Tree House Education and Accessories Ltd, the company which was perceived to be in a sweet spot until recently due to steady growth and high margins, has cut a deal in distress. The stock lost 5% on Thursday after the company said it is merging with Zee Learn Ltd, which lost 1.8%.

Tree House shareholders will receive 53 shares of Zee Learn for every 10 shares. The pre-deal close price gives Tree House shareholders a 5% premium (10 shares of Tree House were worth 2,062; 53 shares of Zee Learn at 2,180). As the correction in the share price suggests, investors have been taken aback by the merger terms.

Though in similar businesses, the two companies are in different baskets. Tree House shares have a face value of 10, Zee Learn 1. Further, Tree House is not only growing faster but it also makes far superior margins—they stood at 59% in the first half of the current fiscal year, compared with Zee Learn’s 21%. As a result, revenue to net profit conversion is far better at Tree House. Zee Learn business is franchise-driven. Tree House is mostly driven by self-operated preschools, as a result of which it has a high capital base. But that has not been a bother as its balance sheet has negligible debt (net of cash).

As a consequence, Tree House used to command good valuations—it was trading at 27 times 2014-15 earnings per share at June end. Zee Learn was trading at even higher valuations but that was due to the extremely low earnings per share. That aside, as concerns about the promoters’ pledge of shares and receivables situation emerged, Tree House shares halved from July. Zee Learn shares gained about 8% during the period.

Even as the promoters got back most of the pledged shares and clarified about the receivables situation, the stock did not recoup the losses. It is in this context that analysts are questioning the deal. One analyst said Tree House could have waited for things to settle. Another said the deal raises red flags as Tree House was not able to extract favourable terms despite superior financials.

According to Cholamandalam Securities Ltd, the merger valuation is significantly lower than what the company received in recent fund-raising activities.

Whatever is the reason, if the reported financials are to be believed, investors who kept the faith got a raw deal.

“We believe that the swap ratio is unfair to minority shareholders of Tree House," Cholamandalam Securities added.