Optiva: A Bizarre Situation Turns Even Stranger
See Optiva: The Perils of a Controlling Shareholder for background.
On Monday morning, ESW made an offer to acquire Optiva at $60 per share. But not really.
Maple Rock and EdgePoint, holders of about 40% of Optiva shares and 55% of shares not held by ESW, are not interested. There is a “majority of the minority” approval requirement under Ontario Securities Commission rules when controlling shareholders are tendering for shares to prevent creeping control. With Maple Rock and EdgePoint opposed, this test cannot be met. So ESW says they will apply for a regulatory exemption to the “majority of the minority” requirement, enabling them to acquire any number of shares offered by minority shareholders. According to Optiva’s press release on the matter, such an exemption has never been granted.
Why is ESW press releasing an offer that seemingly has a near-zero chance of acceptance? Why are they now stating that they are prepared to acquire the company at $60 per share when on January 29th they claimed to be willing to sell their stake at the same price? And why aren’t Maple Rock and EdgePoint interested?
ESW’s press release positions the offer as an attempt to avoid value destruction that will come from unwinding the operating model at Optiva. Presumably this is in reference to the related party agreements with CrossOver and DevFactory. Left unexplained is why the operating model even needs to be unwound. After all, Upland Software, a public non-ESW controlled company has relationships with both CrossOver and DevFactory. I will return to this shortly.
The ESW release also states that “the situation is likely to continue to deteriorate” and holds up the recent debenture financing as “one of many examples” of this downward descent. The release claims the debentures are “markedly worse for shareholders than the preferred shares,” evoking memories of the response to the original Maple Rock letter in which bold claims were made unsupported. The coupon is a quarter-point lower at 9.75%, can be paid in-kind like the prefs, and Board control is reduced. Looks like an improvement to this analyst.
To me, this public offer from ESW reeks of desperation and lack of public market sophistication. They know or ought to know that there is basically no chance that regulators will grant the exemption they seek. So why even bother, especially considering the credibility blow they will absorb as they switch from seller to buyer within the space of six months?
Pursuing this offer in spite of the very low odds of success highlights that ESW is very motivated to regain control of the company. This could be because they are legitimately concerned about the value destruction from the operational unwind and are looking to apply pressure to Maple Rock and EdgePoint to sell. It could also be that this is a last-ditch attempt to take control of the company on-the-cheap before Maple Rock and EdgePoint can get their arms around the true state of affairs. Or it may be an effort to manage potential legal and operational exposures stemming from ESW’s ownership of ZephyrTel.
On the last point, the circular for the upcoming annual meeting filed yesterday morning discloses that Jozsef Czapovics, Senior VP of Engineering and Support, was terminated on June 29th, the day after the debenture financing closed. As a CrossOver contractor, perhaps he was also working with ZephyrTel? This might explain why Optiva cannot adopt an Upland-type model – presumably CrossOver and DevFactory are doing work with ZephyrTel, a competitor to Optiva. Furthering this view, ESW’s release states that, “Optiva declared that ESW, through one or more of its affiliates, competes with Optiva – an assertion with which ESW strenuously disagrees”.
Reading between the lines, it does seem likely that ESW mingled CrossOver and DevFactory resources between Optiva and ZephyrTel. I also continue to suspect that former CEO Danielle Royston left Optiva with plans to move to ZephyrTel. Sharing resources across companies is acceptable in the realm of 100%-owned private firms, but not public companies with minority shareholders. I am no legal expert, but presumably the Board and prior Optiva management will be held responsible for harm done to Optiva as a result of this sharing of resources with a competitor. One also has to believe that any dispute with Optiva could jeopardize the ability to execute on growth plans at ZephyrTel.
Why did ESW offer $60? There was no reference to any supporting financial or valuation metric in the release. In my view, this is the highest price ESW could offer without completely undermining what little remains of their credibility. While the flip from seller to buyer inside of six months is already suspect, if ESW had offered more than $60 it would have confirmed their statements earlier this year to be pure fiction. How could they offer to buy at, say, $70 today, after supposedly being willing to sell at $60 in January? By offering $60, ESW can perhaps argue, however implausibly, that they were indifferent at that price. That ESW strained to offer the highest price possible betrays their precarious negotiating position.
There has been so much questionable behaviour from ESW this year. The bleak financial forecast provided in January, a massive revision to that given only a couple months prior. The refusal to engage with the January Maple Rock letter in a meaningful way. The delay of the special meeting due to covid. The CEO resignation due to a compensation dispute. The attempted substitution of ZephyrTel-related Directors only weeks before they would be replaced anyways. And now this – offering to acquire the company at $60 per share after claiming they would sell their stake at that price in January. How can a reasonable analyst not conclude that ESW was trying to take advantage of minority shareholders?
Where to from here? Shareholders deserve a balanced look at the financial prospects for the firm as it is now apparent that ESW was biased when providing the January outlook. ESW alone has a handle on the true prospects of the company by virtue of having been in control until recently. The $60 offer seems generous when only considering the no-growth on-premise business, but Optiva has a leading position in public cloud which could drive revenue to multiples of the current level with time. If such an upside scenario were realized, the shares could be worth far more than the $60 offer.
ESW has revealed their hand and it is a weak one. It is difficult to understand why they would disclose such an offer except as an act of desperation or a serious misunderstanding of the workings of the public markets. ESW is highly motivated to acquire control of Optiva, perhaps because of the cloud opportunity or maybe to avoid the legal and operational quagmire with ZephyrTel. They should pay a fair price for the privilege.
Disclosure: the author owns shares of Optiva.