The “Merger of Equals” (QANTM and Xenith) – two listed patent attorney firms propose to combine – Part 1

Well, hello.

No more shock ASX announcements on the IPH/Xenith/QIP love triangle this week.  So, as promised, I will take a look at the proposed “merger of equals” of Qantm IP and Xenith IP.  The investor presentation can be viewed at

Let’s go through the beginning of the investor presentation, slide-by-slide and I’ll comment on each in turn.  I’ll just work through the first five slides (and a bit of slide 6) in this post which are really about the financials of the merged entity and continue on to look at the other slides in a following post or posts.

Slides 1 and 2 are the Title Slide and a standard disclaimer respectively.

Slide 3 sets out the brands that will come under the merged entities umbrella.  As you can see, there are more brands than a cheap perfumery.  In the medium-term, it is hard to see that all of these brands will go forward.  It seems likely that some will disappear in a similar fashion to the names of some of the firms taken over by IPH such as Fisher Adams Kelly, Callinan Lawrie and Cullens.

Slide 4 sets out the transaction summary – a key term is that Xenith shareholders will receive 1.22 QANTM shares for each Xenith share held.  Given the relative share prices at the time of the announcement of the merger proposal this seems to be an unfair deal for QANTM shareholders but I suspect it reflects the relative profitability of the two firms per share (or relative revenue, or some such).  More discussion on this is set out below.

The fact that the merged firm has enhanced potential for inclusion in the ASX300 index is very important for the share price and liquidity of the merged entity.  All fund managers are limited in some way or another in the way that they can invest. Many are limited to owning shares of ASX companies that are above a certain size – and the ASX300 index is one way of categorising that size.  Typically fund managers that invest in larger companies have deeper pockets and there tend to be more of them than fund managers that invest in smaller companies.  As a consequence, the merged entity will have better access to investment capital.  In addition, some funds are passive investors and they are required to invest in companies which meet their investment criteria.  Moving into the ASX300 would mean that funds that are required to passively invest in this index would be required to invest in the merged entity.

That is, this merger is a scale play.  At the moment, each of QANTM and Xenith are minnows in the ASX investment universe and do not have the attention of many fund managers and institutional investors.  The larger scale of the merged entity means that the two unloved companies are brought to the attention of the bigger end of investment town.  This in turn is intended to give the merged entity a higher, more stable share price and better liquidity.

The arrangement is set to be voted upon by Xenith shareholders in late February 2019.  QANTM shareholders do not get a vote.

As I have mentioned in my previous post, Xenith is the smaller player in the merged entity.  Its shares will comprise 45% of the merged stock.

Slide 5 sets out a financial overview of the merged entity.  As you can see even though QANTM’s market cap is higher than Xenith’s ($174.3 million vs $110.9 million), their EBIDTA (or profitability) is much closer ($20.1 million vs $18.1 million).  This helps to explain why Xenith seems to be getting a good deal.  The other interesting figure is the margin of QANTM (26.3%) vs Xenith (20.4%).

I can only speculate at the difference in percentage margin, given the similarity of the business models between the two businesses.  Needless to say, Xenith will want to improve its margin.

Slide 6 is entitled “Significantly enhances shareholder value”.  I think this a good time to stop this post as a number of the factors set out in this slide are about more strategic initiatives rather than the financials.  The immediate financial side is that the proposed merger is said to provide cost synergies of $7 million a year  through a “roll out of initiatives including IT transformation and corporate/back office simplification to deliver synergies”.  Standard cost cutting in other words.

Interestingly, QANTM and Xenith had already initiated cost cutting measures that are intended to provide benefits in the next few years.

An important point on the financial side, although not mentioned in this first set of slides, is that each company will be able to pay its interim dividends, ie dividends stemming from the profits of the company in the first financial year.  Those dividends are likely to be very important in determining how the merged entity would be initially perceived.  It would show, for instance, whether Xenith’s cost cutting initiatives have borne fruit.

As I have outlined above, the most significant part of this section of the slides to my mind is the step-change from two small companies to a company that is capable of being part of the ASX300 index.  From what I have heard, an increase in scale of this nature can result in a significant higher share price relative to the company’s financial performance, particularly if the merged entity has a decent strategy.  Some strategic considerations for the proposed merged entity are set out in the remaining slides of the investor presentation and I will turn to them in the next post or posts.

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