Podcasts

Absolute Return Podcast #22: SPAC Attack

By July 15, 2019 No Comments

July 15, 2019—Virgin Galactic To Go Public Via SPAC. What Is A Special Purpose Acquisition Company?

Can’t Trust CannTrust As Cannabis Firm Controversy Grows. What Did The Company Do Wrong?

Fed Chair Sets The Stage For A July Rate Cut. Will It Be 0.25% or 0.50%?

Bank of Canada Holds Interest Rates Steady at 1.75%. What’s Next For Canada’s Central Bank?

Additional Activist Opposes Hudson’s Bay Go-Private Offer As Company Hires Advisors. What’s Next?

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Transcript

Welcome investors to the Absolute Return Podcast. Your source for stock market analysis, global macro musings and hedge fund investment strategies. Your hosts Julian Klymochko and Michael Kesslering aim to bring you the knowledge and analysis you need to become a more intelligent and wealthier investor. This episode is brought to you by accelerate financial technologies. Accelerate because performance matters. Find out more at www.Accelerateshares.Com.

Julian Klymochko: Welcome investors to Episode 22, of the Absolute Return Podcast. I am your host Julian Klymocho.

Michael Kesslering: And I am Michael Kesslering.

Julian Klymochko: Today is Friday July 12, 2019. Have a number of important topics to chat about on the podcast this week, including

    • Virgin Galactic, it announced that is going public via a SPAC or a special purpose acquisition company. What is this? And why did they choose this structure?
    • Canadian cannabis producer CannTrust is mired in some controversy after they got busted by the regulator over illegal growing activities, stock’s down big. We are going to chat about that.
    • Fed Chair Jay Powell is really setting the stage for a rate cut this month. Will it be 25 basis points or half a percent?
    • Also on central banking activity, the Bank of Canada held its interest rate steady at 1.75% at their meeting this week. What is next for Canada’s central bank?
    • Lastly an additional activist opposes Hudson’s Bay go private offer. What is next and what is happening in this deal?

Interesting announcement this week in going public activity we don’t have an IPO or a direct listing as we’ve discussed before but here we have Virgin Galactic going public via a reverse takeover of a SPAC or a special purpose acquisition company. In this case, it is called Social Capital Hedosophia.

What happened? Richard Branson, he has a space tourism start up called Virgin Galactic. It announced that it is going public with Social Capital Hedosophia Holdings through a reverse merger of this SPAC or a special purpose acquisition company. Now Social Capital is run by a Venture Capitalist, and former Facebook executive Chamath and I will try not to screw this up, Palihapitiya. The SPAC will invest 800 million into Virgin Galactic for a 49% stake. This includes 100 million from Chamath himself. He will also serve as chairman of the new company, and what is it doing with his money? Well it is actually paying 300 million of this cash to Virgin’s existing shareholders. Including the Virgin Group, which would be Branson and Abu Dhabi’s Mubadala investment company, clearly an earlier backer of Virgin Galactic. They are looking to exit some or all of their stake there.

What Social Capital Hedosophia is, as I said, it is a SPAC which is a publicly traded shell, with no operations just cash, It IPO’d a couple of years ago in 2017 it has a mandate to merge with the private company and take it public through an RTO within two years. Now they were coming up pretty close on their expiry date. That two-year expiry date to get a deal done which I believe is in September. Some speculating that the deal was kind of a Hail Mary pass to get something done prior to having to return all of shareholders money back to investors.

Getting into some details behind Virgin Galactic. They expect that this deal will give it enough capital to fund the business until its spaceships can commercially operate and become profitable. What Virgin Galactic does, is basically send tourists into space. Now some 600 people have already put down about 80 million dollars in total to secure seats on vehicles as it hopes to put customers in a space over the next few years. They have already raised more than one billion since it was founded in 2004 mostly from Mr. Branson himself. This company has been around for quite a while, 15 years and still has not really made any steady operations actually have not sent any customers into space yet.

Saudi Arabia’s public investment fund announced plans to invest 1 billion into Virgin Galactic in 2017; but Mr Branson himself, suspended those talks a year later after the news of the murder of Jamal Khashoggi, a dissident writer, at the Saudi consulate. Now that was fairly controversial and they were supposed to do a deal. Branson was supposed to do a deal to get investment from inside Saudi Arabia into Virgin Galactic but he scrapped that amidst all that pushback against Saudi Arabia for allegedly murdering that journalist.

What happened then is Chamath saw that and approached Branson with his SPAC Social Capital to do a reverse merger and finance Virgin Galactic that way as a public entity. Competitors on Virgin Galactic include Jeff Bezos his Blue Origin and Elon Musk: Space X. This is really the playground of billionaires it seems.

Some background on SPACs or Special Purpose Acquisition Companies. They have raised 6.8 billion in the U.S. year to date which is the largest six-month total since 2007 so certainly a bull market in SPAC financing. These SPACs facts are also known as blank check buyout funds because initially you are just betting on the management team to find a deal or a company to acquire and bring them public. Sponsors or the management team that launched these vehicles. They can wind up with a 20 percent stake in the eventual acquisition target. I would like to note that historically these SPACs have had pretty horrific shareholder returns over the past number of years. Basically from 2010 to 2017 there a study that indicated SPACs underperformed the market by about 3% per year in the first three years after their IPO. Some caution there just on SPACs in general. What are your thoughts on this really interesting go public transaction via SPAC from Virgin Galactic?

Michael Kesslering: First specifically with Social Capital and Virgin Galactic. Is that Social Capital they are really viewing Virgin Galactic through the lens of a software company. Now Chamath had mentioned in I believe one of the interviews that although they are a hardware company he views them through this lens of a software company that once they do get to scale that he thinks that their profit margins will be very substantial. With regards to that they do project, that profitability will come by Q2 of 2021. Now none of their competitors are profitable. It does remain to be seen whether this firm can become profitable but that is their estimate so far. One thing that you had mentioned with regards to SPAC and their kind of lack of returns is that typically the play it’s kind of a hedge fund play where you look at buying the issuance and with the attention of just redeeming at the par value well holding on to the warrants which is the typical of SPAC arbitrage trade.

Julian Klymochko: Right, so to get into that transaction there. When these SPAC do their IPO’s a bunch of hedge funds typically subscribe because in the IPO you not only get a share which you can redeem to get your money back when they announce a deal because shareholders need to vote on the deal. They also receive a warrant in the proforma company, once the deal gets completed and it starts trading at the operating company level in this case the SPAC will convert to Virgin Galactic assuming shareholders approve the deal. What a hedge fund would do would be subscribe to the IPO, vote against the deal and get your money back for the shares. You have no risk, you get all your money back but you continue to hold on to that warrant which is basically a call option. A long term call option that allows you to participate in any upside on the share price. But the problem is if too many hedge funds are involved and do that, then they receive their money back. The company does not have any more money, so they may have to cancel the deal altogether or go to a bank and borrow that money. Then they could end up just having a much too levered balance sheet, which we have seen on many of these in the past and that has led to some very poor returns basically downward sloping share prices as they spiral towards insolvency. Due to this over leverage because of this redemption mechanism and hedge fund participation in this SPAC IPO.

Michael Kesslering: You do get some really interesting investor dynamics where you get their shareholder base will really turn over from all of the hedge fund arbitrage through the normal course preannouncement and even into the announcement. Then after the company presumably if they do either win the vote or they bring on a bunch of leverage. The investor base completely turns over, and so there are some interesting things, that you can see in the share price dynamics.

Julian Klymochko: And we are certainly seeing that. I saw an analysis that looked at the number of Robin hood accounts holding Social Capital the SPAC that announced the Virgin Galactic deal, because that is how you get access to Virgin Galactic. Is by buying the SPAC which, was trading around 10 dollars and it has rallied as Robin hood investors, which are pretty much millennial retail investors that some consider dumb money because they are more so speculators, are not known for doing substantial due diligence but some of the top holdings of Robin hood account holders would be Cannabis names, Tesla and other speculative names such as that. As you know, Robinhood is the free stock brokerage, discount brokerage account where you can do free trading. It is heavily favoured by millennial traders and you’re seeing substantial amount of interest and shareholder turnover as these Robin hood traders. Millennial speculators pick up the stock from hedge fund holders who participated in the IPO and now are looking to exit again.

Big news in the Cannabis space this week with Cannabis producer CannTrust. Their stock really getting hammered as they remain mired in controversy, a big regulatory misstep by them. What happened was they halted sales of all their products. This amounts to nearly 30,000 pounds of marijuana amid a Health Canada investigation into illegal growing activities at CannTrust. What they did was CannTrust used fake walls in its unlicensed rooms to cover up illegally grown plants in staged photographs that were sent to Health Canada in a regulatory check-up. They were growing cannabis in five unlicensed rooms in its 12-room greenhouse. In Pelham Ontario between October 2018 and March 2019. There were several thousand plants hidden behind these walls, so nearly half of their growing space was unlicensed and they utilized that secretively and tried to hide that from the regulators.

Health Canada was warned about the illegal activity at CannTrust by a former employee who turned whistle-blower, which gives you concern and wonder how much of this these shenanigans are happening at other cannabis producers, because Health Canada totally would not have known about this if not for this whistle-blower, who came out and sent an e-mail to Health Canada warning them about this nefarious activity. In a statement on Thursday evening, the company said that implemented voluntary hold on sale and shipment of all cannabis products, while Health Canada investigates its manufacturing facility.

Some sell side reactions, analysts are now openly questioning whether the company will actually lose its growing license, which obviously would destroy its old business model. And it faces the possibility that it will be forced to destroy thousands of kilograms of cannabis, worth tens of millions of dollars. It could also potentially face a large fine. Now analysts are estimating that 30 to 70 million dollars of sales are potentially at risk here, where Health Canada would just destroy that product. I believe it is over five thousand pounds of cannabis at least nine sell side analysts have downgraded the stock and reduced their target prices dramatically. I saw one analyst downgrading from $13 per share to $5 per share in terms of the target price but really, that is closing the barn door really, after the horse has left. Could use that warning quite a bit before but that’s the game of the sell side analysts don’t really add a lot of value there and their price targets should largely be ignored in my opinion.

Getting into some precedents here. Now Health Canada has suspended Cannabis licenses twice before so it certainly is not unprecedented. They suspended the license of a Maple Ridge BC based grower called Agrima Botanicals Corp. What happened here was they were found to have been selling products into the black market, which is obviously a big nono in this highly regulated industry.

The second precedent would be on Winnipeg based Bonafide Medical Cannabis. What they were doing, they were caught sourcing cannabis from the illegal market. Now CannTrust is not really doing any of the nefarious stuff in the black market. But they were doing something totally different in terms of trying to hide unlicensed growing facilities and these effectively unregulated products that they’re growing.

On Wednesday the Alberta Gaming Liquor and Cannabis commission said that, it was placing a hold on all effective lots from CannTrust while the Ontario cannabis store the province’s wholesaler and online retailer said it was ending its sales of all CannTrust products pending the outcome of the investigation.  Those two regulatory bodies’ certainly major players in the retail and wholesaling space. Bottom line the stock is down 50% just this week. They have lost close to five hundred million dollars in market capitalization of their stock. Basically investors are losing confidence. There was a class action lawsuit disclosed and I have to disclose that we are short in one of our funds (ATSX) Enhanced Canadian Benchmark. So we are short the stock we have been short the stock for quite a while before all of this has come to the forefront.

But what are your thoughts on this really unfortunate turn of events at CannTrust and really mind blowing that they would do this.

Michael Kesslering: Mind blowing in the sense that they were actually viewed as one of the quality operators in the space. This does come as a bit of a surprise. When I say quality, I just mean in terms of their practices, which obviously are not the case.

Julian Klymochko: Yeah, They are viewed to be quite the credible management team but that’s really gone the way of the dodo bird in this controversy here.

Michael Kesslering: Absolutely, and so the question of how much the management team knew. That remains unanswered as of as at this point.

Julian Klymochko: But we can speculate that it is highly probable that they know and likely directed to all of this activity.

Michael Kesslering: Yeah, that is a fair assessment.  What does this mean? So you’d mentioned that they weren’t in any selling into the black markets or anything like that. That was the case for the two suspensions so the only rationale for them not losing their license would be that they were not actually selling into black markets. Even still, something of this scale I don’t think it’s a guarantee that they don’t lose their license. The other option would be destroying this cannabis that is held. It is actually twelve thousand seven hundred kilograms as you mentioned about thirty thousand pounds. In terms of what that would mean in terms their inventory that would be about 70% of their current inventory as of the last quarter, which is a substantial amount just, think about another company where 70% of their inventory was just gone the next day. That is very crippling for any company, so it will be interesting to follow along with that as you had mentioned moving forward even if they don’t lose their license they’ll have the financial implications of losing this inventory as well as just all credibility. Most of their end markets are your government wholesalers so the Ontario wholesaling function is unlikely to be able to continue in a major way with them. It will be really interesting to watch moving forward.

Julian Klymochko:  Right, and so the bottom-line here really a big nono by CannTrust management and trying to hide illegal growing operations. Now the stock has lost a considerable amount of value nearly 50 percent. Investors really cannot trust CannTrust anymore. Analysts really losing faith in the story dramatically reducing their target prices because as you said there are major financial implications potentially wiping out 70% of their current inventory. You are going to see a dramatic hit to sales at a minimum likely and perhaps even losing their license, which would be a serious blow to companies. We will continue to monitor this situation and see how things develop here.

Major news out of the Federal Reserve this week as the Fed chair sets the stage for a July rate cut. Chairman of the Federal Reserve Jay Powell. What he did is he told a congressional committee this week that he would act, quote, “act as appropriate to protect the U.S. economy from the disappointing performance of the global economy.” The comments raised expectations that the Fed could cut rates this month, which is really what the market is expecting here. By stating that he would act as appropriate, he is effectively foreshadowing to the market that look global growth is not great. We will cut rates this month and it is a matter of how much that the market is now guessing. Despite a strong jobs report for the month of June that we saw last Friday and last month’s new truce in the trade war between the U.S. and China, which we talked about on last week’s podcast Mr. Powell, said quote. “Uncertainties about the outlook have increased in recent months.”

Another quote from Chairman Jay Powell he indicated, “That economic momentum appears to have slowed in some major foreign economies and that weakness could affect the U.S. economy. Moreover a number of government policy issues have yet to be resolved including trade developments the federal debt ceiling and Brexit. And there is a risk that weak inflation will be even more persistent than we currently anticipate.” However, Powell did not commit to any timeframe for possible monetary easing nor did he point to the scale of the upcoming interest rate cuts that would be required to protect the U.S. economy from growing risks to halting this expansion, which has been going on for over 10 years now. It is now the longest U.S. economic expansion that is growth consecutively without a recession, the longest of all time.

The Fed, which hiked rates four times, last year they have kept their current benchmark overnight rate, and arranged between 2.25% to 2.5% since December. As we have been discussing on previous podcasts. They were on a hiking cycle going into Q4 of last year. But then the S&P 500 dropped 20%. You have had this flare up in the U.S. China trade war, had some negative economic data points and the Fed really has not seen inflation where it would like to be it is a bit lower than they like. They really changed their tune from steady rate hikes to a pause to now, what is looking like a rate cut.

Looking at market pricing of a rate cut here and on the market is pricing in a 100% chance of a rate cut later this month in July. Now that is divided between an 80% chance of a 25 basis point cut or .25% and a 20% chance of a 50-basis cut. Or half a percent, but that 50 basis cut probability declined after the strong jobs numbers released last Friday which actually beat expectations. That was a scenario in which, good news was bad news for the market because they were not expecting as much stimulus from the central bank after the economic figures came in better than expected. Bottom line here, the market really liking Jay Powell dovish comments here and his desire to cut rates. He saw the S&P 500 crossing three thousand for the first time ever an all-time high. In addition to the Dow Jones industrial average crossing twenty seven thousand for another new all-time high. Certainly, markets liking this at least large cap growth stocks in the U.S. really liking this. What are your thoughts on the Fed action this week?

Michael Kesslering: This is exactly when market commentators talk about the Fed messaging. This is exactly what they are talking about is that last week with the strong jobs numbers. Market participants did not know what to think now because they had these strong numbers come out. The overall thought process was that the Fed should be cutting rates, and so with Powell coming out this week and just completely throwing water on any idea of just holding pat. It all but a sure thing that they will be cutting rates at the end of the month. That is exactly what they talk about is preparing the markets for it is not just a drastic surprise announcement. The other aspect is as you mentioned, it is really is a quick turnaround between four rate hikes over the last year and really just into holding steady and then doing a rate cut. You typically don’t see such a drastic turn in Fed policy. But the last aspect is just that the one thing that really stood out to me was his mention of economic slowdowns globally having a major effect on the U.S., and so sometimes when looking at the monetary policy. It is easy to look at it, as it is in a bubble whether it be the ECB, The Bank of Canada or the Fed that you are just worried about your own country. But actions by other countries so the ECB cutting rates does have an second order effect on what the Fed will end up doing.

Julian Klymochko: Certainly, you need to take what other central banks are doing, what other economies are doing, what is happening in the trade war and there’s so many various intricacies into these types of decisions and what you also mentioned which makes this scenario quite unique is that typically the Fed cuts rates in a recession or a serious stock and bond market flux where you’re having big drawdowns, big volatility. I mean you look at the Fed’s dual mandate. Their dual mandate is for stable prices i.e. no inflation around 2% where it is and full employment. I believe unemployment in the U.S. is at an all-time low.

The jobs market can’t really get better than where it is which is I believe 3.6% unemployment rate around an all-time low. If you look at it from the perspective of the Fed’s dual mandate, there is really no need to cut rates especially when they are supposedly below the neutral rate. And certainly historically quite low to where the Fed has been normally but economists are viewing this potential July rate cut which is now looking like a near certainty. They are viewing it as an insurance policy against a slowdown rather than a reaction to sharply worsening data. What that implies is that Chairman Jay Powell running the Fed. He is what you would consider dovish, which means is very open to easy monetary policy. Easy monetary policy to placate markets, to make market participants happy. He is not hawkish who would hike rates and see the market go down. He wants to see this economic expansion continue. He wants to see the stock market continue to do well. However, one of the risks for the Fed in cutting rates now is that it could leave at less room to stimulate the economy once a new recession does come sometime in the future. It is an interesting scenario where typically the Fed tries to be countercyclical in terms of when that economy slowing down markets getting crushed. They will come in and cut rates ease monetary policy to assist in financial markets and the economy in reversing the downward portion of the cycle.

But in this case it seems like they are looking to implement further monetary stimulus through a rate cut when markets are at all-time highs and the economy is doing great. A real interesting scenario, which we will continue to follow as the Fed, makes its decision later this month. But bottom line markets really loving this S&P 500 and Dow Jones at new all-time highs as Chairman Jay powers dovish Fed comments.

More central bank action this week we are going up north to Canada. Bank of Canada held its benchmark interest rate steady at 1.75% in a meeting this week. The reasoning behind the decision to keep interest rates steady was it could balance domestic economic improvements, which they see the Canadian economy steadily improving with an expanding global slowdown caused by trade conflicts. Basically the Bank of Canada saying that China, U.S. trade war as a major risk not just that but Canada has somewhat gotten involved as they have faced some punishing trade conflict from China due to their involvement in the whole Huawei issue when the Hauwei CFO was arrested in Vancouver a number of months ago.

The Bank of Canada, which was widely expected to maintain its benchmark interest rate. So this really is not a surprising move but it did downgrade its 2020 domestic growth forecasts from 2.1% to 1.9% it also downgraded its global growth forecast to 3% from 3.2% due to these trade disputes.

As you indicated on the last topic is that central bankers don’t just consider domestic issues. They really take the global economy into account. In addition to any sort of struggles that the domestic economy is facing. Now Bank of Canada governor Stephen Poloz is in no rush to change the benchmark rate even as they noted policymakers in the U.S. and Europe as we discussed. They have signalled they may introduce cuts to respond to this weakening of global economic activity.

Got a statement here from the Bank of Canada. They stated recent data show that Canadian economy is returning to potential growth. However, the outlook is clouded by persistent trade tensions. Taken together the degree of accommodation being provided by the current policy interest rate remains appropriate. Escalating trade conflicts geopolitical tensions and unrelated uncertainty are contributing to the broad based slowdown of global economic activity. So there you have it a really balanced view from the Bank of Canada in their interest rate decision to keep their benchmark rate steady at 1.75%. Some details behind that decision now. Consumption in Canada is being supported by the healthy job market and rising wages. While the housing market at a countrywide level is stabilising as we previously discussed. There was concern in Toronto and Vancouver with sales down pretty dramatically but it looks like those markets are starting to turn around sales picking up price levels stabilizing in those two cities.

Interesting comment from Carolyn Wilkins who is basically the number two at the BOC the Bank of Canada’s senior deputy governor. She said Canada and the United States are taking different approaches. As we discussed you have the U.S. Federal Reserve now looking like they are going to start cutting rates and the Bank of Canada looking like they are going to stay pat on rates not hiking nor cutting because they are in different stages of the economic cycle. Wilkins stated that quote, “The fact that Canada’s picking up while the US economy is slowing. Sounds like a divergence but in fact, it is a process of convergence.” The United States is slowing to a more sustainable pace while Canada is moving back to its trend growth as we previously discussed on other podcasts that U.S. economic growth was 3.1% in Q1 annualized which was a very strong growth number, but Canada really lagged that. I believe Canadian growth is sub 2%. So you have quite the difference between the U.S. economic growth, which has been really strong and Canada their economic growth has really been a laggard recently but the Bank of Canada’s view is that that’s going to change. The U.S. economy is slowing somewhat not necessarily recessionary but more so to a growth level of 1.5 to 2%. Meanwhile Canada picking up from a below trend growth rate. What are your thoughts on the Bank of Canada decision here?

Michael Kesslering: You had mentioned it is not technically a divergence just because they are in different portions of the business cycle beyond just the fact that other central banks are cutting and Canada’s just standing pat not looking at raising rates but literally just staying exactly where they are with the job. The data coming in has been quite strongly. We have talked over the last few months about the strong jobs numbers that have been coming in in Canada. Wage growth is outpacing inflation. Although our economy in Canada is not as reliant on consumption as the U.S. is. I believe the U.S. is about 50% of GDP is attributable to consumption which is way less in Canada. Although our growth is not as reliant on that. That still is really good to see as well you do have some response in oil prices which the Canadian economy is obviously very levered to those. Those are two aspects to continue watching moving forward to get an idea of what is going to be happening at the Bank of Canada.

Julian Klymochko: Some market action the Canadian dollar strengthened to a near nine month high against the Greenback the US dollar adding to its gains since midweek when the Bank of Canada made it clear it had no intention of easing monetary policy. In contrast to the Federal Reserve. Now the Loonie here the Canadian dollar has been rallying since June when the US Federal Reserve Chair Jay Powell struck a dovish tone during monetary policy update. He strongly signalled this upcoming July rate cut. Within days, the Loonie jump to more than 76 cents per U.S. dollar from about 74 cents. You are seeing a pretty strong rally in the Loonie. I know the Bank of Canada is really, comfortable with it in this range, but if the Loonie starts trading up over the 80-cent range then I think the Bank of Canada could act. They don’t want to see the domestic currency appreciate too much because that could be damaging for the economy. So one of their roles although not officially but it comes up through the economic data, is they do want to somewhat control the price level of the currency as to keep the economic growth cycle growing and currency that’s rallying too much could put that at risk. That is something that they are looking at. They don’t mind the dollar and the Loonie in the 76 to 78 cent level but if it keeps rallying, then I think that they could move more closer to a potential rate cut to try to get that that Loonie level down.

Some advice for listeners. I mean this is great. If you have a variable rate mortgage, a line of credit, a margin loan, any sort of variable rate debt that depends on prime rate. Because prime rate is dependent on the Bank of Canada’s benchmark interest rate and what Paloz saying is that you don’t have to worry about rate hikes for the time being. He is going to stand pat for now, so your interest rates they are not going to go up. They are going to stay the same, and if anything, they would likely be more likely to do what other central bankers are doing in Europe and the U.S., which is monetary easing through interest rate cuts. If that is the trend then all things equal, I think the Bank of Canada is more likely to ease or cut rates as opposed to hiking which is really off the table for the time being.

Touching now on the Hudson’s Bay go private offer that we have been covering a lot lately because it is a really interesting M&A situation. Now what happened is a third activist investor. They are a Canadian private equity firm called Sandpiper Group. This third activist investor joined a growing list of Hudson’s Bay shareholders who are opposed to the nine dollars and 45 cent go private offer from the chairman Richard Baker in taking Hudson’s Bay private. That is buying the shares off the minority shareholders and taking it off the stock market for nine dollars and 45 cents per share cash.

We talked about why this was a bad deal because the CEO recently indicated that Hudson’s Bay real estate was worth twenty-eight dollars per share. I have seen it disclosed in the past HBC thought their net asset value of their assets, which is largely real estate not the retail operations. These could be worth as much as 35 dollars per share. The company IPO, I believe in 2012 at seventeen dollars per share, was trading at near an all-time low at six and change prior to this go private offer. I mean nine forty five this offer nine dollars and forty five cents cash per share really looks sad when you take all that into account. Now Sandpiper its founder and now they didn’t have a an official comment on this but the founder previously stated that HBC could be worth as much as 35 dollars per share. Other minority shareholders including Land & Buildings, a U.S. based real estate activist investor and Catalyst Capital Group. They all opposed the bid saying it represents a fraction of what HBC is real estate in Canada and the U.S. would be worth if it should be sold. Most of the dissident shareholders have zeroed in on the value of HBC really prime real estate holdings.

You have some in Saks Fifth Avenue New York is one prime example, which is worth billions of dollars itself. That is one of the greatest real estate properties globally. They have said that Mr. Baker’s bid, Mr. Baker is the chairman of HBC, it is worth far less than the value of the retailer’s real estate alone excluding any sort of operating entities. Land & Buildings says the offer should be raised to at least eighteen dollars per share, which is nearly double, where it is at right now. Meanwhile HBC doing some shareholder friendly activity. What they did is the special committee hired an independent financial adviser to help evaluate this one billion dollar go private offer. It also plans to consider criticism from minority shareholders, but basically what dissident investors are doing the activist investor is pushing back on this offer. They would like the company to either hold an auction for this company or just find another bidder. They want to see it sold to the highest bidder not these entrenched management group. They want to see this company shopped to see who is going to pay the highest price. They want to recognize fair value, which they believe, is significantly higher than the current nine dollar and forty-five cent offer; they want a sale process here. What are your thoughts on this continually interesting M&A situation?

Michael Kesslering: Yes, this really lends more credence to what we already knew is that the retail operations themselves really don’t have a lot of value anymore. The real value of this company is just the real estate and the fact of the matter is the activists that are becoming involved Sandpiper; Catalyst is a bit more diversified but as well as Land & Building is. Their focus is real estate; you are not seeing any retail turnaround experts getting involved in the name. You are really just seeing these specialty activists get involved and so I think that just really lends more value that yes there is more value than what is being offered and that in the future the retail operations likely will not exist. Another option that you had mentioned is that these activists are looking for a proper sales process but it even could just be the company self-liquidating itself selling off each of the properties one by one. Now obviously that’s a longer term process for investors but that is if you are even able to get in that 18 dollar per share range that Land & Buildings had mentioned, and waiting a couple of years. That is a better outcome than just getting nine dollars and 45 cents today.

Julian Klymochko: Right and what is problematic is that management has really failed over the past number of years to crystallize that value for shareholders. As I indicated, the stock was near an all-time low six dollars and change before they unveiled this go private offer. It was as high as Twenty-seven dollars per share I believe in around five years ago. They have really been unable or unwilling to unlock this real estate value for public shareholders. It looks like they are trying to go private with the lowball offer such that they can crystallize the value for themselves, and what is really interesting I should note. That part of Chairman Baker buyout group includes WeWork.

What WeWork is doing, they are the co-work office-leasing giant, that is backed by Softbank with a valuation in the tens of billions. What they are looking to do is basically take eight species prime real estate and turning into coworking areas, which could really crystallize the value here. It is unfortunate that HBC has not tried to execute that business plan such that public shareholders, public minority shareholders can retain some of that upside. I think it’s a really good idea and as you indicated a bunch of activist, real estate investors. Real experts in the real estate space, experts at evaluating the value of the real estate really recognizing that value and fighting back against this apparently what looks like a lowball offer. It is an interesting situation, that we will continue to monitor here but the market is really expecting a higher price here. As the shares trade above the nine forty five operate closer to the 10-dollar range analysts expecting a bump or an increase in this offer but hopefully the financial advisors can fully shop this company and get significantly higher value for minority shareholders here.

That is it ladies and gents for Episode 22 of The Absolute Return Podcast. If you liked it, you can enjoy more podcasts on absolutereturnpodcast.com. If you enjoy it please leave us a rating and we will chat with you next week, cheers.

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