On August 2, 2012, NextWave Wireless Inc. (WAVE) announced that it agreed to be acquired by AT&T. AT&T was purchasing the company for its valuable 2.5 MHz EBS/BRS spectrum assets, and most of the cash was going to pay off the Company’s15% Senior Secured Notes, Senior-Subordinated Secured Second Lien Notes, and 16% Third Lien Subordinated Secured Convertible Notes. The equity (only ~$30mm outstanding) was trading at $1.17 after this announcement and had some potential value:

The AT&T merger agreement provides that AT&T will acquire all of the outstanding common shares of NextWave for $1.00 per share plus a contingent payment right representing a $25 million interest in an escrow fund, representing up to approximately $0.95 per share, such escrow fund being subject to reduction to satisfy indemnification rights held by AT&T in respect of breaches of representations and warranties, certain pre-closing liabilities, balance sheet adjustments and other items described in the Agreement. [1]

There was a total of $50mm in escrow of which $25mm (~$0.95/share) could be paid to equity holders and $25mm to the third lien notes, with priority being given to the notes. There were to be two potential distributions: one year after closing and two years after closing. The first distribution was to be 75% of the remaining funds in escrow, and the second would be the remaining funds (if any). See below for more information:

The first release from the escrow fund, if any, will be made on the first anniversary of the Closing Date, in an amount equal to 75% of the escrow fund then remaining and not subject to any reserves for pending claims (the “First Release Amount”), and shall be delivered (a) first, to the Third Lien Holders in an amount equal to the lesser of (i) the First Release Amount or (ii) $25 million plus the Additional Amount; and (b) second, to the Rights Agent for the benefit of the CPRs, the balance of the First Release Amount. The second release from the escrow fund, if any, will be made on the second anniversary of the closing of the Merger, in an amount equal to the balance of the escrow fund then remaining and not subject to any reserves for pending claims (the “Second Release Amount”), and shall be delivered (a) first, to the Third Lien Holders, in an amount equal to the lesser of (i) the Second Release Amount and (ii) $25 million plus the Additional Amount minus the amount released to the Third Lien Holders with respect to the First Release Amount, (b) second, to the Rights Agent for the benefit of the CPRs, the lesser of (i) the balance of the Second Release Amount and (ii) $25 million minus the amount released to the Rights Agent for the benefit of the CPRs with respect to the First Release Amount; and (c) third, the balance, if any, to the Third Lien Holders. Thereafter, any amounts then remaining in the escrow fund in excess of any reserves maintained by the escrow agent will be delivered first, to the Third Lien Holders until they have received an aggregate amount equal to $25 million plus the Additional Amount; second, to the Rights Agent for the benefit of the CPRs until it has received an aggregate of $25 million from the escrow fund; and third, the balance of such amount to the Third Lien Holders. [2]

The best case scenario for equity holders on the first distribution would be no funds removed from the escrow account, $25mm paid to the third lien notes, and $12.5mm (~47 cents) paid to the equity holders. In this scenario, the second distribution would all go to the equity holders of 12.5mm, resulting in a total payout of 1.95 over two years.

Buying the stock at 1.17 would mean I would need a distribution of at least 17 cents to break even (excluding time value of money) or roughly $30mm of the $50mm to remain in the escrow account after two years.

Risks: 1. The deal falls apart and the stock goes to 0. I felt as though this was very little risk given the deal was already backed by shareholders and bondholders. The company was not operating a legitimate business and was simply being purchased for their spectrum. 2. Escrow account goes below $25mm and the equity receives no future payouts. This was a bit more difficult to handicap but it seemed this account was simply to be used if there was a lawsuit or for small adjustments to working capital.

I believed that there was a significant margin of safety here with $20mm to work with and that this situation existed because at only a $30mm marketcap, a potential investment would be too small for many funds.

The deal ended up going through around 1/28/2013, and the first distribution payment of $0.393 was received on 2/12/2014 which indicates the escrow fund was only reduced by roughly $2mm. I would expect another payment to be received in 2/2015 between $0.40 and $0.47 resulting in a net gain of roughly 60 cents resulting in a ~35% IRR.

Update 2/10/2015:

The final distribution was received on 2/4/2015 and was actually higher than estimated, roughly $0.56 / share meaning the entire $25mm allocated to equity holders was paid out without impairment.

[1] http://www.sec.gov/Archives/edgar/data/1374993/000119312512330572/d390733dex991.htm [2]http://www.sec.gov/Archives/edgar/data/1374993/000119312512336129/d391832d8k.htm