Our Activist Insight on SMG's Pending Buyout of AeroGrow International (AERO)

By Jan Svenda, GeoInvesting Analyst

Description

• Aeroponic gardening systems for homes distributed through various channels, but mostly direct-to-consumer model (Amazon and their own website)

Initial thesis

• The company is being bought out at $3 per share while they just started to see revenue growth and profitability as COVID19 hit. There is also a cannabis angle as the system could be used for home growing.
• This could mean SMG, a controlling shareholder of about 80%, is stealing the future growth from the shareholders.
• Given SMG’s involvement, the whole M&A process was heavily reliant on them. The documents from the investment banks raise several red flags about how fair the assessment of the situation actually is.
• The DCF models raises questions about revenue projections and WACC assumptions. One slide talks about potential cannabis exposure as negative, while this is likely to be one large opportunity for the company. SMG also seems to paint the picture that AERO is reliant on their IP, however AERO’s management does not think so.
• While the buyout will go through, there might be an opportunity to try to dissent and ask for a fair value of the shares. Though this can lead to a protracted legal debate.

SMG Involvement

• 2013 first involvement whereby SMG, an agroindustry participant, made a deal with AERO about their IP assets
• 2016 SMG increases equity ownership and board on their side
  • In 2016 the Board was reconstituted, with three members affiliated with Scotts Miracle-Gro (currently, Ms. Ziegler and Messrs. Hagedorn and Miller)
• Merger talks started in 2020
  • Questions about efficiency of the business model
• Started to offer share repurchase
• Now at $3 per share

Red flags in proxy documents

Source – SEC Filings

• Concerns about future revenue might be well-founded, but the online shift could be lasting and thus AERO might be able to sustain the levels of interest from people.
  • SMG does not talk it about online shift themselves as their main business is not really sold through online as much (they distribute through big box stores etc.)
• The reliance on SGM’s IP assets cited as negative is dubious as this was questioned by AERO’s management as per below extract from their proxy.
  • On September 1, 2020, the Special Committee met telephonically with representatives of Stifel and Bryan Cave. The Special Committee considered Scotts Miracle-Gro’s position on existing intellectual property agreements and its August 18, 2020 bid. Discussion included management’s position that the Scotts Miracle-Gro trademarks are not of value to AeroGrow and the nutrients patent, which management believes to be the sole remaining piece of Scotts Miracle-Gro intellectual property in use in AeroGrow’s current product range and will not be used in Large Size Products (“LSPs”) under co-development with Scotts Miracle-Gro, has a simple work around for a third-party bidder, leaving only the retail distribution rights to the LSPs, excluding Amazon and direct-to-consumer, as the lone potential value generator for AeroGrow that would be lost to a third-party acquirer.
  • The representatives of Stifel supported management’s view that a third-party bidder would not need these trademarks or the patent to successfully operate AeroGrow.
• The potential cannabis exposure cited as negative seems dubious as SMG’s own management is talking about the market as an opportunity.
  • As per SMG’s conf call 04/11/20
    • Can you explain the cannabis market opportunity in Jersey and Arizona, and how it compares to other states that have well-established medical user bases already?
    • Answer – Christopher J. Hagedorn: I can explain what we know of it. There's a lot of regulation obviously yet to be written in those states. So it's a little premature, I think, to give our opinion on the morning that we saw that those went positively. That being said, if you look at even just the sort of opportunity size, particularly in New Jersey I think significant…
    • …They make us think that there'll be a rationally regulated tax rationally tax marketplace there that should be pretty business permissive. So we think there's significant opportunity there.
• Future revenue projections by Stifel also raise some red flags
  • How come the gross margin is flat if revenues increase?
  • Why the sudden drop in revenue after 2022?
  • WACC seems quite high as they assume the company will pay 10% on its debt

Source - SEC Filings

Source - SEC Filings

Points to remember (if legally exercising rights)

• Dissenter right (appraisal rights) will be according to Nevada law
• Here are some limitations
  • https://www.calcorporatelaw.com/2012/07/dissenters-rights-and-the-saddest-plaintiff#:~:text=Under NRS 92A.,Act of 1933, 15 U.S.C.