Cloudera (NYSE:CLDR) is being taken over at way too cheap a price, based on the private equity offer made on June 1. I highly suspect that some other group could jump in and make a counteroffer for CLDR stock.
The board has until July 1 to shop itself and accept any alternative bids, “with an additional 10 days to negotiate a definitive agreement with qualifying parties.” As a result, this is both a merger arbitrage play, based on the cash transaction, and a potential upside play.
Here is why I think Cloudera, an extremely profitable SaaS enterprise data cloud company, is too cheap at the $16 go-private offer. It is gushing cash flow. Any normal offer would be at least double the price offered.
Why Cloudera’s Takeover Offer is Too Cheap
Both KKR and Clayton, Dubilier & Rice (“CD&R”) agreed to pay $5.3 billion for the shares. Moreover, entities related to Icahn Group, collectively holding approximately 18% of CLDR stock, agreed to the $16 takeover price. But the company just reported its first-quarter earnings with astounding free cash flow figures. The company did not hold a conference call to explain what happened during the quarter.
Here is what the cash flow statement shows. Cloudera generated $162.2 million in cash flow from operations (CFFO) and had just $1.575 million in quarterly capex spending. That can be seen in its earnings release under the Consolidated Statement of Cash Flows. That means that its free cash flow (FCF) was $160.6 million. This is astounding since the total revenue during the quarter was just $224.28 million.
In other words, its FCF margin was an amazingly high 71.6%.
If we apply this to what analysts expect this year, the total FCF could be as high as $660 million. For example, analysts curated by Seeking Alpha estimate 2021 revenue will be $921.85 million. Next year they foresee $1.01 billion in sales. So, for example, 71.6% times $921.85 million equals $660 million in FCF for 2021 and $723 million for next year.
The offer is for $5.3 billion. This is way too cheap at a 13.64% FCF yield (i.e., $723 m / $5.3 billion). Another metric showing is the price-FCF ratio. That works out to just 7.33 times (i.e., $5.3 b / $723 million).
And that is not it. Cloudera already has over $500 million in cash on its balance sheet. So the real takeover cost is just $4.8 billion. That works out to a price-to-FCF of just 6.64 times. That is insanely cheap.
What to Do With CLDR Stock
It is way too early to even think about selling your shares in CLDR stock if you already own them. For example, an average FCF yield for a company like this would be 5%, at least, if not 3%. Here is what that means.
If we divide even the forecast 2021 FCF figure of $660 million by 5%, we get a target value of $13.2 billion. That is 149% higher than the $5.3 billion takeover offer. In other words, in a real auction for this company, assuming its FCF holds up at these high margins, CLDR stock is worth 2.49 times its present price of $39.84 (i.e., 2.49 x $16 per share).
So you can see there is no need to give up your shares at this point. Wait at least until July 1. Moreover, you have nothing to lose. With CLDR stock at $15.75, the merger arb ROI is 1.587% (i.e., $16 / $15.75). Assuming it takes three months to close the deal, that works out to an annualized ROI of 6.5%. That is way better than you can make with your money in cash. In addition, you have all the upside if another offer comes through, which I highly suspect will happen.
On the date of publication, Mark R. Hake did not hold a position in any security mentioned in the article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.