By Nigel Somerville, the Deputy Sheriff of AIM | Tuesday 28 June 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.
For all of yesterday’s ramping over Device Authority (formerly Cryptosoft) a big question mark is being hoisted over AIM-listed investment company Tern plc (TERN) after the arrival of some confidential documents at Deputy Sheriff Towers. It appears that Tern has been somewhat tardy with ‘fessing up to losses on its first investment, Flexiant Corporation Ltd. Oh dear….this looks poor. Very poor indeed.
On 26 May 2016 Tern announced by RNS that it was buying out Flexiant Ltd from the parent company, Flexiant Corporation Ltd. Tern has previously invested in the parent via equity (£100,000) and later a debt instrument and Tern’s FY15 accounts show that the total value of its investments were carried at £269,270. Previous accounts showed that the £100,000 had been revalued (on the basis of a subsequent equity issue) to £200,000 and thus the remaining investment cost of £34,635 looks to have been via the debt instrument – valued at £69,270 for Tern’s FY15 balance sheet, one presumes on the basis of a 100% redemption premium written into the loan instrument.
The deal involved the issue of 8 million new shares in Tern to the parent company in settlement of intercompany debts owed by the subsidiary, and this would come after the sale of the Cloud Orchestrator business from within the subsidiary. There was also to be a defcon of up to £2 million in the event that Tern managed to sell on the assets being bought in the deal for more than £6 million.
Of course the deal fell through as the conditions listed in that 26 May RNS were not met. I wondered whether (amongst other things) this might have been because the sale of the Cloud Orchestrator business had failed in some way. Too damned right it was – the bidder walked - but that’s not the beef here.
No, the beef is that when Tern announced the (now defunct) deal it was known that there would be little or no value left in the equity of the parent. Indeed, the debt also looked to be heading for the barbers' shop – albeit with the possibility of some recovery if the defcon conditions were triggered.
So whilst shareholders in Tern were told of this great exciting development in that Tern was buying out (the dreg leftovers of) the subsidiary, something was being held back from Tern’s investors.
As you can see from THIS company confidential letter, dated 25 May 2016 (the day before Tern’s acquisition RNS) from Flexiant to its loan note holders and shareholders, the result of the proposed deal (if all the conditions were met) would be that the parent would then go into solvent liquidation, but that:
Distribution to shareholders will be minimal.
This, of course, means that when Tern released its acquisition RNS it already knew that its equity holding in the parent was toast. In other words Tern’s £200,000 carrying value (as at FY15) of its equity holding in Flexiant was, in fact, worthless.
The full terms of the sale of the subsidiary’s assets (as proposed) were that the Cloud Orchestrator business was to be sold for just $500,000 – $100,000 of which was to be retained by the purchaser for six months. Even at $1.35 to the £ that values the Flexiant flagship at just £370,000. The remaining assets were to go to Tern plc, with 8 million Tern shares to be issued (about £1.26 million worth at the time of the RNS) in lieu of remaining outstanding intercompany debts.
The outstanding loan notes came to £2.25 million (nominal) so there was about £1.6 million coming in to settle this amount – plus a pie-in-the-sky defcon (which obviously would have made for good optimistic reading by Tern’s BBMs). But it gets worse, for there was a 100% redemption premium on the loan notes. So actually £4.5 million needed to be found before shareholders in the parent would see a cent.
That’s a bit of a problem! But this is why the whole deal also was conditional on loan note holder approval – as they were being asked to accept a pro-rata distribution of Tern shares (with a six month lock-in) in lieu of monies owed.
Thus, a solvent liquidation of the parent would be possible.
Loan note holders were told that under the deal they would receive 3.5955 Tern shares per loan note, amounting (at the then share price) to the equivalent of 56.629p per loan note. That’s a bit of a far cry from the £1 nominal – and the £2 carrying value on Tern’s balance sheet.
But since the 8 million Tern shares were being issued to the parent in lieu of all outstanding intercompany debts (around £12 million at the last count, FY14) in fact this was set to result in an astonishing write-off on the parent’s balance sheet.
So as far as I can see, of the (just shy of) £270,000 carrying value of Tern’s investment into Flexiant Corporation Ltd (the parent) this deal would see a near-enough wipe-out of the £200,000 equity carrying value and the eventual receipt of its own paper worth just under £20,000 in lieu of the remaining £70,000 or so – and some pie-in-the-sky defcon.
The last full balance sheet presented by Tern to the market was for (calendar) FY15 which showed NAV of about £1.7 million, but this deal was set to wipe out about £250,000.
Yet Tern chose not to mention any of that in its acquisition RNS of 26 May 2016.
Now it may be argued that the pie-in-the-sky defcon might improve the returns (at least on the debt instrument, but not on the equity) but since it appears that Flexiant had been trying for a sale since 2013 I’m unconvinced.
It might also be argued that since the deal to combine the Cryptosoft business with the US-based Device Authority business at an implied value of more than £6 million for Cryptosoft (and thus, due to the B-share mechanism, about £4.5 million for Tern’s balance sheet) the disappearance of about a quarter of a million from Tern’s balance sheet is relatively small beer. But that £6 million was a mutually agreed figure for each of the two businesses being combined and, as Cynical Bear pointed out at the time, the deal smelt a bit Worthington-esque to him.
So I think that the acquisition RNS of 26 May 2016 stinks.
Why was the market not informed that the proposed deal would take a quarter of a million chunk out of Tern’s balance sheet in the RNS of 26 May 2016?
Indeed, even when Tern announced that the deal was off in an RNS of 9 June the losses were still not admitted – even though it now seems crystal clear that Flexiant was headed for the corporate knackers’ yard. It was not until the RNS of 24 June that Tern slipped in that the previous £269,270 carrying value in the FY15 accounts had been fully provisioned.
One might wonder what else is going wrong behind the scenes which Tern has yet to ‘fess up to, or whether any future problems may see a bit of a delay in being reported to the market.
Just for the record, the whole thing fell through when the bidder for the Cloud Orchestrator business walked (just like all the others in previous deals set up but never consummated) and both parent and subsidiary Flexiant businesses then went into administration as a result. In other words it was the only deal in town.
Just like the placing of Dec 2014 on the back of false information in the market which Tern chose not to correct in a share price movement RNS, this episode stinks to high heaven.
My target price for Tern is buttons. There are plenty of other Casino chips out there to choose from: why anyone would select this one on the back of this sort of behaviour is beyond me.
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