Seeking Alpha • Aug 09
Romeo Power: Merger With Nikola Is A Must
Infamous electric truck manufacturer Nikola is buying electric vehicle battery manufacturer Romeo Power.
This merger arbitrage case is currently offering a 24% annualized return.
The acquisition is likely to be approved by Romeo Power’s shareholders as the transaction has a strong strategic rationale while also providing the target with much needed liquidity.
Vertical merger in the commercial electric vehicle (EV) space. Heavy-duty EV manufacturer Nikola (NKLA) is acquiring its lithium-ion battery supplier Romeo Power (RMO). The consideration is all-stock and values each RMO share at 0.1186 of NKLA stock. At current prices, the spread is at 8% and seems to be largely explained by borrowing fees which stand at ~10% on IB. A spike in borrowing fees remains a risk here and could erode the entire spread. Expected closing is in Oct'22 which would imply a 24% annualized return after deducting borrowing fees.
NKLA Borrow Fees (Interactive Brokers)
To acquire RMO, NKLA will launch a tender offer. The merger requires that at least 50% of RMO's shareholders participate in the exchange. All shares not tendered will be canceled and an amount equivalent to stock-consideration will be paid to these equity holders in cash.
Other merger conditions, including regulatory approval and no bankruptcy of the target before the merger closes (discussed below), do not seem likely to present any issues here. For this reason, merger close hinges on the majority of shareholders participating in the tender. I see several reasons why this is likely:
The transaction has strong strategic rationale as both companies are already tightly vertically integrated - RMO is NKLA's key battery pack supplier. Moreover, the combined company is projected to realize substantial cost synergies.
The merger is expected to ease RMO's liquidity issues and avoid bankruptcy as the combined company will be able more easily raise funding for its operations. Moreover, NKLA will provide the target company with interim funding before the merger closes.
The acquisition values RMO at a significant premium to the unaffected share price.
RMO's shareholder base, which is largely institutional, has not voiced any concerns over the transaction.
Strategic Rationale
Strategic rationale for the combined company seems evident as NKLA seeks to secure and expand the supply of battery packs used in its electric semi-trucks. NKLA has recently emphasized that a short supply of battery packs, which are essential and the most expensive elements in electric truck production, has been one of the biggest obstacles in scaling NKLA's truck production. Despite the fact that NKLA already purchases the majority of RMO's battery packs - the buyer made 62% of the company's revenues in 2021 - capturing the remaining RMO's battery cell supply seems like a clear strategic benefit for NKLA in the current supply chain environment. With the transaction, NKLA will acquire RMO's newly built battery manufacturing facility and start to develop its in-house battery production capabilities.
What is important to emphasize here is that RMO produces high-volume nickel-based battery cells as opposed to entry-level low-cost lithium iron phosphate or high performance specialty application technologies. Put simply, the company focuses on battery packs that can produce the longest range performance in trucks. Meanwhile, long range has been a focus of NKLA and has been highlighted as a key competitive advantage. In this light, the products of both companies seem highly complementary. NKLA's CEO during Q2'22 earnings call discussing the company's Tre BEV semi-truck:
And as you point out, at this point, we have the longest range truck that we know about out there and it's performing extremely well.
Romeo Power Investor Presentation, May 9, 2022
Moreover, the companies already have a strong ongoing engineering collaboration as some of NKLA's engineers have been working with RMO on battery packs which were produced for NKLA. More specifically, the companies worked closely on battery module and pack architecture, thermal systems and software battery management systems. With NKLA's knowledge of the target company and highly overlapping cell technology used/produced, the company estimates annual cost savings of up to $350m by 2026 - very significant compared to $694m and $96m in NKLA's and RMO's operating expenses in 2021. Cost synergies are expected to come from non-cell related battery pack costs (mostly battery enclosure cost savings) which are projected to be lower by 30%-40% by the end of 2023.
Shareholders
I expect RMO's shareholders to approve the merger given its strong strategic rationale. The all-stock structure of the deal will allow current RMO shareholders to realize synergies expected for the combined company. Moreover, the merger was announced at a 34% premium to RMO's closing price. At current NKLA share price, the premium to RMO's pre-announcement closing price is even higher at 56%.
RMO's shareholder base appears to a significant degree institutional - six largest institutional shareholders, including Vanguard, Blackrock and Renaissance Technologies, hold a combined 24% stake. Another 10% is owned by Yorkville Advisors who acquired its stake via an equity purchase agreement (SEPA) with the company in Feb'22 at the average price of ~$1.50/share. I see incentives for these shareholders to approve the transaction to preserve the value of their shares given RMO's risk of bankruptcy and NKLA's superior liquidity position (see Financials below). Adding the company's management (2.5% stake) and smaller institutional shareholders, the count should handily exceed 50%. So far, none of the shareholders have voiced any opposition to the merger. Proxy advisory firms ISS and Glass Lewis have not issued their recommendations yet.
Financials
Ever since the IPO in Apr'19, RMO has been struggling to reach profitability. Recently, cash burn from SG&A and R&D has stood at around $25m-$30m while the current net cash position is at ~$38m. Production has picked up significantly this year, however, even assuming that the management could execute on its revenue guidance of $40m-$50m in 2022, the standalone company could realistically maintain its operations only through around H1'23. This suggests that there is a risk of bankruptcy should the company continue as a standalone entity. That said, the company becoming insolvent before the merger closes does not seem likely given recent production pick-up, current net cash position and interim funding to be provided by NKLA.
Selected RMO financial data:
2019
2020
Q1'21
Q2'21
Q3'21
Q4'21
2021
2022 Q1
2022 Q2
Revenues
8.5
9.0
1.1
0.9
5.8
9.1
16.8
11.6
5.7
Gross Income
-9.0
-8.7
-3.8
-5.0
-4.7
-7.8
-21.3
-17.7
-14.0
SG&A
13.9
17.3
18.0
22.9
17.6
22.2
80.7
22.2
18.7
R&D
11.2
8.0
3.8
1.8
4.7
5.0
15.3
6.7
7.1
Operating Income
-38.5
34.3
-25.5
-29.7
-27.0
-35.0
-117.3
-82.0
-39.8
Net Income
-59.9
-7.6
90.0*
-28.7
-18.0
-33.4
10.0
-81.1
-40.4