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Absolute Return Podcast #42: M&A 101: The Bidding War

By December 2, 2019 No Comments

December 2, 2019—Private Equity Apollo Forced to Increase Price for its Tech Data Acquisition. What Happened Here?

Catalyst Capital Lobs $11.00 Per Share Offer for Hudson’s Bay, Topping the Chairman’s $10.30 bid. Will This Put the Company in Play?

Kirkland Lake Gold Agrees to Buy Detour Gold in $4.9 Billion Deal. Why Did its Stock Drop so Much?

LVMH Raises Offer for Tiffany’s and Clinches Deal. By How Much Did They Need to Bump Their Bid?

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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, ladies and gents, to Episode 42 of the Absolute Return Podcast. I am your host, Julian Klymochko.

Michael Kesslering: And I am Michael Kesslering.

Julian Klymochko: Today is a freezing Friday, November 29. Clearly, winter has started, but we have a hot episode today talking about mergers and acquisitions heating up in the market.

We are going to chat about a number of interesting situations and some bidding wars out there.

    • Firstly, private equity firm Apollo, they are forced to increase the price paid for its recent tech data acquisition that was just announced. We previously spoke about it. This is the largest leveraged buyout of the year, but a mystery interloper showed up. We are going to chat about who that is. It is a famous buyer, and we are going to talk about why that is so important.
    • Up in Canada, Catalyst Capital, they lobbed in $11 per share offer for Hudson’s Bay, which tops the insider group’s $10 and 30-cent bid. Is this going to finally put the company in play?
    • A gold deal with Kirkland Lake Gold agreeing to buy Detour Gold in a nearly $5 billion friendly acquisition. Why did Kirkland Lake’s stock drop so much on deal announcement?
    • Lastly, we are going to talk about LVMH. Now, that situation turned into a definitive deal in which they made a friendly deal with Tiffany. We previously spoke about how that was a speculative pre arbitrage situation, but now that has turned into a legitimate deal here.

Apollo Global Management

Julian Klymochko: Leading private equity firm Apollo Global Management. They were forced to increase their friendly offer for I.T. distribution company Tech Data by over 11 percent, boosting the share price from 130 per share to one hundred forty five cash per share for their acquisition of Tech Data. Now, why were they forced to increase the price? Well, what happened here was during the go shop process, because Apollo and Tech Data announced a definitive agreement that was public. And they also had a go-shop provision in the merger agreement that allowed the Tech Data board of directors to effectively shop the company, meaning they could talk to potential other buyers for interested in putting in a higher bid. And during that process, they received a superior proposal from a competing bidder. And the most interesting and fascinating part of this situation is that the competing bidder was none other than Warren Buffett’s Berkshire Hathaway. Perhaps the greatest acquiror out there, so it is pitting a large leveraged buyout shop versus Berkshire Hathaway. Now, what happened here initially Apollo bid a hundred thirty dollars and then Berkshire came over the top at one hundred forty bucks per share.

Then Apollo followed that up, boosting their price to 145, and you know, Buffett, he does not participate in auctions, so he chose to walk away. And it’s an interesting dynamic here, because you have an LBO shop focused on leveraged buyouts and Buffett is a pretty big critic of leveraged buyouts. He is famous for saying that he is a purveyor of the UBO, the unleveraged buyout, because he certainly does not have the same love for leverage that these leveraged buyout companies do. Nonetheless, the increased consideration will cost Apollo an extra six hundred million bucks. That boosted the deal price from 5.4 billion to $6 billion, marking it still the largest leveraged buyout of the year. The valuation goes up from six point eight times to 7.6 times EBITDA, which on deal announcement when we chatted about this; this was a relatively low valuation. Classic LBO style where they actually buying it at a significant discount to the market.  In my opinion, that is probably what attracted Buffett here, Berkshire Hathaway. What do you think about it?

Michael Kesslering:  Yeah, so just to go into some background on how the process went with Berkshire. Bank of America, the investment banker for TechData, contacted Todd Combs, one of Buffett’s PM’s, on November 19. Now, Todd Combs, he was a former hedge fund manager and brought on to manage part of the equities portfolio along with Ted Weschler. This this was about six or seven years ago in that range. But, you know, he’s viewed as a very strong candidate to become the next Berkshire CEO. In my opinion, one of I would say the front-runner, just based on his past experience and working on deals such as the J.P. Morgan and Amazon Partnership for Health Care, as well as the Home Capital Group deal. He has been very involved in the M&A side. They came to him about six days after the initial deal announcement. The next day, Buffett decided that he would be willing to offer one hundred and forty dollars per share, so a very quick turnaround. Two days after that, Berkshire vice chairman Greg Abel, who is actually Canadian.

Julian Klymochko: Albertan, right?

Michael Kesslering: Yes, he sure is. He met with Tech Data management team. Then the next day on Saturday, November 23, Berkshire had then made a formal offer to the tech data team, which is a very quick turnaround to come to a formal offer.

Julian Klymochko: Certainly, they can do that quickly. As I understand how Berkshire works typically. Todd and Ted can do their own deals, but if it is above a billion dollars, they need to get the nod from Buffett himself.

Michael Kesslering: Absolutely, and the other interesting aspect is just in terms of their streamline process, as we were talking about, is they really just took Apollo’s existing agreement and amended only a few areas. So really, he is saving on legal expenses. Buffett is very keen on really finding any efficiencies he can in the deal. Ultimately, as you mentioned, Apollo did come in over the top. Likely, that will be the end. Berkshire likely won’t come with another another offer.

Julian Klymochko: Right, I just wanted to comment on the pre-arb situation on this one prior to the deal being announced, because I do remember when it got announced at one hundred thirty bucks per share. It was initially trading in the market at a slight premium as arbitrageurs in this kind of speculative situation; we’re bidding it above the consideration. What does that mean? It was pricing in optionality or a chance that another bid will come through. Likely due to the skinny 16 percent premium and low 6.8 times EBITDA valuation. And they’re proven right in this one, in terms of bidding it up north of 130 per share. It was not a huge premium, maybe less than a dollar. However, those arbitrageurs certainly rewarded today. The stock’s trading near 145, so a big win on that one because merger arbitrage is really the business of pretty skinny spreads.

So when you can earn a double-digit return in a couple of weeks, which is just a fantastic result.

Catalyst Capital

Julian Klymochko: Toronto based private equity shop Catalyst Capital they announced an $11 per share unsolicited offer for department store Hudson’s Bay Co. Now, this has been an on and off situation that we’ve been discussing over the past, what, six months or so when Hudson’s Bay initially struck to take private deal with their chairman, along with some other insiders at $10 and 30 cents per share in which shareholders were not impressed with that price. The reason being Hudson’s Bay has a tremendous amount of real estate. Management recently claimed that it was worth nearly $30 per share.

I remember a few years ago. They were that claiming it was worth between forty to forty five dollars per share. The $10 and thirty cents per share is not enough for many of the minority shareholders that own the company. Now, this Catalyst offer comes after they made a tender offer, a partial tender offer for seventeen point five percent of the stock, with the goal of blocking Chairman Richard Baker’s takeover offer. Now, Baker’s group controls 57 percent of the shares. What they are trying to do is take out the minority shareholders here such that they can take the company private and realize that real estate value without having to share it with minority shareholders. Now, Catalyst’s offer is worth one point five billion, about a hundred million dollars more than Baker’s friendly deal that was supported by the board. I got a quote here from one of their managing directors from Catalyst. He stated, “The Catalyst offer is independently financed, superior in both value and treatment of shareholders and can be completed in a timely matter.” This comes from Gabriel de Alba, M.D. at Catalyst. He also stated that the valuation process for HBC was corrupted and that Mr. Baker and his allies, armed with inside information, sought to buyout the minority as cheaply as possible. He argues as we do that the real estate value of HBC is much more valuable and is not reflected in Richard Baker and his group’s $10 and 30 cent per share offer. Nonetheless, a spokeswoman for Mr. Baker’s group, they said Catalyst offer is a conditional, non-binding proposal with uncertain financing that is intended to mislead shareholders. What are your thoughts on this quagmire of a situation?

Michael Kesslering: Yeah, it is an interesting situation for sure. I mean, Catalyst, they have really ramped up their ownership position, becoming the third largest shareholder. But their main arguments, as you mentioned, is that the management buyout isn’t independently financed. It is effectively using shareholder money to acquire the company for the benefit of the management team. Their argument is that their deal is independently financed, and keep in mind that this is a non-binding offer with nothing being definitive.

Julian Klymochko: Subject to due diligence.

Michael Kesslering: Absolutely, they don’t have a financing condition in there, but it’s somewhat irrelevant because it’s non-binding anyway. They believe that their financing will include cash from Catalyst for equity, an asset based loan, a term loan, and then some additional debt. But right now, none of that is definitive, and it is just, you know, a matter of financing as the bit larger share price consideration. And they also did make one comment, which may be somewhat of an olive branch in terms of that they would be willing to consider a higher offer after doing their due diligence. I am not really sure how serious they are about that. That seems like it may be somewhat of an empty promise,

Julian Klymochko: Right, and so what most people are asking and wondering here is. Is Catalyst offer legitimate? Well, I like to point to, you know, what have they done in the past? Are they reputable? Have they followed through? And the fact of the matter is they bought nearly 18 percent of the company already in a tender offer, a partial tender offer at, what, $10 and change, slightly below their $11 offer here. They have put money on the table, and now if you look at it, they are quite pot-committed. I do think that their intentions are real here and that if given the opportunity by the board of directors, that there would be a chance that they could close this. Not saying its 100 percent by any means. However, you need to take that into account but it’s also important to note that they aren’t the only activists involved here.

There are two other activists making noise. There is Land and Buildings. Who owns what – 6 percent? There is also a smaller group called Sandpiper. They have all come out and stated the same thing that this insider bit greatly undervalues the company and they will not be quiet about it, and they are going to vote against Baker’s deal. And if he can’t get the vote, which clearly he cannot, because he needs a majority and minority approval. And that’s just not going to happen due to all these activist positions controlling much more than half of the remaining shares. That is another important aspect here. Lastly, you think about why is Catalyst doing it? I believe that they truly don’t want to own the underlying business. I think their main goal here is to get the board of directors and the special committee to commence a sale process for the company that will put it in play such that they can recognize true value for their shares in an auction process such that many companies can bid on it. Many real estate companies can take a look at their vast real estate assets or even private equity firms. We have seen Blackstone just go crazy on the private equity real estate side, buying nearly everything in sight.

Michael Kesslering: Absolutely, and this is a tactic that is really right out of the Carl Icahn playbook is make an offer for the company. In worst-case scenario, you take take it over add a price that you deem to be significantly below what the true value is. But the ideal scenario is that it is sold to someone else. And just to go back to the other investors involved, Land & Buildings did come out after the Catalyst letter, an offer, and they did indicate that they were encouraged by the Catalyst offer, that they may be interested in participating in a buyout of the company, which was interesting as well.

Kirkland Lake Gold

Julian Klymochko: Really interesting gold mining deal this week with Kirkland Lake Gold announcing the friendly acquisition of Detour Gold and an all share $4.9 billion dollar merger, this one came out of nowhere. There were no media reports, no pre-arb speculation, none of that. They just straight up announced it this week. This valued detour stock at 27.50 per share, representing a premium of thirty five percent. But what happened here is that premium nearly vanished because it was an all-share deal, and Kirkland Lake shareholders absolutely hated the deal. Their stock tanked about 16 percent when they announced it, so management of Kirkland Lake; they really have their work cut out for them on this one.

Wanted to give you a bit of background on these two companies. And why this deal is so controversial from the perspective of Kirkland Lake shareholders. Now, due to how, they operate an open pit, low-grade mine gold mine in north eastern Ontario. They had been subject to some shareholder activist activity. Their shares have doubled over the past year, but prior to that really struggling. New York hedge fund Paulson and Co, they led a campaign to overthrow the board in 2018. After a bitter proxy battle in which they were successful, so they did manage to get some changes there. And they were calling for a sale of the company, so perhaps this is a result of that shareholder activism by Paulson. As for a Kirkland, their biggest project is the Fosterville Gold Mine in Australia. Now, they acquired this mine through the Newmarket Gold acquisition, which was a nine hundred and twenty two million dollar deal in 2016. Back in day, we held a position in that merger arbitrage trade. Now, to give you a sense of what has happened since that new market deal, which was just an unmitigated grand slam, just a home run of a deal, because their stock price absolutely surged. Back when they announced the Newmarket gold deal, their stock was between six to seven dollars per share and it’s gone up over 8x since then.

So it’s been a huge winner. Profits have just soared since then. However, you figure shareholders would give them the benefit of the doubt given their historical track record on these acquisitions, such as the huge winning deal of the Newmarket gold deal. But they’re not.

Like I said, the stock price tanking here. What concerns investors a lot being that you look at Detour Gold all in sustaining costs. So this measures how much to dig one ounce of gold out of the ground. That is nearly 12 hundred dollars per ounce. If you compare that to the current gold price, that is a pretty low margin. They are not very profitable at all, and you contrast that to Kirkland Lakes, all in sustaining cost. That is about five hundred and fifty bucks an ounce. So roughly half the cost and a massive difference in margin because you get that operating leverage on that one. So interesting dynamic where you have Kirkland going from a low cost to a higher cost model, shareholders not liking it. Got a comment here from the Credit Suisse analyst. He indicated that the deal increases Kirkland Lake’s overall cost profile, and most importantly, it raises concerns about potentially weaker exploration updates coming at that Fosterville gold mine that has been so successful in the past, interesting deal. I should disclose that we are long Kirkland Lake Gold stock in one of our funds. It is important to note that as we chat about it, but what are your thoughts on this deal?

Michael Kesslering: Yes, when you mentioned the higher cost structure being basically, you know, more than double the cost structure of Kirkland’s Fosterville mine is the rationale for that is that Detour is an open pit mine. It is not very efficient in terms of their they’re digging up a lot of material for very low percentages of actual gold, whereas underground mining, which is it’s comparable at the Fosterville mine. It is thought of as more efficient as you are taking less out of the ground and overall decreases the cost, it is a lot more targeted. When looking at the strategic rationale for this, I mean, Kirkland believes and you know, this has been argued against by some of their analysts, but they believe that they’re able to get Detour costs down to about eight hundred and fifty to dollars per ounce. There would be significant value creation there if they were able to execute on that. As well, it does add to their reserves in safe jurisdictions, so they are not having to go to South America or anything like that. This is a northern Ontario mine and it has 22 years’ worth of reserves compared to the nine years at the Fosterville mine. That is some of the rationale. I mean, it as you had mentioned, investors really have not like this deal. Eric Sprott has lost a lot of money on this deal.

Julian Klymochko: Yeah, Eric Sprott is one of the largest shareholders of Kirkland Lake, and his stake was down 140 million dollars. Is that worth just on this deal announcement? I read in the Globe and Mail, he is not sure how he is going to vote. What investors should know is that this deal is subject to a vote at Kirkland Lake. They need this to be supported by a majority of shareholders. At this point, I am not too certain that they would be able to get that. It really depends on how the stock trades if it continues to recover, and it has recovered slightly. I think they have a decent chance after they go tell their story to investors and really get back that investor confidence. This deal by no means is a slam-dunk in terms of closing because it is subject to this buy side vote, and clearly, Kirkland Lake shareholders right now not too happy with the big decline in the share price.

Michael Kesslering: Absolutely, and one of those other shareholders being Resolute Funds. There are also a major shareholder of in this situation. It has to be a very higher hurdle that management is going to have to be able to convince these investors.

LVMH

Julian Klymochko: Last time we chatted about Tiffany’s and LVMH, it was pre arbitrage speculative situation. What happened this week is that global luxury goods leader LVMH; they struck a friendly, definitive deal to acquire Tiffany’s for sixteen point six billion dollars after raising its offer effectively twice to land on one hundred thirty five bucks per share.

This results in an ultimate premium of 37 percent. Just to go over the background a little bit here. This definitive deal came one month after LVMH, initial hundred twenty per share unsolicited offer, which appeared in the media. We previously discussed that on the podcast. And this was boosted to one hundred thirty bucks per share last week in order to have Tiffany’s board effectively open up the books such that they can conduct due diligence on the company.

Now, this is really M&A one, a one from an investment banker’s perspective on how a process works. You do not start with your highest price. Clearly, LVMH had a game plan here to end up probably in the 135 range, but you do not come out with 135 at the start. You come out with one hundred twenty bucks per share. You get the stock moving, you put that in the media, could be in terms of a bear hug letter, which is a letter of an unsolicited bid for a company that you send to the board and you send it to the media as well so they can publish it. Get the stock price moving. and that really leads to a turnover in shareholders, more event driven pre-arb traders wanting the company to be put into play. And that’s exactly what happened here, and Tiffany’s, they’re actually pretty open to a deal in terms of their executives because Tiffany’s had been going through a bit of a struggle. Their revenue was actually down year over year and they are going through a tough transition. So they’re open to a deal, figuring that they could execute their turnaround strategy better as a private company with LVMH support. But really tie up some loose ends and wrap this one up. A successful pre-arb trade for everyone involved. And Tiffany is getting a good price. I mean a 37 percent premium. Who is really going to complain with that one?

Michael Kesslering: Absolutely, and moving from the pre-arb trade to the merger arb trade, as it’s currently trading for the folks that just get in on definitive deals is it’s now trading at about a three and a half percent annualized spread, which is a reasonable spread given the upside of the very small potential of a competing bid emerging. So you’re not really paying for any optionality there, but do keep in mind that that annualized spread is using an end of May transaction close date. And what’s really going to be driving this is Chinese approval as it’s going to be the key determinant for timing, so that estimate in terms of closed date could be off.

Julian Klymochko: Yeah, in my opinion, a fairly safe deal in my just because you look at LVMH, a very reputable buyer, they have access to financing. No big anti-trust risk here. But like you said, the main risk here just on the timing. I also wanted to touch on the notion of pre-arb versus a definitive deal in terms of event driven and arbitrages trading these situations. The pre-arb situation is obviously has a significantly higher risk profile, but you can earn higher returns as we have seen on this one. But those situations have a much higher rate of falling apart, so it is a riskier strategy. Some do it some do not, but if you want to stick with plain vanilla merger-arb and earn those consistent low risk returns, then you typically want to wait until the deal goes definitive, until you get involved and take a position at that point.

Michael Kesslering: And one last comment just on the timing and regulatory framework is do keep in mind that LVMH is a French company as opposed to U.S. Company. As we know U.S -China relations are not going so well right now. The French situation is a little bit better, so there is less of a political and interference in this situation given their domicile.

Julian Klymochko: And that is all we got for you this week on episode 42 of The Absolute Return Podcast. Hope you liked it, and if you did, you can always check out more at absolutereturnpodcast.com.

Until next week. We wish you happy trading, good investing, and we will chat with you soon. Cheers.

Thanks for tuning in to the Absolute Return Podcast. This episode was brought to you by Accelerate Financial Technologies. Accelerate, because performance matters. Find out more at www.AccelerateShares.com. The views expressed in this podcast to the personal views of the participants and do not reflect the views of Accelerate. No aspect of this podcast constitutes investment legal or tax advice. Opinions expressed in this podcast should not be viewed as a recommendation or solicitation of an offer to buy or sell any securities or investment strategies. The information and opinions in this podcast are based on current market conditions and may fluctuate and change in the future. No representation or warranty expressed or implied is made on behalf of Accelerate as to the accuracy or completeness of the information contained in this podcast. Accelerate does not accept any liability for any direct indirect or consequential loss or damage suffered by any person as a result relying on all or any part of this podcast and any liability is expressly disclaimed.

 

 

 

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