition and high barriers to entry. We look forward to continuing our partnership with Pangaea and facilitating its continued growth.”

Catalysts:

September 29^th Vote and deal closure shortly thereafter

September 29^th Vote and deal closure shortly thereafter