Background and Rationale of the Transaction

Spin-outs in conjunction with an acquisition have become an innovative way for Constellation Software (CSU) to implement M&A strategies for certain target companies. These target companies could not otherwise be acquired under CSU’s umbrella for a variety of reasons such as valuation discrepancy or culture, as the acquiree wants to maintain its own identity. 

Given the success of the recent spin-out of Topicus (TOI), CSU has decided to spin out one Lumine Group in conjunction with an acquisition. CSU believes spin-outs will grow faster and perform better as an independent public company than under the umbrella of CSU. Going forward, CSU’s management indicates that more spin-outs of these types will take place to unlock shareholder value.

What Has Happened
CSU has recently announced that they would implement another spin-out transaction. The main operating businesses of the new spin-out company would include the Lumine portfolio of companies that are currently under the operating group of CSU (Volaris Operating Group), and the business of the acquiree – WideOrbit Inc., a U.S – based media vertical market software (VMS) provider.

The purchase price for WideOrbit is $490 million which would be funded through a combination of cash, debt, and issuance of special shares. On a Pro-forma basis, in 2021, the combined entity would have total revenue of $395 million and generate EBITDA of around $99 million.

Following the spin-out and the acquisition, on the fully-diluted basis, CSU will indirectly own a 61.05% in the new company, public shareholders will own 25.12% interest in the new company, and the remaining 13.83% interest in the company will be owned by a group of pre-acquisition shareholders of WideOrbit Inc.

Shares of the spin-out company will be distributed to current CSU’s shareholders as a special dividend. The dividend will be paid at a ratio of 3.0 spin-out company shares for every common share of CSU that is outstanding, CSU has 21,191,530 Common shares outstanding. Therefore, there will be 63,582,712 issued and outstanding.

The spin-out shares will be treated as a taxable dividend. And the amount of taxable dividend will be equal to the fair market value at the time the spin-out shares are received.

Capital Structure
Similar to Topicus’s transaction, CSU will use a set of financial instruments (Preferred shares, Super Voting share) which could be either convertible to common shares after certain appreciation conditions in share price are met or redeemable at certain price targets.

Right after the spin-out the capital structure would include:
63,582,712 Common shares outstanding, mostly owned by public shareholders.
63,582,712 Preferred shares with 5% cumulative dividend entitlement, owned by CSU.
1 Super Voting Share, owned by CSU.
10,204,294 Special Shares, owned by former shareholders of WideOrbit.

The capital structure may confuse most people at first glance. However, the purpose of the complexity is to not only allow CSU to retain control of the spin-out company but also allow public shareholders to enjoy appreciation in common shares through the leverage structure.

To simplify the capital structure, we believe current and prospective shareholders should value the company on a fully-diluted basis, of which there will be 253,104,971 common shares in total after all the financial instruments are converted to common shares, which includes:

154,519,381 Common Shares owned by CSU, equivalent to 61.05%
63,582,712 Common Shares owned by public shareholders, equivalent to 25.12%
35,002,878 Common Shares owned by former shareholders of WideOrbit, equivalent to 13.83%.

What does it mean for the current shareholders?
The new spin-out shares could be owned either in registered accounts (TFSA, RRSP, RRIF, etc…) or cash accounts. Additionally, non-resident holders from outside Canada who receive the spin-out shares will be considered to have received a taxable dividend and would be subject to withholding taxes.

In conclusion, we like this transaction and believe this is a shareholder-friendly move from CSU. Again, the spin-out proved that CSU management’s objective is not to build the largest conglomerate possible but to maximize shareholders’ value on the per share basis. We believe CSU’s management is one of the best capital allocators in Canada, and the opportunity to ride along with a high-quality management team is rare.

Take Care,

Disclosure: The analyst(s) responsible for this report do not have a financial or other interest in the securities mentioned.