Description

All cash offer, only 30 days for inspections, no financing contingency!

The term sheet to acquire SNCR is more reminiscent of an offer to buy a house during the housing bubble than it is to acquire a public company. However, we believe the strategy is similar: take a well-priced property off market before it gets into a bidding war.

Summary:

The largest shareholder of Synchronoss Technologies, B. Riley (RILY) is trying to acquire the company for $1.15/share, a 21% premium to the current share price. RILY has Board representation and likely knows the asset better than anyone else. While RILY was expected to complete due-diligence and sign a definitive offer by April 10th, there has yet to be any formal announcement and the stock could sell-off if a deal fails to materialize. We are unperturbed by the timing and believe 1) the expedited terms of RILY’s offer could be a mechanism to take SNCR off-market prior to competing bids, and 2) the company is worth at least 2x the offer price as a stand-alone entity.

**Please note this is a $0.95 stock that trades 220k shares a day so it may only be suitable for smaller funds or personal accounts.

Situation Overview

SNCR is a provider of white label cloud solutions to mobile telecom operators. From 2017-2020, the company was the subject of several short reports (including three on VIC) that brought forth allegations of accounting shenanigans, management misleading investors, and declining customer economics. These allegations turned out to be mostly accurate and if you shorted the stock, you would have made a lot of money.

The company, beleaguered by customer losses, declining profitability, and ongoing legal/restructuring costs, failed to generate free cash flow for years. SNCR turned over its C-suite and was forced to raise dilutive financing in 2021, led by RILY, now its largest shareholder following the deal. That was then…

Presently, the company is on the cusp of turning the corner and is expected to generate $50 million of EBITDA this year. The last time expectations were at this level the stock was $6/share and valued at 15x EBITDA; however, due to prior “red flags” the shares now trade at $0.95/share, a measly 6x EBITDA.

As its largest shareholder, investment banker, and Board member, RILY understands this disconnect and is trying to buy the company on the cheap. On March 13, RILY offered to buy the company for $1.15/share. The headline premium of 44% over the prior day’s close is misleading -- the stock did close at $0.80/share the day before, but three days prior was at $1.02/share, which represents a 13% premium. We illustrate this because part of the thesis is that RILY is trying to swoop in and buy SNCR on the cheap. The term sheet brings us back to the heydays of the housing bubble – all cash offer, only 30 days inspection period, no financing contingency!

Investment Thesis:

SNCR is a special situations/turn-around/levered equity investment driven by an inflection in fundamentals and improving cash flow (25% FCF yield), which presents a longer-term re-rating opportunity should the RILY offer, or a superior offer, fail to consummate. We believe there are three likely outcomes, all of which offer asymmetric risk/return profiles and absolute returns ranging from 21-100%+. Our expected scenarios are detailed below:

1. RILY Acquisition Most Likely, Providing a 21% Return in 3-6 Months. While not the highest return scenario, we believe the most likely outcome (and least risky) is for SNCR to accept RILY’s offer at $1.15/share. This outcome offers a 21% return (50% IRR over 6 months) with very low risk. RILY arranged the recapitalization in 2021 and is now the largest shareholder of common and preferred stock. They have invested $146 million in the company and have Board representation. Hence, there are likely no acquirors that know the assets better. Additionally, under RILY ownership the capital structure could be fixed immediately as they are the owners of the high-cost preferred stock and could forego payment. This would significantly improve SNCR’s cash flow and drive accelerated growth and value creation, which is being hampered under the current capital structure.
2. A Competing Bid Could Arise, Valuing SNCR closer to $1.50/Share, Providing a 58% Return in 6-12 Months. Management previously engaged an investment bank to sell the company, but some believe that interested parties balked at the asking price (speculated at $2.00/share+). Interestingly, the terms of the RILY bid indicated there is no financing contingency and that due diligence could be completed in 30 days. While one could interpret such generous terms as RILY’s desire to swiftly acquire a mispriced asset, we believe it could have been in response to other potential suitors showing interest amid the stock’s decline.  An acquiror paying $1.50/share could still generate a 20% IRR with the current capital structure.
3. An Acquisition Fails to Materialize but Fundamental Improvement Should Drive a Re-Rating over 1-2 Years. A failed acquisition would likely induce a near-term sell-off and we want to make it clear that the company is far more valuable in private hands (with a cleaner capital structure and unburdened by public company costs) rather than as a microcap levered equity. That being said, we believe there is a path forward as a public company that could offer substantial upside. Over the last several years, the company’s cash flow has been burdened by legal and restructuring costs, impeding growth. Historic issues are waning and point to an inflection in revenue growth and cash generation. Additionally, the company is supposed to receive a $28 million tax refund, a decent amount compared to its $310 million enterprise value. We estimate $21 million of free cash flow next year, representing a 25% yield. Driving a material portion of incremental growth is fundamental improvement in the cloud business. Below is our free cash flow bridge:

Risks:

There are a host of risks that should not be taken lightly.

1. RILY Withdraws Offer: If RILY decides not to pursue an acquisition, investors will question what issues were discovered during due diligence. Given RILY’s history with the company and Board representation, this seems unlikely. Additionally, RILY has already invested $146 million and has a material incentive for the company to succeed.
2. Customer Concentration: Verizon represents nearly 40% of revenues. While its contract has several years remaining and switching costs are high, Verizon’s exit would have a material impact on the business. 

Catalyst

1. RILY offer is accepted.

2. A competing bid arises.