MDC Partners (MDCA) got added to my 3-month high alert in the past week. Its chart has caught my eyes as it shows a textbook example of accumulation phase - it's currently traded on flat tight price bars with low volume and there was a record weekly volume spike just a few months ago. Digging deeper into how much the insiders have paid for their shares, it has strengthened my conviction to buy into this stock - I'm always happy to pay less than the insiders because no smart money wants to lose their investment. Interestingly, a catalyst is already in place: the Chairman and CEO, Mark Penn's private equity, Stagwell Group, is the largest shareholder of MDCA and has proposed to combine with the company by acquiring all the shares at $4.25/share. That's what has caused the record volume back in June.
Value investors may not like this thesis as much. This is a special situation type of investing strategy. I couldn't care less about the company's business outlook and fundamentals.
Numbers about MDCA:
- Current share price: $2.35
- CEO's private equity, Stagwell, has paid $3.5/share and also holds 50,000 preferred shares with a conversion price of $5
- CEO, Mark Penn, also holds 1.5M option awards with exercise price of $2.19 due in 2024
- Goldman Sachs, holds 95,000 preferred shares with conversion price of $7.42
- A going concern: positive free cash flow and no major debt due until 2024
Textbook accumulation phase
MDCA has been an embattled advertising company for years with a declining net income and share price. I like how flat the price has been since 2019 with tight price bars and low volume. This stock apparently has gone out of favor with the market until this June when a record volume has piled in. High volume bars are where millions of shares have transferred hands. Smaller retail investors typically are not big enough to create such a surge in volume; big volumes often reveal the footprints of those big players in the market.
One simple thing to remember is that insiders are in the market to make profits. They have more information than the public and have the resources to maneuver the public sentiment towards a stock by manipulating accounting practices and timing news releases. Insiders always buy low and sell high.
When the price is low, insiders buy; when the price is high, insiders sell. Just as simple as that. Combined with volume bars which can tell you where the insiders are, you have the tool to easily tell when insiders are accumulating or distributing based on the price level.
Coming back to the case of MDCA, the current price is near historical low and now you see a huge volume spike. Do you think that's insiders buying or selling? To me, shares are clearly transferred from weaker hands to stronger hands.
Riding the wave together with the smart money is one of the safest investing strategies out there, because you can firmly believe that the smart money won't allow themselves to lose money. The good news is that an upward trend has yet been developed following the volume spike. That gives us plenty of time to enter and build positions as the stock continues to trade within a narrow range.
The price insiders have paid
We now know that the insiders have been accumulating shares. Let's look into how much skin they actually have in the game.
Mark Penn, a Microsoft vetaran and founder of Stagwell Group, a private equity fund focused on the marketing services industry, has paid $100M in 2019 to invest in this troubled ad agency. Stagwell has become the single largest shareholder of MDCA and Mark has been assigned as CEO and chairman since then.
The following is what I've found in Schedule 13D filed on 3/14/2019.
"On March 14, 2019, SAH and the Issuer entered into a Securities Purchase Agreement (the “Purchase Agreement”), pursuant to which the Issuer agreed to sell: (a) 14,285,714 Class A Shares for an aggregate purchase price in cash of $50 million and (ii) 50,000 newly authorized and issued Series 6 convertible preference shares (the “Preference Shares”) for an aggregate purchase price in cash of $50 million, subject to the terms and conditions set forth in the Purchase Agreement (the “Transaction”). The sale closed on March 14, 2019."
And this is the detail about Series 6 convertible preference shares in 2019 10-K.
"The holders of the Series 6 Preference Shares have the right to convert their Series 6 Preference Shares in whole at any time and from time to time, and in part at any time and from time to time, into a number of Class A Shares equal to the then-applicable liquidation preference divided by the applicable conversion price at such time (the “Conversion Price”). The initial liquidation preference per share of each Series 6 Preference Share is $1,000. The initial Conversion Price is $5.00 per Series 6 Preference Share, subject to customary adjustments for share splits and combinations, dividends, recapitalizations and other matters, including weighted average anti-dilution protection for certain issuances of equity or equity-linked securities.
The Series 6 Preference Shares’ liquidation preference accretes at 8.0% per annum, compounded quarterly until the five-year anniversary of the Series 6 Issue Date..."
The math is simple for common shares: the CEO, Mark Penn, has paid $50,000,000/14,285,714 shares = $3.5/share last year.
The calculation for preference shares is a little bit more complicated. Each preference share is initially $1,000. Each preference share can be converted into $1000 ÷ $5/share = 200 common shares at the end of 5 years. With 8% annum dividend yield compounded quarterly for 5 years, the total dividend per share aggregates to $1000 × (1 + 8% ÷ 4)4×5 - $1000 = $485.9. Deducting the dividend, each preference share is equivalent to being acquired at the price of $1000 - $485.9 = $514.1. Now you get 200 common shares with each preference share - the average cost is $514.1 ÷ 200 = $2.57/share.
Whether it is common shares or preferred shares, the acquisition cost for the CEO is higher than the current stock price.
In addition, in the 2019 proxy document, I found that Mark Penn is holding 1.5 million options with an exercise price of $2.19 due in 2024. The options were awarded to him as part of his 2019 compensation package. If the stock price is lower than $2.19 by 3/18/2024, all his 1.5 million options will expire completely worthless. What would you do to the stock price if you were the CEO? If I were him, $2.19 is absolutely the lowest price I would aim for by 2024.
The catalyst
In June 2020, Mark Penn's Stagwell Group, has made an announcement that proposes to combine with MDCA and value MDCA's shares at $4.25 per share. This is the exact reason why the volume spiked in June. The stock has jumped almost 80% on the day of announcement, but it is still currently trading ~45% discount to the proposed acquisition price.
Stagwell Group, the largest single shareholder of MDCA, is holding 29.4% of outstanding shares. It's hard to imagine why the proposal will not be approved by the shareholders. The below is the reaffirming message from Mark Penn during the most recent Q3 earnings call.
"In terms of the special committee, I have to let the special committee speak for itself. Obviously, like Stagwell, we announced an agreement in principle. And so the next steps obviously are to go into the next level of agreement. And beyond the fact that I think I remain hopeful that - optimistic that we'll be able to bring the companies together. And their specific requests should go to the special committee.
In the modern world, complex combinations simply just have a lot of evaluative and legal steps. So I won't comment directly. But there is nothing unusual in the process that I've seen so far. It's just, in some sense, an education in just how one has to dot every I and T in a very significant transaction such as this."
The one risk I'm concerned about is that Stagwell Group is going to lower the proposed price at the cost of the rest of the minority shareholders. However, as we've seen earlier, $2.19 is absolutely the lowest it can go so that the CEO's personal options will not expire worthless.
Some improving fundamentals
Stagwell Group invested in MDCA in the first place with the hope of turning it around under the help of its strong partnership and networks. There are some business fundamentals improving here and there. They may be good additions to the overall turnaround story but it's not something I really pay much attention to in this specific case. For example, in the recent quarter, the EBITDA margin continues to expand as Stagwell has been working with MDCA to centralize back office operations and real estate in order to reduce the cost.
With that said, one thing I did check is the solvency of the business before the catalyst is realized. MDCA is heavily indebted but the majority of its long-term debt will not be due until 2024. Its operating cash flow has been consistently positive and the interest expense is well covered.
Conclusion
Joel Greenblatt once defined margin of safety as "limit downside risk; the upside will take care of itself".
I will confidently add to my position when the price drops below $2.19 to eliminate my downside risk. A catalyst is around the corner and good things will eventually happen. I'm not sure exactly when but I know the business can survive long enough to see that day to come.
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