Merger headlines are abuzz that IronFX and FXDirectDealer (FXDD) are to be combined via a fairly complicated reverse takeover transaction. Neither of these entities currently has operations in the United States, but the global footprints of each company will, by their very nature, require a host of regulatory approvals from a number of disparate jurisdictions. At this stage, there have not been a lot of details, but there have been a few limited interviews and legal filings with the NASDAQ exchange, ostensibly in preparation for an initial capital raise. Each day brings more answers, followed by twice as many questions that require further review.
Last year, financial headlines in the forex industry were consumed with the merger appetite of Teddy Sagi, an Israeli billionaire, and his flagship company, Playtech, a gambling-based profit machine, traded publicly on the London stock exchange. The storyline went on for months, until two separate regulatory agencies stepped in to quell the deal. This time around, the two target companies appear to have clean operations that have both survived the crisis in Cyprus in 2014 and the Swiss Franc debacle of early 2015. Each event destroyed many forex brokers and hedge funds in the industry. After each of these horrific episodes, scores of companies had to either find new capital, be acquired, or close their doors for good.
The financial tsunami caused by these two events still ripples through the global forex brokerage community, causing insiders to foresee the need for more consolidation. The simple truth is that competition has been heating up. The lagging global economy has dampened revenue growth, while operational costs surge and increasing regulatory requirements ratchet up the financial pressure. Amidst this chaos, however, there will always be opportunities for those with the means to pursue them. The overriding question at the moment is whether this complex merger is a singular event or a sign of more mergers and consolidation to come?
What do we know about the IronFX/FXDD deal today?
The deal, as explained to the press, will be a reverse takeover (RTO) style of merger. By definition, “A reverse takeover or reverse merger takeover (reverse IPO) is the acquisition of a public company by a private company so that the private company can bypass the lengthy and complex process of going public. The transaction typically requires reorganization of capitalization of the acquiring company.” This type of transaction can be accomplished within weeks, but, in this case, regulatory approvals may to take more time. In any event, if a public entity already exists in the United States, then the Securities and Exchange Commission (SEC) can help bypass many state and federal regulatory reviews from having to take place.
The name of this acquiring, already existing, entity is “Nukkleus”, a listed company in the OTC markets. Its newly appointed CEO, president, secretary and treasurer, as well as chairman of the board of directors, Mr. Emil Assentato, announced that, “Our step today in acquiring IronFX Australia is just a first step towards our long term strategy of identifying leading brands around the world inside Nukkleus. I wish to emphasize that our method of operations will be for each brand to maintain its own autonomy and separate operating identity. What we are contemplating is that Nukkleus will operate in parallel several global leading brands. The first step for the company is the acquisition of IronFX Australia.”
Neither IronFX, nor FXDD have the capital or the wherewithal to acquire each other. The need for a third party in the equation is where Nukkleus and the RTO mechanism become the enablers of the recombination. There have already been preparatory moves in anticipation of next steps – the funding of Nukkleus with $1 million, a transfer deposit of $175,000 to GVS Holdings to acquire IronFX Australia and FXGiants (previously spun off from IronFX Global), and additional cash of an undeclared amount to acquire a 9.9% interest in IronFX Global. The Australian Securities and Investments Commission (ASIC) must approve this part of the deal.
The next stage will require regulatory approvals from CySEC and regulatory officials in Malta, the licensing body for FXDD. After CySEC approval, Nukkleus will acquire the remaining shares of IronFX Global and inject $1 million of operating capital into the company. An option agreement to acquire FXDD and related entities will proceed after approvals are obtained. What is lacking at this time is how much cash will ultimately transfer to stockholders. At this stage in the process shares in Nukkleus must suffice until it raises new capital in the NASDAQ OTC market.
Are you confused yet? We are not finished. The investors behind this deal want to create a parent umbrella company that will enable these acquired entities to “share resources, with a multitude of brands, making Nukkleus a multi-branded public firm that is focused on technology in FX space and the execution of client orders via the brokers.” Once all of these dominos are in place, then Nukkleus will sell shares in the open market to raise something north or south of $200 million. The distribution of these funds, the exact details of the deal, and how these companies will be restructured will appear in an offering prospectus that has yet to be made public, better sooner than later.
Yes, this deal sounds awfully convoluted, with potential roadblocks strewn about at every turn. The RTO is a useful tool in the right circumstances. It can save time and money in the long run, if the parties are acquainted with its benefits and how to avoid potential disadvantages that could sour the transaction. Stay tuned, because we are only past the initial press releases, a time when optimism is at its highest. As the weeks pass, we will get a better fix on the determination of investors behind this deal and if they have done their homework. The forex industry is primed for a consolidation phase. If a group has an open checkbook at the outset, they could cherry pick the best targets at reasonable prices, before the herd behind them gets wind of the opportunity.
What are a few issues and unanswered questions with this proposed transaction?
You can be assured that Mr. Assentato and his financial backers and advisors are performing a great amount of due diligence on this complicated RTO. Here are a few of the issues that they must nail down, if not already, then down the line:
1) Previous M&A Activities: Both IronFX and FXDD have frequented M&A news and rumor mills over the past few years. IronFX was actually purported to be on Teddy Sagi’s target list of potential takeovers. Meetings were held, but nothing ever transpired. FXDD, on the other hand, had a history of problems in the United States, which eventually led to its sale of its U.S. operations to FXCM in mid-2014.
2) Signs of Financial Difficulty: IronFX has been in the news several times regarding staff cutbacks, due to problems with hyper growth, a failing business model, and far too much emphasis on marketing and promotional bonuses. Global offices have been curtailed, with staff counts, as some have estimated, falling from 800 to 500 over the past two years. Leaked internal documents note that IronFX has downsized four times since February of 2015. FXDD, however, has been in the news over heavy fines and customer disputes over slippage. If you add up everything, there has been a hit of nearly $5 million on the bottom line. Whether all of these issues have been resolved is open for conjecture;
3) Prior Regulatory Skirmishes: Both management teams at IronFX and FXDD have had well publicized battles with regulators. IronFX has been cited for refusing to honor withdrawal requests and a host of other violations that have not been made public. CySEC went so far as to fine the firm €335,000, its largest fine to date, and ASIC ordered the firm to correct its disclosure documents. FXDD ran afoul of the National Futures Association (NFA) over slippage issues, resulting in $1.8 million in client restitution and $1.1 million in fines. The NFA had already hit the firm for $75,000 for AML process violations, while the CFTC tagged them for another $275,000 for capital adequacy shortfalls.
4) Potential Legal Roadblocks: Yes, several regulatory approvals are necessary, but what about shareholders, creditors, and employees? There could be any number of contractual obligations that could poison the deal or require additional negotiation or capital. Will key employees stay or will they leave in disgust? No one likes surprises, especially if they are uncovered after a deal has been consummated;
5) Backgrounds of Principals: Besides Mr. Assentato, there have been a few other names disclosed of advisors and investors. Do any of these individuals have any skeletons in their respective closets that could cause regulators to withhold their approvals? If you recall the Playtech acquisition debacle, the checkered past of Teddy Sagi is what many believed nixed those proposed takeovers. There are also initial financial commitments that must be made before the funding event can take place. Are these funds already secured?
6) Actual RTO Process: The Nukkleus corporation is an existing “shell” company that has a history and whose shares are also no longer traded on an exchange. There may be disgruntled shareholders from the prior activity of the shell, undisclosed lawsuits or litigation, or shareholders ready to dump their shares at the first chance. Are the lawyers for the acquirer well versed in how to handle an RTO? Have lockup provisions been put in place?
7) Shell Stock Offering: Preparing a prospectus and offering shares to the public is one thing, but getting someone to buy the shares is an entirely separate matter. Nukkleus must have a compelling story to tell on the street or, in other words, it must create “a bona fide public interest in the company” and generate demand in the market. Do the principals involved have the necessary experience with public companies, i.e., small OTC companies with little or no liquidity, to wade in these shark-infested waters? If not, then hedge funds that short new stock offerings as a profession will have a field day;
8) Technology Shortfalls: Processing companies, especially those that are having a tough time financially, can easily fall behind in needed software and hardware system upgrades. The fact that IronFX needs a $1 million operating capital infusion is indicative of this potential problem. Technology companies make good acquisition targets, as long as there is one highly efficient IT platform upon which newly acquired customer accounts can be consolidated. There cannot be two platforms. Either the IronFX or FXDD platform must be the survivor, the first difficult decision that must transpire in order for the deal to work in the long run;
9) Acquisition Angst: The casualty rate for corporate mergers is over 50%, due to several reasons. Mashing different corporate cultures together is only one aspect. Mergers that profess a sharing of management, marketing, and capital expertise have a long history of failing. Cost efficiencies are the true measure of success, which demands restructuring and making many tough decisions. Initial public statements have been rosy and stated that the deal will enable “each brand to maintain its own autonomy and separate operating identity.” These are nice words for the ears of acquired employees, but cost efficiency will necessitate major changes going forward, if returns are to meet investor expectations. The prospectus should be clear on this point or shares will not be purchased by savvy market participants;
10) Economic Conditions: Lastly, economic conditions will play a role in the success or failure of this transaction. Will more operating capital be needed? Are there funds for major system upgrades? Will there be long delays until cost efficiencies are realized? Will the global economy support an appetite for new share offerings? Will a recession in 2017, a very real possibility, create the need for more funding? When will forex volumes begin to grow again?
Merger announcements will always generate excitement in an industry and command headlines in the press. As for the true intentions of Nukkleus, Mr. Emil Assentato has already disclosed that, “The online financial sector consolidation is long overdue both in terms of merging technological backbones and creating efficiencies with respect to regulatory capital requirements, while ensuring a truly global product and service coverage. With Nukkleus we have a first mover advantage in creating value through the aggregation of selected online trading and financial technology assets. We are excited with the value creation opportunities present in the sector.”
Excitement is the mood at this juncture of this very complicated transaction. At the outset of any anticipated merger, there is always obvious optimism that a major corporate recombination will be a boon for the companies, its employees, existing shareholders, and new investors. Current optimism, however, will eventually give way to the difficulty of the task. Warts will appear. Negotiations will commence. Regulators must be appeased. This story has miles to go before it sleeps. Stay tuned!