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Tern – acquisition of Flexiant: a marriage made in heaven, or one of convenience?

By Nigel Somerville, the Deputy Sheriff of AIM | Monday 30 May 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.

On Thursday of last week AIM-listed investment company Tern (TERN) announced the acquisition of Flexiant Limited. It looks a bit of a complex deal, but the question in my mind is what Tern has actually bought? And since Tern already has a holding in the parent company of Flexiant, how does it leave that looking?

There are two Flexiant entities: Flexiant Corporation Limited (FCL) which owns 100% of Flexiant Limited (which we shall refer to simply as Flexiant). Up until the announcement, Tern held 1% of FCL (the parent - not, as erroneously stated in the RNS, of Flexiant) – along with some convertible debt.

We are told that:             

Flexiant is a leading European provider of cloud management software for cloud orchestration for on-demand, fully automated provisioning of cloud services.

But the deal is conditional on the disposal of the Flexiant Cloud Orchestrator business, so I’m none the wiser as to what it is that Tern proposes to buy, beyond a reference to Concerto in relation to which Tern has agreed a defcon with the parent in the event of a sale of that business. I’m assuming here that this is some residual operation which the proposed buyer of the cloud orchestration business is not acquiring.

We are further told that Flexiant reported made an operating loss of £3.9 million on turnover of £750,000 for FY14 – the last available set of accounts. I’m not sure it is quite as bad as that, as the p&l account deteriorated by just £3.7 million in the period, but what do I know….

But given the disposal of the cloud orchestration business ahead of the acquisition the numbers presented seem pretty meaningless! What does Concerto actually do, what are its assets and what will the balance sheet look like?

In terms of the consideration, we are told that in addition to the defcon arrangement:

Tern will issue 8 million new ordinary shares ("the New Ordinary Shares") which will be allotted to FCL in full and final settlement of the intercompany debt

With the shares having closed last week at 15p in the middle, that values the deal at £1.2 million. But that comment about full and final settlement of intercompany debt brings me back to THIS piece which discussed the accounts of both parent and subsidiary for FY14.

As pointed out at the time, for the same period the subsidiary owed the parent £12.6 million as a non-current liability, and the parent was due £12.6 million as a current asset – all of which seemed very odd to me.

What we don’t know is what that intercompany debt now sits at ahead of completion of the deal. But given that the cloud orchestration business is to be sold by Flexiant, might one assume that the proceeds will be returned to FCL, the parent, in part-payment of the intercompany debt?

 And that brings me back to the statement that the 8 million shares of Tern being issued to FCL will be in full and final settlement of the outstanding intercompany debt (owed to the parent, FCL). That, of course, suggests that the sale of the cloud orchestration business will not pay off the debt on its own – and, indeed, we don’t know how much will be left. Will it be £1.2 million? Might it be more, with the remainder to be written off? How big a write-down might that entail?

As at FY14 (FCL’s last set of accounts) the shareholders’ funds were noted as being £12.4 million (including that current asset of intercompany debt  of £12.6 million). Tern says it owns 1% of FCL which would put its portion of that at £126,000, as against Tern’s most recent accounts (FY15) which attributes £269,270 of value to its investment in FCL, a figure which includes convertible loan stock.

But if that intercompany debt is written down in some way?

Meanwhile we are told that the acquisition is conditional on, amongst other things, the agreement of FCL’s loan-note holders – which one might assume include Tern, unless there are separate convertible loans and secured loan stock. There is a charge against the assets of FCL in favour of loan-note holders dating from last year, although I can’t see from the documentation at Companies House how much the loan is for – we’ll have to await the FY15 accounts of FCL to get to the bottom of that.

Now it could be that Angus Forrest and his team at Tern have identified a cracking little business, and that the shareholders will reap a generous reward in the fullness of time.

But the RNS of last Thursday gives us nothing concrete to go on – perhaps that is why the shares failed to respond to the news in any meaningful manner. Perhaps there will be a bit of clarity as/when the deal completes.

Of course, as suggested by Cynical Bear (HERE), it could simply be that Tern was in need of a new investment in order to comply with new rules which govern what constitutes an AIM investment company. The FY15 accounts of FCL will make an interesting read as and when they come out (by the end of Sept) as to what might have attracted a company in which Tern has an equity interest to a deal under which it is handed £1.2 million worth of Tern stock. The market capitalisation of Tern sat at £10.8 million at the close of last week. We’ll be watching the TR-1s….

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