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Tern – this deal smells a bit Worthington-esque!

By Cynical Bear | Saturday 23 April 2016


Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from ShareProphets). I have no business relationship with any company whose stock is mentioned in this article.


Following on from Nigel’s piece yesterday (HERE), I thought I’d dig into the acquisition a bit further as it’s got a slight whiff of Rob Terry or Doug Ware about it.

So Cryptosoft and Device Authority have, in essence, agreed a 50/50 all-paper merger with a valuation of £6.1 million being attributed to each business before further funds of approximately £1.35 million are pumped into the business - £1 million from Tern and $500,000 from the VC backing Device Authority, Alsop Louie Partners.

So is £6.1 million a fair valuation for each business? We know very little about the Cryptosoft financials other than the massive £26,000 contract announced last December, but we do know that in the year to 31 December 2015, Device Authority earned revenue of $254,000 and made a loss of $1.5 million. Hmm, I appreciate that valuation is all about the future cashflows but nevertheless, £6.1 million feels a bit toppy.

I wonder if the negotiation between Tern and Alsop Louie Partners went something like this:

ALP: “Hey guys, I think this partnership between Device Authority and Cryptosoft has been great but Device Authority now needs more funding and we were wondering if you guys fancy taking it on from here as I’m sure you can tap up some extra funds from AIM?”

Tern: “That sounds like a great idea, we’ll be twice as big and be able to make twice as much money out of the Internet of Things. Why don’t we do an all-share merger, both put in £750,000 to fund the combined business for the next year and then let the magic happen?”

ALP: “Sounds great….although we don’t have much money and can only put in $500,000”

T: “Oh, ok, well we’ll put in a million then, we can always raise more from the mug punters on AIM if needs be. How do we agree on value?”

ALP: “Well look, both companies make sod all revenue and lose a fortune so I reckon we’re pretty equal, wouldn’t you say, so let’s just agree a high number that we can both ramp to our respective investors. We hear that sort of thing goes on all the time on AIM, right?”

T: “Sure, it’ll be fine. We’ve done some maths and reckon that if we go for £6 million, then that will really help to justify our current share price and may even give it a boost, which is pretty important as we will need to do another placing soon. Presume that that will be an uplift on your original investment too, so does that work?”

ALP: “Great, but let’s go for £6.1 million as that sounds a bit more precise as if there’s a detailed calculation behind it.”

T: “Great, done – anything else?”

ALP: “Sure, what is the Internet of Things?”

In all seriousness, this is ridiculous.

You have two investors who are both incentivised for different reasons to come up with a high valuation agreeing a value between themselves that is now being used as a justification for the Tern share price.

I appreciate that there are third party investors in Device Authority too, but it’s also in their interests that the valuation is high as the dilution from the new injection of funds is less for them.

The only people who lose out in practice from the high valuation are the Tern shareholders as if a more reasonable lower value was attributed to the businesses, Tern would end up with a higher percentage of the business when putting in the extra £1 million. But who cares about them?

The reality is that Tern now owns 52% of a combined business with limited revenues and a hefty cost base. Maybe it can find another business to merge with in a year’s time when the money has run out and do the same exercise all over again.

Wouldn’t go near this myself and would get out now if I was in it. Doubt you can short it but if you can, the best time is probably in a few months when the Tern interims come out and everyone gets excited about the £5 million profit in the accounts, courtesy of the Cryptosoft investment valuation uplift!


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Comments

1 comments


  1. Drunken Sailor

    Classic house of cards building through paper swaps. It will all end in tears when one of the cards topples. The BBMs seem to be lapping it all up nicely for the time being.


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