Market Musings - January 17, 2018

We continue our blog series: Market Musings, Volume 2, Edition 4, giving our (hopefully not too random) thoughts on recent goings-on in the markets. Today, we present Zais Group Holdings Buyout--An Offer Shareholders (Literally) Cannot Refuse.

Zais Group Holdings (ticker ZAIS) is an investment advisory and asset management firm focused on specialized credit strategies with approximately $4.144 billion of assets under management as of the end of Q3 2017. In September 2017 the company received a $4/share buyout offer from its founder, chief investment officer and board chairman, Christian Zugel. The price represented over a 100% premium to the prevailing trading level for the stock. As can be seen from the above chart, to that point in its life ZAIS had been an unmitigated disaster for shareholders. The company went public through a merger in 2015 with a special acquisition company (or SPAC) called HF2 Financial Management Inc. (from 2013 to 2015 the stock traded at the $10.50/share SPAC cash redemption value). Since the merger with HF2, ZAIS shares fell over 80% to below $2 by the time the Chairman made his buyout offer.

Why did ZAIS's share price collapse? Mainly due to plain old conflicts of interest and egregious disregard for shareholder rights. First, while Chairman Zugel held 1,131,000 of the Class A shares (or 7.7% of the outstanding Class A shares) at the time of the buyout offer (see details regarding original offer here), following the HF2 / ZAIS combination he also retained (and still retains) control over 20,000,000 (noneconomic) Class B shares. Since each Class B share has 10X the voting power of a Class A share, this means that Zugel has about 93% of the overall voting power despite holding just 7.7% of the economic rights. When such a disparity exists, a dominant (in terms of voting power) shareholder has the ability to siphon off all of the economic benefits of the enterprise with impunity. In ZAIS's case, there are conflicts of interest and various related party transactions which take almost 10 pages in the proxy statement to describe (link here).

Unsurprisingly, the company has never paid shareholders a dime in dividends. In contrast, insiders (including the aforementioned Zugel) been paid quite handsomely while ZAIS's share price has plummeted (note that these amounts are just for 2014 & 2015; in yet another "thumbing of the nose" to shareholders, the company did not even bother to put out a proxy statement during 2017, presumably because Chairman Zugel knew it would be superfluous given his buyout intentions):

Meanwhile, a different shareholder, Neil A. Ramsey, owns 9.6 million Class A shares, representing 69% of the economic rights for ZAIS. Normally, one would think that Mr. Ramsey would be outraged at the fact that Zugel could apparently drive ZAIS's stock price into the ground through his super-voting control and unfortunate stewardship of the company. That is, one would think that except for the fact that Ramsey seems to have paid a grand total of just $25,000 for 5.4 million of his 9.6 million shares, or about one-quarter of one cent per share for these shares(!!!) (source):

Since March 9, 2015, the date of filing of Amendment No. 1, the Reporting Persons engaged in the following transactions in shares of Class A Common Stock:

· On March 17, 2015, upon the closing of the Issuer’s initial business combination with ZAIS, SpecOps purchased an aggregate of 3,492,745 Founders’ Shares at a price of $0.0005875 per share (or an aggregate of $20,519.88) in a private transaction pursuant to the Allocation Agreement described in the Existing Schedule 13D. SpecOps used its working capital to fund the purchase of such shares.

· On March 17, 2015, upon the closing of the Issuer’s initial business combination with ZAIS, NAR acquired beneficial ownership of 1,135,973 shares of Class A Common Stock, including 796,973 Founders’ Shares. Voting and dispositive control over these shares had been transferred to Randall S. Yanker until the closing of the business combination. NAR did not use any funds for the acquisition of such shares.

· On March 17, 2015, upon the closing of the Issuer’s initial business combination with ZAIS, NAR sold an aggregate of 757,742 Founders’ Shares at a price of $0.0005875 per share (or an aggregate of $4,451.73) in a private transaction pursuant to the Allocation Agreement described in the Existing Schedule 13D.

How is this possible? Well, Ramsey seems to have been a principal organizer of the SPAC and received "founder shares" for his role (basically free shares). It makes one a lot more accepting of conflicts of interest by insiders when one pays virtually nothing for one's stock. Welcome to the oftentimes scummy world of SPACs, where the sponsors and insiders can confiscate all of the economic benefits of a business enterprise for themselves while leaving the helpless third-party shareholders holding the bag (of course, these shareholders have the opportunity to "opt out" at the time of the original merger and receive back their $10.50 (or, more often, $10.00) subscription price (but with no interest paid), but once this period has passed, they are at the often at the mercy of insiders).

In connection with the proposed merger, Zugel will purchase 6.5 million of Ramsey's Class A shares for $4.10/share, the same price being offered to the unaffiliated third-party shareholders. (Yes, that's correct, between the September 2017 original offer and the signing in January 2018 of a definitive agreement, the supposedly "independent" board members managed to convince Zugel to raise the offer price a whole 10 cents, or 2.5%, from $4 to $4.10--well done, special committee, give yourselves a round of applause!)

Below are the specific terms of the definitive buyout agreement, from the company's press release (source):

ZAIS GROUP HOLDINGS, INC. ENTERS INTO DEFINITIVE MERGER AGREEMENT; TRANSACTION WOULD RESULT IN COMPANY GOING PRIVATE

Red Bank, NJ – January 12, 2018 – ZAIS Group Holdings, Inc. (NASDAQ: ZAIS) (“ZAIS” or the “Company”) today announced that it has signed a definitive merger agreement with Z Acquisition LLC, a Delaware limited liability company (“Z Acquisition”), and ZGH Merger Sub, Inc., a wholly-owned subsidiary of ZAIS. Christian Zugel, the founder of ZAIS Group, LLC, the Company’s operating subsidiary, and the Company’s Chairman and Chief Investment Officer, is the sole managing member of Z Acquisition. Pursuant to the merger agreement, all of the outstanding common stock of ZAIS that is not (i) beneficially owned by (A) Z Acquisition, the members of Z Acquisition (including Mr. Zugel and Daniel Curry, the Company’s President and Chief Executive Officer), certain trusts for members of Mr. Zugel’s family, and Mr. Zugel’s current spouse (collectively, “Purchaser Group”), or (B) any person who, after the date hereof, acquires common stock of ZAIS through certain issuances pursuant to an exercise of exchange rights, or (ii) owned by certain stockholders who agree with Z Acquisition to retain certain of their common stock in connection with the merger, will be converted into the right to receive $4.10 per share in cash, less any required withholding taxes (the “Merger”).

The $4.10 per share price represents a premium of more than 138% to the closing price of the Company’s shares of Class A common stock (“Class A Common Stock”) on September 5, 2017, the last trading day before the initial proposal from Mr. Zugel and Z Acquisition was publicly disclosed. The majority of the funding for payments required to be made to stockholders of the Company in the Merger will be provided by existing cash of the Company, but a portion of the funding for such payments will be provided by Z Acquisition by means of an acquisition of Class A Units of the Company’s majority-owned subsidiary, ZAIS Group Parent, LLC (“ZGP”).

As previously disclosed on September 5, 2017, Z Acquisition and Mr. Zugel entered into a Share Purchase Agreement (as amended, the “Share Purchase Agreement”) with Ramguard LLC (“Ramguard”) to purchase from Ramguard 6,500,000 shares of Class A Common Stock at $4.00 per share. That agreement has been amended and restated to provide that the purchase price for the Ramguard shares will be the same $4.10 per share price to be paid in the Merger. Once this share purchase is completed, Z Acquisition will own, before consummation of the Merger, approximately 44.66% of the Company’s currently outstanding Class A Common Stock and Purchaser Group overall will own approximately 48.01% of the currently outstanding Class A Common Stock.

The Company’s Board of Directors, acting on the unanimous recommendation of the special committee formed by the Board of Directors (the “Special Committee”), approved the merger agreement and the transactions contemplated by the merger agreement and resolved to recommend that the Company’s stockholders adopt the merger agreement and the transactions contemplated by the merger agreement. The Special Committee, which is comprised solely of independent and disinterested directors of the Company who are unaffiliated with Purchaser Group and management of the Company, negotiated the terms of the merger agreement with Purchaser Group, with the assistance of its legal and financial advisors.

Paul Guenther, Chairman of the Special Committee, said, “We are confident that we have negotiated a fair price and that this merger is in the best interest of our minority stockholders. The price of $4.10 is an approximately 138% premium over the last trading day before the offer.”

Mr. Zugel said, “On behalf of Z Acquisition, we are pleased to have reached this agreement, which we believe is in the best interests of unaffiliated stockholders of the Company.”

Unbelievably, Zugel is offering to pay shareholders with their own money ("The majority of the funding for payments required to be made to stockholders of the Company in the Merger will be provided by existing cash of the Company"). The chutzpah of it all! Not only that, the "Special Committee" (indeed, they are very "special") has the arrogance to claim that the merger is in the best interests of shareholders because the buyout price represents a large premium over the rock bottom price the company's shares had fallen to due to the apparent incompetence and abysmal leadership of the very person making the offer, Mr. Zugel (while ZAIS has a separate CEO, it is clear that Zugel as board chairman ultimately calls the shots at the company).

Moreover, while the merger is subject to a "majority of the minority" vote, shareholders are completely in a Catch-22, because if they vote against the deal the stock price will likely go right back to sub-$2 again (possibly on its way even lower). So ZAIS shareholders have been screwed at every turn. Not only did they see 80% of their wealth vaporized in just two and a half years following ZAIS going public, they are now faced the unenviable choice of either (A) voting for the merger, thereby giving up their ownership of ZAIS at a bargain basement valuation (book value at 9/30/17 was $6.36/share) in return for receiving back their own money (currently being held hostage by the company on its balance sheet) or (B) voting against the merger and suffering a likely 50% or more immediate drop in the share price and a return to the disastrous status quo ante. Thus, it seems that Chairman Zugel has made the Class A shareholders of ZAIS an offer they (literally) cannot refuse.