Updated July 8, 2020
On July 2, 2020, Belden announced that it had completed the previously announced divestiture of Grass Valley
The acquirer is Black Dragon Capital, a Florida-based private equity firm founded by and managed by Louis Hernandez Jr., the former Chairman and CEO of Avid.
The transaction was relatively complicated and there were several important changes made its structure between the time it was first announced on February 4, 2020 and when it closed in July 2, 2020. Therefore, we’ve put together this post in an attempt to review and unravel the terms of the deal, as much for our own understanding as anything else.For those interested in the background and history of the an overview review of the background of the transaction – and Belden’s unsuccessful decade-long $700 million foray into the media technology sector – please refer to the podcast we recorded prior to the announcement that the deal had been finalized.
Black Dragon Capital has successfully completed the acquisition of Grass Valley from Belden on July 2, 2020.
This is a complicated transaction with a lot of moving parts, and the final deal terms are different than those disclosed when the transaction was announced (a common occurrence in M&A).
After reviewing multiple announcements and regulatory filings; and having had the opportunity to speak with both Black Dragon and Grass Valley management, we now have a more well-informed (but still not comprehensive) view of the transaction.
This is complicated. Consequently, our analysis of the deal is lengthy. Here is a high-level summary:
Deal Parties: Belden sold its Grass Valley subsidiary to Black Dragon Capital
Deal Timing: Belden publicly disclosed the Grass Valley sale process on October 30, 2019. The sale to Black Dragon Capital was then announced on February 4, 2020. The deal closed on July 2, 2020. Between the date of the close and the announcement, the deal terms were renegotiated to the benefit of Black Dragon and to the detriment of Belden.
Price: $120 million cash (paid at closing), plus a $175 million note, plus $88 million in note interest, plus a potential earn-out of up to $178 million.
Deal Value: Belden described the aggregate proceeds as approximately $295 million, though no explanation of the $295 million figure is disclosed.
A full accounting of the deal requires a summation of net cash proceeds, retention of non-trade liabilities, and estimates for the fair value of future consideration.
- The net upfront cash amount was $67 million ($120 million less $53 million cash left with Grass Valley)
- Based on its Q1 2020 balance sheet, Grass Valley kept $5.3 million of its pension liability while Belden retained around (an estimate) $25 million of the liability. Those net to around $20 million of liability remaining with Belden (subtracting from deal value)
- All other components of the deal value provide no cashflows to Belden for at least five years. Each of those cash flows then requires discounting from five years’ time using an interest rate reflecting the specific considerations for Grass Valley and whatever conditions are necessary to satisfy the payments. As a practical matter, the note and associated interest are contingent on Grass Valley’s performance. The earn-out is further contingent on the equity returns of Black Dragon’s investment, which would likely require a liquidity event.
In its most recent 10-K filing for the 2019 financial year, Belden’s auditors Ernst & Young discussed its process for evaluating the value of Grass Valley (as of December 31, 2019), a similar process to the valuation of the deal components above. Here is an excerpt of Ernst & Young’s disclosure:
The estimated fair value of the consideration expected to be received was calculated based on a combination of cash expected to be received at closing, as well as an interest-bearing note receivable from the buyer with a five-year maturity and additional consideration available to the Company. The additional consideration is contingent on certain performance thresholds being met and certain assumptions underlying this contingent consideration, such as revenue growth rates, projected EBITDA margins, and terminal growth rates all used in projecting earnings, are subjective and sensitive to change.
Valuation: As a multiple of Grass Valley’s 2019 financial results, the aggregate proceeds (as described by Belden) represent 1.2x annual sales and approximately 6.0x annual EBITDA. The critical caveats to those valuation figures are the negative change in Grass Valley’s operating performance (based on Q1 2020 results), perhaps making 2019 financial results less applicable, and whether you view the $295 million value as an appropriate valuation of the deal components.
To provide one possible, alternative view of valuing the deal, consider the following approach. On an enterprise value basis (netting cash and debt) there is approximately $45 – $50 million of value changing hands upfront.
It is reasonable to not ascribe value to the earnout component of the deal at this time, since any potential payment won’t happen for at least five years and dependent on a third-party’s equity term at an unknown amount.
If you then view the note and interest as having venture levels of risk, you will discount those figures to perhaps $75 – $85 million of deal value. Those assumptions would then imply deal value of $120 – $135 million, which is substantially below the annual revenue levels of Grass Valley.
Devoncroft Verdict: The low valuation of Grass Valley does not make this a “bad deal.” On the contrary, the final agreement massively shifted the deal terms in the favor of Black Dragon Capital, who appears to have negotiated a fantastic deal for one of the broadcast industry’s marquee brands.
It’s a remarkably bad deal for Belden, who had already designated Grass Valley as a discontinued asset and presumably wanted to move on and get the asset divested (especially with a new CEO in place for just over one quarter).
It’s a very good deal for Black Dragon Capital, and if they can achieve their stated vision of creating a transformed Grass Valley it will become a great deal for them.
Belden announced on October 30, 2019 that it intended to divest the Grass Valley and had re-categorized the company as a discontinued asset.
Initially, Belden was optimistic that the transaction would be completed quickly. On its Q3 2019 earnings call, company CEO John Stroup told analysts:
“It’s certainly our preference to be able to get [the divestment of Grass Valley] resolved as quickly as possible. We have been working on it for a little while. If we were in a position to announce something definitively, of course, we would have done it today, but we’re not. So, we’re – it’s top priority for me and for [Belden CFO Henk Derksen]. We’d like to get it done this quarter, if possible, but if not, then we’ll get it done as quickly as we can. But it’s – it absolutely has our full attention.”
And in a regulatory filing at that time, Belden described the disposal process and disclosed a snapshot of the Grass Valley’s assets, liabilities, and losses:
“During the fourth quarter of 2019, we committed to a plan to sell Grass Valley, and at such time, met all of the criteria to classify the assets and liabilities of this business as held for sale. As a result, the Grass Valley disposal group will be included in discontinued operations commencing in the fourth quarter. We intend to complete the sale of the Grass Valley disposal group during the next twelve months. We recognized an impairment charge for the disposal group of $342.1 million during the third quarter of 2019, which consisted of impairments to goodwill, customer relationships, and trademarks of $326.1 million, $14.4 million, and $1.6 million, respectively.
“As of September 29, 2019, Grass Valley had total assets and total liabilities of $491.8 million and $194.0 million, respectively, and accumulated other comprehensive losses of $73.2 million.”
Although the Grass Valley divestment took longer to close than anticipated by Belden management, on February 4, 2020 it announced that it had found a buyer, and John Stroup told analysts:
“As we reported last quarter, we completed a rigorous strategic review of our portfolio of businesses and concluded that it was in the best interests of our shareholders, customers and employees to separate Grass Valley from Belden. Today, we announced that we reached a definitive agreement to sell 100% of Grass Valley to private equity firm, Black Dragon Capital. The transaction is expected to close in the first half of 2020.”
Understanding the transaction
Understanding this transaction requires unpacking its multi-part structure. There are four financial components to the deal, and we review each form of consideration below.
However, changes made to the original deal terms contribute additional complexity to the final transaction.
The modifications to the terms are meaningful. Therefore, we believe it’s helpful to start by reviewing the original deal structure, then comparing this to the final terms, and finally assessing the impact of each change.
Generally speaking, it’s our opinion that these changes negatively impacted Belden’s position, while positively impacting Black Dragon’s position.
The original deal terms:
As outlined by Belden management in public statements made on February 4, 2020 during the company’s Q4 and full-year 2019 earnings call, as well as in subsequent regulatory filings, four considerations were used to determine the valuation of Grass Valley.
- An upfront, gross cash payment of $140 million remitted to Belden by Black Dragon Capital;
- The creation of a note (“Sellers Note”) in the amount of $213 million (less certain UK pension obligations assumed by Black Dragon) due in full to Belden in five years, unless it is extended;
- Payment-in-kind (“PIK”) interest – at 10% per annuum – on the Sellers Note for as much as $130 million and payable in full in five years, but subject to extension; and
- A potential earn-out for a maximum of $150 million based on the performance of Black Dragon Capital’s investment meeting certain performance thresholds.
When describing the deal to analysts on its Q4 and full-year 2020 earnings call, Stroup said:
“These earn-out payments are based on certain performance thresholds, but the seller’s note and the interest on the seller’s note are not. We are pleased to announce this definitive agreement and extremely excited about the opportunities for Belden going forward as we continue our transformation.”
On the same call, Belden CFO Henk Deksen described how Grass Valley was valued, and thr four parts of the deal:
“There are four components to the Grass Valley proceeds. So, there’s $140 million of cash up front, a seller’s note of $213 million. And both of those are not tied to any performance. So, roughly $353 million is not tied to performance. We could earn a PIK over a five-year period, so seller’s note is five-year period, and interest paid in kind of another $130 million and then there’s an earn out of $150 million, and the earn-out is in essence tied to performance criteria. So, I think the best way to think about valuation, is $140 million, $213 million seller’s note, it’s about $353 million, [or] about one times revenue.”
Of course, this happened about a month before the Covid-19 pandemic led to a global shutdown and a further transaction delay.
The final deal terms:
Belden’s July 2, 2020 press release announcing the successful divestiture of Grass Valley, as well as its associated regulatory filings, reveals meaningful adjustments to the original deal terms.
Although the same four considerations remain central to the deal, their underlying structure has been modified as follows:
- An upfront, gross cash payment of $120 million remitted to Belden by Black Dragon Capital (a ~14% reduction, in favor of Black Dragon);
- The creation of a note (“Sellers Note”) in the amount of $175 million (less certain pension obligations assumed by Black Dragon) due in full to Belden in five years, unless it is extended (an ~18% reduction, in favor of Black Dragon);
- Payment-in-kind (“PIK”) interest – at 8.5% per annuum – on the Sellers Note for as much as $88 million and payable in full in five years, but subject to extension (a 15% reduction in the annual interest rate, and a ~32% reduction in the total contemplated interest payment, both in favor of Black Dragon); and
- A potential earn-out for a maximum of $178 million based on the performance of Black Dragon Capital’s investment meeting certain performance thresholds (an ~18% increase that will benefit Belden if the earn-out is triggered)
- Belden has agreed to make a $3 million equity investment in Grass Valley, with Belden able to exercise a put-back option after 120 days.
It’s unclear why this fifth provision – Belden’s $3 million equity investment in Grass Valley – was added to the deal terms, it’s a new one for us. Nevertheless, although it seems a bit unusual, the 120 day put-back option makes it a moot point in the grand scheme of things, so we’ve decided to exclude it from this analysis.
The following table summarizes the difference between the original and final deal terms, along with our opinion as to which party benefit from these changes.
Comparing the original versus final deal terms
In a regulatory filing describing the final terms of the transaction, Belden describes the aggregate consideration of the above five components as approximately $295 million.
Note that this is 16.4% less than the $353 million Derksen told analysts on February 4, 2020, based on the original deal terms.
Regardless, we were unable to arrive at an obvious summation of the five components of the final deal terms that resulted in $295 million. Instead, our back of the envelope calculations (which exclude the presumably short-term $3 million equity investment), sums to $562 million, or $508 million excluding cash in the business ($67m + $175m + $88m + $178m = $508m), compared to $602 million in the original deal, using the same math.
This is not a good or bad thing. We can work only with publicly disclosed figures and we have no inside knowledge of transaction specifics. Although Belden has not offered an explanation, we suspect the difference is likely explained by adjustments for retained liabilities (discussed below), or discounting of the future payments, both to account for time value of money and the likelihood of actual receipt of the funds (much more on this below).
Still, the details are a little confusing, so we created the animation below that visualizes the original and final deal terms. Admittedly it is over-simplified by useful in illustrating the complexity of the deal.
The most obvious takeaway from a comparison of the original and final deal terms is that the price changed considerably.
The repricing of the deal is almost certainly due to a combination of the current market environment and Grass Valley’s poor Q1 2020 financial performance.
Using Belden’s Q1 2020 regulatory filings, we estimate that Grass Valley’s year-over-year revenues in Q1 2020 declined by 41%, to approximately $51 million. Like virtually all other companies, the quarter was severely impacted by COVID-related disruptions starting in mid-March 2020 (note that Belden management has stated publicly on multiple occasions that a disproportionate amount of Grass Valley’s sales occur in the final few weeks of any given quarter, and with much of the world on lockdown, the company was almost certainly impacted.
Grass Valley’s Q1 2020 revenue shortfall contributed to a gross margin result of 31% for the quarter and an operating loss of $33.6 million ($10 million loss prior to the latest asset impairment charge).
And it appears Belden’s loss became Black Dragon’s gain.
This was effectively confirmed in a LinkedIn post by Frank Capria, a member of the Black Dragon deal team, who said the current market environment offered an opportunity for Black Dragon to renegotiation the deal on more favorable terms.
Reviewing the impact of changes to the original deal terms
Having briefly reviewed the publicly available terms of the final transaction, we believe the deal has become slightly more rather than less complex (but also substantially more favorable to Black Dragon Capital and Grass Valley).
Understanding the final deal terms requires “unpacking” the details, along with a reference to the original terms.
Accordingly, we review in order below each form of consideration in the final deal terms.
1. $120 million upfront payment (originally $140 million):
The upfront cash consideration of $120 million seems clear-cut at first glance, but Belden’s July 2, 2020 press release notes that the net cash consideration is $67 million, versus a contemplated $120 million under the original terms – a decrease of 44% ($120 million vs. $67 million), in favor of Black Dragon, compared to the original deal terms.
Accordingly, it is now more appropriate to view the upfront cash portion at the net amount of $67 million rather than the previously contemplated $140 million cash payment, with Belden leaving only $20 million of cash with Grass Valley.
Moreover, a recent Belden regulatory filing dated the day after the announced transaction in February indicated a portion of the then $140 million upfront payment would be funded through a new debt offering. Neither the Belden nor Grass Valley press releases discuss the source of funds.
This implies Belden is “selling” Black Dragon approximately $52 million of cash along with the Grass Valley business, compared to the approximately $20 million previously contemplated, and reduces the aggregate consideration value to Belden by the same amount.
The amount of cash left in the Grass Valley business as per the final deal terms represents an increase of 160% (in favor of Black Dragon) compared to the original deal terms.
Focusing on the source of funds used for the upfront payment may seem pedantic, but it is an important distinction because of the impact to the going-forward Grass Valley business and because of the nature of the other deal components.
First, the responsibility for servicing any debt used to fund the transaction will rest with Grass Valley. This will create a burden on Grass Valley’s ability to invest in its business, which is a potential concern to customers.
According to Belden’s regulatory filing in February 2020, Black Dragon’s ability to secure this new debt financing was a closing condition to the deal. Belden’s filing says that “actual results could differ materially from those reflected in the Form 8-K for various reasons, including the failure of the Company to meet closing conditions and the failure of the Buyer to obtain its expected financing.”
The customary sequence of events in M&A deals is for the buyer (in this instance Black Dragon) to secure the financing from a third-party lender based on the cash flow or assets of the target business (in this instance Grass Valley) and then at the time of the closing, the funds raised by the lender are provided to the seller (in this instance Belden) with the debt obligation remaining with the target business (Grass Valley).
The use of debt to support the initial payment would not be surprising since some back-of-the-envelope math shows that the value of the gross up-front payment ($120 million) represents approximately 2x Grass Valley’s 2019 EBITDA (the funds available to service debt). What is unclear currently is the size of the debt offering (which is an amount less than $120 million) versus an equity contribution from Black Dragon. Neither Belden nor Black Dragon Capital have made public statements on this matter. In speaking with both the Grass Valley and Black Dragon neither expressed any concern around the impact of this financing component.
2. $175 million Sellers Note (previously $213 million):
Belden issued a 5-year Sellers Note for $175 million. In substance, this is a future obligation calling for a payment by Black Dragon to Belden in five years at the stated value of $175 million. Under the original deal terms the value of this note was $213 million in the original deal terms. The renegotiation reduced this figure by approximately 18%.
It is important to make clear the cash flow associated with the Seller Note: there is none today.
The promise of the future payment creates a ‘debt’ obligation in the future for Grass Valley and an ‘asset’ for Belden today. Black Dragon pays nothing today; Belden receives nothing today.
Transactions including seller-note financing usually occur when a traditional source of funding is not possible on the terms desired. Consequently, this type of deal structure is typically not the first choice of sellers – especially a financially-sophisticated seller such as Belden – because the seller maintains risk exposure in the divested entity.
Before choosing to view this in a negative light, keep in mind during divestitures it is challenging to describe the going-forward cash flows of a newly independent organization and a Sellers Note can serve as a vehicle to bridge to a more traditional financing.
Nevertheless, by issuing the $175 million Sellers Note Belden has agreed to finance 65%+ of the contractually guaranteed payments (i.e. the two of four deal components that are not subject to Grass Valley’s future financial performance) from Black Dragon Capital for the purchase of Grass Valley for a period of at least five years.
But it transpires that the Sellers Note may not actually be for $175 million as described. The final amount of the Sellers Note was previously contemplated as $213 million (now $175 million) less any amount of Grass Valley’s UK pension liabilities assumed by Black Dragon Capital.
The root of this issue is traced back to Belden’s acquisition of Snell Advanced Media (SAM) in February 2018. When Belden acquired SAM, it also acquired liabilities arising from final salary pension schemes in at least two companies previously acquired by SAM. At the time Belden bought SAM, the outstanding UK pension liability was $31.7 million (it is likely smaller in early 2020 but still meaningful).
For obvious reasons, Black Dragon did not want to assume these liabilities. And according to two statements in Belden’s 2019 10-K filing, it appears Black Dragon avoided most or all of them.
“The Agreement provides for us to receive $140 million in cash, a subordinated note with an initial face amount of $213 million (less the amount of certain pension liabilities being assumed by the Buyer);
The Agreement requires that, prior to closing, [Belden] transfer [Grass Valley’s] U.K. pension obligations to one of our non-Grass Valley subsidiaries, obtain any required approvals in connection with that transfer, and fulfill various other closing conditions. We expect the sale to close in the first half of 2020.”
The reduction of the Seller Note, however, does not reduce the size of the deal. All things being equal, saving a $1 liability is the same as receiving a $1 asset today. In this instance the asset is not today, but rather five years in the future (and a $1 today is more valuable than $1 in the future). The trade then raises the value of the deal since it is trading a $1 defined liability (from Belden to Black Dragon) today for a $1 future asset (from Black Dragon to Belden).
Of course, the reverse is true. Every $1 of the liability Belden retains equates to a reduction of deal value. Grass Valley’s Q1 2020 balance sheet indicates a $5.3 million pension obligation will remain with the business. This would then reduce the Seller Note by $5.3 million. Since it would appear Belden is retaining substantially all of the liability (based on filings perhaps $20 – $25 million), this represents a reduction of upfront deal value of perhaps 30% of the net cash proceeds (remember net cash is $67 million). Belden is then selling a business with tangible net assets of over $200 million (as of December 31, 2019) and around $50 million of 2019 EBITDA for an initial net price of perhaps $45 million.
Before moving on from a discussion of the Seller note, we must point out that it appears the term of the Sellers Note may extend beyond the initially described 5-year period. This was disclosed in Belden’s February regulatory filing, which included the following contract language that describes the potential duration of the Sellers Note.
“The note is contemplated to be a five-year instrument, but that term is subject to extension if the Buyer’s senior indebtedness is extended beyond December 31, 2025.”
In other words, should Black Dragon Capital (in practice Grass Valley since the future debt will be paid by Grass Valley) chooses to extend the debt facility used to fund the upfront gross payment of $120 million beyond December 31, 2025, the term of the Sellers note will also extend beyond five years (so will the PIK interest described below), making the term of the note potentially open-ended.
3. PIK interest:
Payment-in-kind (PIK) is a mechanism whereby interest is accrued as additional principal on an obligation and the borrower can thus avoid making interest payment until the maturity date of the obligation. In other words, Belden will not receive any payment from Black Dragon / Grass Valley for five years, but instead will see an increase in the seller note by $88 million.
Note that PIK interest of $88 million is based on the Seller Note of $175 million at an 8.5% annual compounding interest rate. The original deal terms called for PIK interest of $130 million based on the Seller Note of $213 million at a 10% annual compounding interest rate. This means Black Dragon negotiated a 32% reduction in PIK interest due to Belden at the end of five years.
Belden’s management has stated the PIK facility is not dependent on the future performance of Grass Valley.
This would then mean of the first three components of value Belden is financing 70%+ of the consideration.
4. Potential Earn-Out:
The entirety of the references to the earn-out are a statements by Belden management during its Q4 2019 earnings call and a February 2020 regulatory filing indicating (i) the maximum value attainable of $150 million and (ii) the contingency of earn-out depending on Black Dragon earning “an agreed upon return on its equity investment.”
The deal announcement press release revises the earn-out to $178, an 18% increase.
Assuming the same contingency exists as described in February regulatory filings, dependency is not any achievement of specific operating target, rather the return on equity of the buyer.
One increases equity returns by decreasing the initial equity investment (i.e. more debt, lower purchase price, non-cash deal components, etc.) or increasing the ultimate equity exit value (i.e. sell the business for a large cash price) or some combination of the two. Tying the payment to the equity return of the new owners, rather an operating target, is a vote of confidence in Belden’s view of the Black Dragon team’s ability to generate a successful future sale of Grass Valley.
By having an earn-out or other forms of contingent consideration, a seller can reasonably claim a higher (possible) deal value. Having covered many M&A transactions in this sector, earn-outs tend to occupy a much more prominent positioning in press releases than they ever reach in practice.
5. A $3 million equity investment by Belden in Grass Valley:
The final deal terms reveal a curious addition calling for Belden to make a $3 million equity investment in Grass Valley (a business Belden had owned 100% of the equity and has now sold). Belden has the right to put the equity investment back to Black Dragon at any time during the next 120 days. In more plain terms, the ‘put’ means Belden can cause Black Dragon to buy the equity position back at – we presume – the same valuation in the next 120 days.
There is only a one sentence disclosure of this condition in Belden’s press release. It raises several questions as to why the $3 million could not have been folded into the upfront cash consideration, why it requires an equity position, or why the 120-day convention. We can only guess at the motivations, and we prefer to refrain from guessing.
Belden’s management has issued no revised statements about the deal or how investors should the view the deal. We will instead work from management’s disclosures during its Q4 2019 conference call. Notably the below comments came before the present lowering of the deal terms.
During Belden’s Q4 2019 call with analysts, Belden’s CFO Henk Derksen stated “the best way to think about valuation [of the Grass Valley business] is $140 million, the $213 seller’s note is about $353 million, it’s about 1x revenue.” (Grass Valley’s historical financial performance is covered in an earlier post).
This was curious logic. To illustrate, let’s make it a more familiar problem by dropping the moniker of millions and recasting in the form of this first-person statement. “How does this sound for a deal? I will lend you $21, you pay me $14, and then let us call it a $35 total transaction!”
The above is only intended to illustrate the value of a deal is the value you receive, not the value you negotiate.
While we dispute Belden management’s characterization of a 1x revenue valuation, we acknowledge this was the best offer available for Grass Valley.
It’s worth pausing and reflecting on this for a moment.
Belden made a public disclosure on its intention to sell the business and retained JP Morgan to run a structured sale process. Further, at the time Belden announced its intention to divest Grass Valley (late 2019), there was more than $800 billion of capital controlled by US private equity firms having a purchasing power of perhaps $2.4 billion (with leverage and reinvested equity) this was (and remains) the best deal available for Grass Valley.
Note that Belden spent approximately $700 million in cash on the acquisitions of the precedent businesses of Telecast, Miranda, Softel, Grass Valley, and SAM.
Forget the market disruption of the first half of 2020, those were unknown at the time this deal was agreed. Consider only that Grass Valley was in 2019 around $350 – $360 million revenue business operating at around 18% EBITDA margins, and was positioned to benefit from the calendar of live events in 2020 as well as the increasing deployment of IP-based technology by broadcasters and media companies world-wide.
If it’s likely that Grass Valley will benefit from secular tailwinds over the next few years, then this was an attractive valuation at an effective price (original terms) of $120 million in cash (~2x trailing EBITDA) and a lot of contingent promises based on vague future criteria that sound good in a press release.
Further, Derksen specifically told analysts that the $353 million (the upfront $140 million payment, plus the principal of the $213 million Sellers Note) is not tied to performance.”
While this may be correct as a contractual matter, in the cold practical real world all the disbursements beyond the $140 million upfront payment are in practice dependent entirely on the performance of Grass Valley for at least the next five years.
The only way the Sellers Note will be paid in five years (or ever) is if Grass Valley has the funds to pay it. The possible sources of future funds are either (i) an increase in the cash flow of Grass Valley; or (ii) an increase in the equity value of Grass Valley. Therefore, ALL future remuneration to Belden is subject to the future performance of Grass Valley and by extension Black Dragon’s ability to drive that performance.
Thus, it appears Belden has entered into a deal that leaves them on the hook for Grass Valley and actually created a situation where Belden has more financial risk (skin in the game from a divested asset) in Grass Valley than Black Dragon – Grass Valley’s new owners. In other words, Belden remains subject to many Grass Valley-related performance because it financed ~70% of the deal value (not including potential PIK interest and/or earn-out), before taking into account the ~$25 million of UK pension liabilities that Belden is keeping on its books.
As a general observation, this is the type of deal structure a seller resorts to after having explored all more straightforward options.
The vast majority of the stated consideration is several years in the future, or dependent on the future performance of a business the seller no longer controls, or both.
Rather than calling it a partnership, it is more appropriate to think of the transaction as an investment by Belden in Black Dragon.
The structuring of the deal is then most likely explained either by Belden’s belief in the operational history and expertise of Black Dragon to generate a significant escalation in the value of Grass Valley, or a reflection in the lack of alternative options available to Belden, or a bit of both.
It is worth reiterating Belden’s primary goal of the divestiture is to cease ownership of Grass Valley and a secondary goal is to reclaim as much value as possible. The divestiture allowed Belden to designate Grass Valley as discontinued operations.
During the third quarter of 2019, Belden wrote-down the carrying value of Grass Valley by $342.1 million, which is spread across the intangible assets of goodwill ($326.1 million), customer relationship ($14.4 million), trademarks ($1.6 million). The goodwill balance was created during Belden’s prior acquisitions of Miranda, Grass Valley, and SAM.
In the fourth quarter Belden added a further impairment write-down of $180.4 million, bringing the total 2019 write-down of Grass Valley to $521.4 million.
To lay out the accounting sequence, Belden’s Grass Valley subsidiary started the 2019 calendar with $628 million dollars of net asset value. During the third quarter the team revisited certain intangible assets and determined the asset values were then overstated by $342.1 million. Fair value was determined during Q3 2019 by “calculating the present values of their estimated future cash flows.”
During the fourth quarter and because of the sale price agreed with Black Dragon, Belden determined it was necessary to impair the assets of Grass Valley by a further $180.4 million. The filing states,
“We determined the estimated fair values of the assets and of the reporting unit by calculating the present values of their estimated future cash flows, which was based in part on the assumed proceeds from a divestiture of Grass Valley.”
Note that a $180 million charge against Grass Valley’s end of year 2019 balance sheet is more than the company’s balance of remaining intangible assets and would have to apply against tangible components of value. Belden decided to create a contra-asset to capture the additional write-downs.
Below is an illustration of the impact of the 2019 impairments on Grass Valley’s balance sheet.
The above write-downs were joined by another $23.2 million impairment of Grass Valley at the conclusion of Q1 2020, bringing the total impairment charges to $545.7 million since January 1, 2019.
While not stated explicitly in the filings, the implication is the accountant’s determination of the fair value of all the components of the deal is less than $200 million, thereby necessitating the further impairment.
To put this in plain business terms, it appears the original deal terms valued Grass Valley at lower than its tangible net asset value. Remember, this valuation is from February 2020. The final deal terms highlight an even further decline in Grass Valley’s valuation.
How can a profitable business sell for less than tangible net asset value? This is a first for us. It is logical consistent accounting. Otherwise, the write-down and transaction would create a paradox where a write-down is necessitated by a review of the cash flows of an asset, while an arms-length transaction with a valuation based on those same cash flows would have created an asset.
Again, we dispute Belden management’s characterization of a 1x revenue valuation. In our opinion, neither the net cash received, the fair value estimates, nor common sense allow for the conclusion that this was a 1.0x revenue sale.
Having said that, don’t lose sight of the bigger picture for Belden. By moving the $521.4 million write-down to discontinued operations, Belden’s negative $377 million 2019 GAAP net income is in large measure improved to a positive $209 million adjusted net income.
A criticism of a seller is perhaps better leveled as a complement to the buyer. The mechanism of the Sellers Note with PIK keeps the cash flow of Grass Valley within the business of Grass Valley (so the management team can invest in growth initiatives, etc.) rather than continually siphoning off profits to pay debt holders – and Grass Valley is going to need the investment funds. As the press releases and associated announcements make clear, Grass Valley has some investments to make to transition its business to new business models.
The early February Black Dragon Capital press release announcing the deal includes the following three quotes in succession:
Louis Hernandez Jr. [Founder and Managing Director of Black Dragon]:
“We’re excited by the opportunity Grass Valley has to lead in an industry where other heritage brands have struggled. Grass Valley’s investments in cloud-based and Software as a Service (SaaS) solutions are promising. We believe the combination of a broad product suite, a great team, and the direction of the market will make Grass Valley the partner of choice as the digitization of the space accelerates.”
Tim Shoulders [CEO of Grass Valley]:
“We are excited about this new phase for Grass Valley. Black Dragon’s experience and vision will help us accelerate our move to cloud-based and SaaS solution product lines that will please customers seeking the most robust and flexible models for content production and delivery.”
John Stroup [CEO of Belden]:
“We are very pleased to partner with Black Dragon Capital. Their deep media-related expertise, proven track record and relationships in the broadcast community make them the perfect partner to drive Grass Valley to the next level.”
There is a noticeable theme of transitioning the Grass Valley business to a cloud-based and SaaS solution model. There is also great attention given to the expertise and familiarity of the Black Dragon team and with good reason. Louis Hernandez Jr. is after all an alumni speaker (twice) at the annual Devoncroft Executive Summit | Las Vegas.
Such a transition in business model will take time and substantial investment (as discussed in earlier posts). Undiscussed – at this time – is the complement of resources available to Grass Valley to fund this transition.
According to Belden, at the time the transaction closes, Belden will transfer to Black Dragon the Grass Valley business with “an agreed-upon level of cash and other working capital.”
Under the original deal terms, this was contemplated to be about $20 million. Based on the deal announcement, we the agreed upon level of cash appears to have jumped to $53 million.
As of the March 31, 2020, Grass Valley had total assets of $344.2 million against liabilities of $135.4 million (the working capital accounts are not disclosed). Grass Valley will no longer benefit from the shared corporate functions provided by Belden (HR, finance, etc.), though according to Grass Valley, there is not a substantial incremental expense burden envisioned. Belden called out a shared services agreement during its third quarter 2019 earnings to allow for an orderly transition of shared corporate functions. The transaction service agreement was referenced in Grass Valley’s press release, though no terms of the agreement were disclosed.
Subtracting from the above is the debt service associated with the borrowings to support the $120 million upfront cash payment. The amounts are unknown, but this is an important point for the going-forward Grass Valley business and the customers of Grass Valley. While we have discussed the upfront payment on a net cash basis, it is crucial to make clear the monies actually change hands. In the case of Grass Valley this will create a debt balance and associated interest payment, which is then a draw on operating cash and impacts the business investment capability of the Grass Valley business.
Black Dragon’s access to capital is not discussed as part of any of the transaction announcements or fillings, and a third-party observe could view the transaction as having the potential to exhaust Grass Valley’s access to capital outside its own remaining cash flow and the equity resources of Black Dragon.
And while Louis Hernandez Jr. is well-known in the industry, Black Dragon is not. According to SEC regulatory filings, Black Dragon is in the midst of a $125 million fundraising, having secured $33.9 million of this goal as of late 2019. Because Black Dragon is in the middle of fundraising, the firm is not able to comment on access to funds and also under no obligation as a private pool of capital.
The above only highlights the lack of information in the public domain about Black Dragon’s access to capital or its intended views on how to finance Grass Valley’s business model transition.
We therefore discussed (in February 2020) this very point with Louis, who has direct experience managing the cash flow impact inherent in transitioning a business away from capital expenditure technology deployments toward cloud-based technology deployments and subscription business models. While serving as the Chairman and CEO of Avid, Louis not only had to manage the business model transition, but also an associated public financial restatement, all undertaken with a constrained cash position.
An expansive enterprise customer base, diverse product portfolio, and substantial initial progress along the transition give Louis great confidence about the Grass Valley’s ability to not just succeed in the transition, but to avoid the need for substantial additional infusions of capital to fund the transition.
Louis and the firm he founded (Black Dragon) are all-in on the investment. Black Dragon is not going to earn a return based on clever financial engineering; the only way Black Dragon earns a return is by driving a material increase in the equity valuation of Grass Valley.
And ultimately the structure itself is a bet by Belden management on the same proposition: that Grass Valley under Black Dragon ownership can both transition its business without substantial additional equity investment and can substantially grow the value of the business.
Perception matters when making long-lived technology investments – this transaction has the potential to impact the perception of Grass Valley either positively or negatively.
Customers who made a big commitment to Grass Valley in 2019 with the expectation of the corporate resources of Belden supporting future product investment are now relying on a different owner with a different corporate profile.
There are two main components involved in a customer making a long-term commitment to technology supplier. The first is an aligned view on the technology roadmap, and the second is a belief the technology supplier can execute on the technology roadmap.
Customers are the ultimate arbiter of these points. Both Grass Valley and Black Dragon have extensive customer relationships in the global media sector and have already started in earnest to discuss these points with customers.
So then two final points to consider about the future: How will the transaction and post-transaction activity impact the perception of the ‘Vision of the Future’ for Grass Valley and the ‘Stability’ of the business?
To illustrate the possible impact, consider two league tables from Devoncroft’s 2019 Big Broadcast Survey (BBS) about Stability and ‘Vision of the Future.’
As a reminder, the BBS has been tracking the brand drivers of 100+ technology suppliers active in the global media technology sector for more than a decade.
Below are the league tables for the top 30 ranked brands for the driver of Stability and for the driver of ‘Vision of the Future.’ For added emphasis, please keep in mind the rankings are based on global technology purchasers and users. It is sorted in alphabetical order. You will note the appearance of Grass Valley: A Belden Brand in the Stability league table, but not the ‘Vision of the Future’ table.
The rankings for the above were gathered during the first half of 2019, well in advance of the public disclosure by Belden to divest Grass Valley.
How will the acquisition by Black Dragon impact customers views on the Stability and ‘Vision of the Future’ of Grass Valley? And more broadly, how does the current level of M&A activity in the supplier community impact customer purchase decisions? These are topics will intend to explore in depth with the release of the 2020 Big Broadcast Survey data and in future posts.
If you made it to the end of this post, we applaud you.
Devoncroft Podcast: Waiting for Closure — Belden, Grass Valley, and Black Dragon Capital
Belden Press Release: Belden Announces Completion of Grass Valley Divestiture
Grass Valley Pres Release: Grass Valley Acquisition by Black Dragon Capital Completed
Belden to sell Grass Valley to PE Firm Headed by Former Avid Chairman and CEO
Belden Announces Intent to Divest Grass Valley, Exit Media Technology Sector
Podcast: Tim Shoulders, President Grass Valley, Discussing the Impact to Media Technology Supplier Community
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