Technology incubator NewMarket Technology Inc’s (NMKT.ob) merger announcement with toy firm Action Products International (APII) has caused some confusion about the valuation and logic of the transaction. However, the transaction is a canny way to get listed on NASDAQ and to try NewMarket’s strategy in another market segment.
The Deal Sleuth normally specializes in tracking bad deals, so when a good deal comes along, we usually don’t write about it. In NewMarket’s case, we were surprised that a pretty good deal got some very bad press and incorrect comments, and after some deliberation, we break with our custom and give credit where credit is due.
NewMarket describes its business as systems integration, and identifying new technologies and bringing them to market. So what will a systems integrator do with a toy manufacturer? Clearly, there is no strategic fit. But CEO Phillip Verges defines NMKT more as an incubator and is broadening the company’s scope far beyond systems integration. He asserts that the incubation process can be applied to non-tech products also. If this works, there is significant upside for NMKT in this deal. APII seems unable to continue as a stand-alone entity, but could be turned around with NewMarket’s incubation experience. Expect to see announcements about the spin-off of various toy brands into majority-owned subsidiaries. Clearly, this is a risky proposition, but given Verges’ track record and the favorable risk/reward ratio of applying its incubation process to consumer products, it is worth a try.
The seemingly inflated $100 million valuation of NMKT has caused some bewilderment. If NMKT is valued at $0.50 per share for the purpose of the transaction, for a market cap of $100 million (give ortake a few million), while APII has a market cap of $11 million, then former NMKT shareholders will own approximately 91% of the combined firm, while former APII shareholders will own the remaining 9%. The $0.50 cent/share valuation does not mean that NMKT is actually worth $100 million; it is simply a mathematical artifice that limits dilution and creates the negotiated post-merger ownership structure. Verges can be criticized for his convoluted description of what amounts to a simple cap in the exchange ratio. But as the comments from some baffled shareholders show, a lengthy explanation is needed.
Finally, there is one hidden gem in APII: its recent announcement of a $5.1 million award in a lawsuit against Hong Kong toy maker Lung Cheong. It is likely that Lung Cheong will appeal, and it may take a few years for the cash to come to NMKT. But thanks to the recent growth in the litigation funding industry, NMKT may well be able to monetize the award in the event that it needs cash urgently. Terms would be much more favorable than if a microcap like NMKT were to go through other capital market channels to raise funds.
The result of the merger is that NMKT will give away no more than 10% of its equity valued at some $11 million, and in return get a shot at trying its incubation process on a portfolio of toy brands, a $5.1 million legal award, and a NASDAQ listing. This is yet another example of Verges’s cunning dealing and wheeling.
Disclosure: The author is long shares of NewMarket Technology Inc.