Global Education & Technology (GEDU) – A Chinese Merger Breakup Arbitrage

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Global Education & Technology Group (GEDU) is a Chinese ADR that offers English language training in China. It has become embroiled in an insider trading scandal surrounding its pending acquisition by Pearson (PSO), the large British media and education company. Pearson announced on November 21st that they would acquire GEDU for $11.006 in cash per ADR. That represented a 105% premium to the prior closing price and a whopping 214% to the 30-days prior average trading price.

On December 5th the SEC filed an emergency court order to freeze the US brokerage accounts of four Chinese citizens accused of engaging in trading in GEDU on material non-public information in the days leading up to the announcement of the transaction. One of those accused had her brokerage account funded by an entity controlled by GEDU’s Chairwoman (and wife of the CEO). On December 14th the SEC filed an amended complaint which also implicated Yonghui Zhang, an employee of GEDU and the brother of GEDU’s CEO.

The question now is whether Pearson will call off or at least postpone the closing of the deal in light of the accusations. GEDU closed at $5.29 the day before the deal announcement and at $3.62 just two days prior.  With the stock trading at $10.40, if it falls back to $4 that would be a 62% gain. Even an announced delay in the transaction, which Pearson has said would close in Q4, would probably send GEDU stock tumbling. The potential downside is that the deal closes and the stock trades to $11- a 6% loss. It doesn’t seem anybody is interested in outbidding Pearson for GEDU.

An extensive presentation of the short thesis and links to the SEC complaints can be found at Absaroka Capital’s website. After Absaroka came out with their short report at 1:30 PM on December 8th, GEDU stock dipped from $10.85 to $9.55. At 2:35 PM that day, Fly on the Wall reported that Pearson had told Bloomberg the GEDU transaction was proceeding as planned despite the allegations. However, Bloomberg never published anything about Pearson’s response, so that rumor remains a rumor. In any event, after the Fly on the Wall report the stock recovered to the $10.30-10.40 range where it is still trading. The market clearly seems to think Pearson will close the deal with GEDU stock trading at just 5% below the buyout price.

My guess based on the information that has come out so far is that Pearson still goes through with the deal. The merger proxy discloses that Pearson has been angling to acquire GEDU since September 2010, having made no less than eight offers since that time. As Absaroka notes, Pearson is almost certainly overpaying for GEDU and it is probably not a good deal for PSO shareholders on its own merits, but I think that is irrelevant to the short thesis. The question at hand is whether Pearson will go through with the deal, and clearly setting the scandal aside they think GEDU is worth buying at $11.00.

As this securities lawyer notes, the central difficulty in the SEC’s case is establishing the source of the inside information. The only hard link proposed to GEDU insiders is the funding of one of the trader’s accounts by wire transfers from an entity whose sole director is the GEDU Chairwoman. That certainly looks terrible, but I am not sure it will be enough for Pearson to call off the deal if they really think it is a good one on its business merits. The Chairwoman might have to resign, and Absaroka thinks that Pearson would perceive that as a huge negative because of how critical Chinese government relations are to businesses in China. It is difficult to tell how much the Chairwoman matters to the business in this case. I am not sure her resignation what would be enough for PSO to back out of a deal they want to do so badly. That said the trade is perhaps still tempting as a mispriced option given you are risking 6% to the downside for 50%+ upside.

P.S.

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Disclosure: No position in stocks mentioned.

 

 

 

 

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8 Responses to Global Education & Technology (GEDU) – A Chinese Merger Breakup Arbitrage
  1. Tom
    December 16, 2011 | 4:35 pm

    The amended statement also charges the co-founder and CEOs brother with insider trading.

    Reply
    • Elie Rosenberg
      December 17, 2011 | 7:13 pm

      Right, sorry if that wasn’t clear in the post.

      Reply
  2. Baruch
    December 18, 2011 | 2:52 pm

    Isn’t it odd that Pearson should bid for a company at such a premium to market value? Doesn’t that smell a little fishy? (Especially when you look at the history of the bids- they were all way overpriced). Wouldn’t it make more sense for them to try to take the company over by buying shares on the open market first?

    As far as the risk/reward ratio goes, usually the market price will slowly inch up towards the takeover price as the deal becomes closer to reality, but will keep a few points below the actual target until the deal is done- if so, your downside is really only about 3% if you are carefull to exit shortly before the deal is clinched (if ever).

    Reply
    • Elie Rosenberg
      December 20, 2011 | 12:25 pm

      It is not so uncommon for takeout bids to happen at a large premium to market value, although this was a very large premium. I don’t think it is fishy as much as Pearson just appears to be getting a bad deal, companies overpay for acquisitions all the time. Strategic acquirers usually make friendly offers and don’t try to take a company over on the open market. Also GEDU had very low trading volumes prior to the Pearson announcement so PSO probably could not have bought much on the open market anyway.

      On the risk/reward- you are right, stock was trading in the 10.80 range prior to the allegations coming out so risk might be more like 3-4%.

      Reply
  3. Baruch
    December 20, 2011 | 2:25 pm

    I tried to short gedu, but was declined by my brokerage firm- tdwaterhouse is really bad at this- i missed out on mmany good shorts because they didn’t have any to lend- do you think I should take my business elsewhere?

    Reply
    • Elie Rosenberg
      December 20, 2011 | 2:36 pm

      I can’t get shares either. Seems like a lot of the online retail brokerages are not good at sourcing shares to short.

      Reply
  4. Harry
    December 20, 2011 | 3:18 pm

    Stock has moved back up to with in pennies of buy out price. I also can’t find shares to short.

    Reply
  5. Harry
    December 21, 2011 | 8:41 am

    Looks like the deal is going through. Good thing there were no shares to short.

    Reply
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