January 22, 2020—WESCO Wins Bidding War for Anixter at $100 Per Share. Who’s the Real Winner?
Recent IPO Troubles Don’t Spook Casper as Mattress Company Files for IPO. Should Investors Ghost this Deal?
U.S. and China Strike Phase One Trade Deal. What Does the Agreement Entail?
Visa Acquires Fintech Startup Plaid for $5.3 Billion. What’s the Strategic Rationale?
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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 48 of the Absolute Return Podcast. I am your host Julian Klymochko.
Michael Kesslering: And I’m Mike Kesslering.
Julian Klymochko: Today is January 20th, 2020. It’s lovely Monday here. Going to talk about:
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- The most exciting M&A takeover battle finally coming to conclusion with Wesco winning the bidding war for Anixter at 100 bucks per share, bumping out the private equity firm CD&R in a competition to get this asset. We are going to discuss who is the real winner here.
- A private M&A transaction, just huge, huge in the start-up Fintech space. Visa acquiring Plaid for 5.3 billion just stunning. Going to chat about the strategic rationale behind that transaction.
- Some IPO news with Casper the Mattress Company going public. Should investors ghost this deal? You like that one, don’t you?
- Lastly, on the trade war front, U.S. and China strike a phase-one trade deal. What does this agreement entail?
Bidding War of 2019
Julian Klymochko: The most exciting public company bidding war of 2019, it finally came to an end with interloper Wesco, their hundred dollar bid prevailing and topping private equity firm Clayton, Dubilier & Rice’s ninety three fifty friendly deal. We have been covering this situation for a while and this is really, just to conclude the series covering the Anixter takeover bid. What happened here? The final price resulted in 23.5 percent increase in the price paid to Anixter shareholders from the initial deal announcement, which is a big win for Anixter shareholders, not to mention a big win for merger arbitragers who got in in the low 80s and now you see it trading near 100 bucks per share on this friendly transaction. On the other hand, this deal really represents a loss for private equity firm CD&R they are trying to buy Anixter on the cheap. Initially we talked about how it is a very low premium deal, very low multiple deal, but that share was fixed, given the bidding war pushed the price up 23.5 percent. The other interesting aspect is CD&R disclosed that they also made an offer for interloper Wesco. They wanted to own the combined entities, but it just kind of gives you the story of the current times, which is P.E. firms continue to be outbid by strategic acquirers. Because these strategic acquirers have, pretty, significant synergies, which allow them to pay higher and higher prices because they do have the value of those synergies, not to mention the campaign richly valued stock as well, which obviously private equity firms cannot?
The other thing that we wanted to discuss is what is known as, ‘the auction winners curse’. Now, this deal may or may not work out for Wesco. The auction winner’s curse is that, basically, the winner in an auction is the person selling the asset because in an auction process, the dynamics are when you have two competing bidders, they become irrational and pay more than fundamental value. Did that happen here? I mean, it is to be seen but Wesco, they end up with quite a bit of debt here. Nonetheless, this deal really working out for Anixter investors and arbitrageurs, who are the real winners behind this transaction. Not to mention I mean, Wesco so far they are working out pretty well. Their stock has rallied 10 percent since this whole auction process was announced so Wesco shareholders doing pretty good thus far. What are your thoughts on it?
Michael Kesslering: Absolutely. It is interesting to see Wesco rallying actually on the news of the acquisition usually that would indicate that shareholders are in favour of it. As well, one more data point as you had mentioned, Anixter shareholders are the real winners in this situations and merger arbs in general. This vast price of one hundred dollars per share is actually 36 percent above where I Anixter was trading prior to the announcement. So a very healthy premium, for any, investors that got in prior to any of the offers but as well CD&R, although they lost out on a undervalued asset with their original bid being bid up by Wesco, they still are entitled to a 100 million dollar break fee that will be paid by Wesco.
Julian Klymochko: Yeah. The other thing is that private equity firms they really need to save face and prove that they cannot be pushed around by other firms at some point, they just said enough is enough. We have to protect our reputation because if they allow themselves to get pushed around on this one, then people know next time, look, you can force these guys to pay more and they’ll just roll over.
Michael Kesslering: Absolutely. I guess, lastly, what do you think the probability of CD&R pursuing the pro forma Wesco after Anixter has been properly integrated. What do you see that probability being?
Julian Klymochko: I think there is a decent chance as they indicated in their filing, it was disclosed that CD&R did make a bid for Wesco because they are trying to buy both companies and perhaps that’ the main reason why Wesco stock has rallied double digits since this whole drama commenced.
Casper IPO
Julian Klymochko: Recent IPO troubles do not spook Casper as the mattress company filed for an IPO. Now what happened here was direct to consumer mattress company Casper they filed their paperwork for an initial public offering and this paperwork is known as an S-1 or prospectus. Casper intends to list their shares on the New York Stock Exchange under the symbol CSPR underwriters being, Morgan Stanley, Goldman Sachs and Jefferies. Some background on the company. They have raised almost three hundred and forty million dollars to date. They lasted a Series D venture financing for 100 million bucks at a 1.1 billion dollar valuation. This was up from a nine hundred twenty million valuation after one hundred and seventy million dollar series C in 2017. We want to talk about fundamentals here. Should investors buy this IPO? Let us take a look. Number one, a lot of refunds, returns, and discounts. Eighty million bucks lost in 2019 on returns, refunds and discounts. This is nearly one quarter of its revenues. Not good. They spent nearly half a billion dollars on marketing over the past four years.
I am sure everyone has seen it on social media, Instagram, Twitter their everywhere, Facebook. This is a marketing company number one. Another point being, it is a slow growth company they have non-recurring revenues. I mean, what is the lifecycle of a mattress? Fairly, long right? Really no path to profitability. And their financials – the company’s free cash flow is nearly negative 70 million for the first nine months of 2019 and that is up from over 50 million dollar loss during the same period of the year before. Wanted to chat about unit economics on a per mattress basis. After the 40 percent gross margin, they spend 29 percent on marketing, 27 percent on G&A, which is general and administrative costs, basically everything it costs to run the company and so a net margin of negative 16 percent per unit, not the best company you’ve ever seen in the world. Nonetheless, they are looking to copy WeWork in some of that IPO marketing which just as whacky, whacky definition of total addressable market. They are claiming that it is a four hundred and thirty two billion dollar global sleep economy market that they are pursuing. So, I mean, does not look too great, does it?
Michael Kesslering: No absolutely, not. Just to add to some of the fundamentals that you brought up is that their gross margins have been trending up from 42 percent in 2016 to about 51 percent in their most recent quarter. Most of that gross margin growth has been due to shifts to a higher margin, ancillary products like pillows and lamps. As you had mentioned, they are really working to pursue this whole total addressable market of what they call their sleep economy. It has them moving into things such as sleep apnea masks, but also products focused towards pets. It really seems like they are trying to do everything. Typically, if you try to do everything, you do not end up doing anything really, really well, at least not well enough to disrupt incumbents. As well, you had mentioned their returns as a percentage of their gross sales and what I guess, disturbing is that that’s actually been trending up pretty substantially. So the argument could be made that a lot of their recent growth is due to, as you mentioned, marketing, but as well as this trend of their 100 day refund period where you can just, you know, return the mattress. Keep in mind that these are, you know, heavy mattresses they cost, they would weigh in there 50 to 90 pounds range. So that is a pretty decent logistics cost, which is not really, as scalable as other costs, such as marketing but as well, so much other interesting titbits. They mentioned influencer-marketing regulation is one of the risks to the company and this is really brought about by the FTC becoming a lot more stringent on what influencers have to disclose in their posts. Casper has been very, very aggressive with their influencer marketing. I mean, in 2015, I believe it was they had a post from Kylie Jenner, which like is estimated to have cost in the hundreds of thousands of dollars.
Julian Klymochko: Oh my God.
Michael Kesslering: A very good deal for Kylie Jenner. I am not sure what the ROI on that investment from Casper would have been.
Julian Klymochko: Did it all for the ‘gram, didn’t she?
Michael Kesslering: Certainly. Just a couple last comments on their business model from my side is really it looks like their success here will be dependent on at the very first, just reversing the trend of returns as a percentage of gross sales. That is, absolutely, imperative for them. Also, it looks like they’re really wanting to focus on adjacent product markets that have a faster replacement cycle, as you’d mentioned the mattress segment is a really slower replacement cycle probably in that 8, 10 years. So as you know, the issue with that being that the brand of loyalty that they expect to the Casper brand may be overestimated, because if you’re only purchasing something once every 10 years, you don’t really pay attention to what the brand is. Right?
Julian Klymochko: Yeah. Exactly. Not to mention a tremendous amount of competition. I heard there are actually 200 direct to consumer mattress companies. Like when there is one, yeah, that is a novel concept selling direct to consumer online with social media advertising but when one hundred and ninety nine other competitors are doing that, there’s really no moat, no durable competitive advantage here. The other red flag is they are now moving into retail locations. I believe they have 60 retail locations looking to expand to 200. So, you know, from soup to nuts, you look at what happened here, basically venture capitalists find massive losses direct to consumer looking to make incumbent retail stores such as mattress firm go out of business, which they did. They went bankrupt and now they are just looking to become another bricks and mortar retailer and they are losing a ton of money getting there. So was it all worthwhile? You have to ask yourself that.
Michael Kesslering: Yeah, absolutely. What it really looks to me like is that eventually I guess if they execute the way they would like to is that their mattresses would just basically be a loss leader and they’d sell all these ancillary products. I really do not know how successful they will be on executing that strategy. Its execution risk is, pretty, massive.
Julian Klymochko: Yeah, they are trying to turn it into the next Bed, Bath and Beyond. I mean, that business is certainly struggling, so I do not know how successful that strategy will be. Just looking at all the red flags here, our conclusion? Ghost the Casper IPO.
U.S. and China Strikes a Deal
Julian Klymochko: After nearly two years of fits and starts, the U.S. and China finally signed the, “phase one trade deal”, which will have Beijing purchase an additional 200 billion of American goods and services over the next two years. In return, the U.S. agreed to reduce that 15 percent of tariffs on 120 billion in Chinese goods, down to 7.5 percent. So from 15 percent to 7.5 percent tariff still outstanding. Now, this eighty-six page documented echoed previous pledges made by China at the WTO or in previous G20 summit. So sceptics such as us tend to think nothing has really changed here. They initially agreed to do this stuff over a year ago, so it should be nothing ground breaking. Also, agricultural goods account for a big chunk of these new purchases under this so-called phase one trade deal. Under this agreement, China will buy an additional 12.5 billion of those goods in year one and then 19.5 billion in year two. This is compared to 2017 and these goods largely made up of soybeans, pork, cotton and wheat.
The interesting aspect is this agreement does not require the government to change any laws or regulations in China. Cyber theft by China, as well as its use of industrial subsidies and its barriers against some U.S. technology investments were not addressed. Trump started this trade war nearly two years ago, as I believe it was February 2018 to accomplish a list of things. Number one is to reduce the trade deficit by turning billion that is not happening here. Number two, is to prevent cyber theft that is not happening here. Number three reduce subsidies to Chinese companies that is not happening here. So ultimately, my view is this is just kind of a marketing agreement to such that both Trump and President Xi and China can claim a win. They got something done but ultimately, it has not accomplished any of the initial goals of this trade war. I think it’s largely a marketing exercise to get positive sentiment out there. What are your thoughts on it?
Michael Kesslering: Absolutely. I think it will be something that is used on the campaign trail and so, yeah, really just marketing. I guess it has strengthened a little bit some of the protections for intellectual property theft in several ways for U.S. companies that are seeking recourse after the theft of trade secrets but really the way its structured is that it is more for industrial IP theft and less the cyber side. It is really something that is more driven in the 20th century as opposed to the more software intensive world that we live in now.
Julian Klymochko: It is all happening in technology. Right?
Michael Kesslering: Absolutely.
Julian Klymochko: That is where all the theft is happening.
Michael Kesslering: Absolutely. It is really addressing, you know, some recourse for something that was not the main issue. So a little bit of diversion there, that sounds good in theory, but really does not do a lot. The other interesting thing that I saw from the agreement was that China had agreed to not, devalue their currency for the benefit of their exporters. My initial thoughts were just that that is very unlikely to be followed as any sort of monetary policy changes can be argued that they are not just to devalue the currency that they are done for other reasons. I do not see a lot of recourse being able to befall there. As well, just overall, they did mention it in very vague terms, a dispute settlement structure, but it looks like it would just be very difficult to enforce. As you had mentioned before, Julian a lot of these issues that that they did agree to were things that were ratified in different agreements and if you don’t follow the agreements, then there’s not a ton of recourse.
Julian Klymochko: Right. The only recourse being more tariffs, which really has not worked out over the past couple of years. Nonetheless, I mean, you look at what got accomplished here, which we say is not much however, a very positive sentiment. At the end of the day, it seems to be dialling back tensions between the two largest economies in the world. Investors cheering the news. They pushed market indices to new all-time highs and I really think it is just fabulous marketing on Trump’s behalf. If you look back on his career and mostly his success has been from marketing. He is a very good marketer and I believe his ability to create this conflict and then stage certain resolutions, you can call this one a stage one or phase one resolution and there will be more and more down the line. What the conflict does is it brings down sentiment, brings down the market slightly hurts the economy but then the resolution; it bumps it up even higher than it was previously. It is such that I believe if this trade war had never even existed; the market would be significantly lower because you are not having that feedback loop of conflict resolution pushing up the indices higher and higher. Just to recap, Trump achieved none of his initial objectives, such as reducing some subsidies, cyber theft or any reduction in the trade deficit. However, U.S. officials promised to tackle these in the Phase 2 talks that will begin later this year. So there we have it. We have the second the season of the trade war coming to you and it should be an exciting one.
Visa acquiring Plaid
Julian Klymochko: Big deal in the private investment space, with Visa announcing that is acquiring privately held Fintech start-up plaid in a massive 5.3 billion dollar deal. Now Plaid’s Technology helps people link their bank accounts to mobile apps and is used by one in four Americans with a bank account used by apps such as Venmo, Acorns and Chime. It is, basically, an API just connecting various apps to bank accounts so Plaid is a middleman and they can charge fees for acting as that middleman. Plaid was founded in 2013. I believe it has gone through a number of iterations and pivots on its way to this massive success. I also believe that they changed their names two to three times, as they went through those pivots. It goes to show you that, you know, it takes commitment and, you know, a lot of different hits at the bat to land a great success in this business and Plaid certainly with massive success, a multi-billion dollar exit. They currently connect with over eleven thousand financial institutions across the U.S., Canada and Europe.
Now, how they started out was I believe they created a personal financial app and they had a lot of difficulty connecting that app to various bank accounts so then they decided to pivot and make that a key focus of their technology. So the 5.3 billion dollar price tag, this is actually double what Plaid was valued at in its December 18 series C round venture financing, which interestingly enough, not only did Visa participate in that round, but rival MasterCard as well. MasterCard is an investor in Plaid. Some comments on the strategic rationale behind this deal. Well, card networks are concerned that consumer payments can move away from debit and credit cards to bank accounts. What this essentially does is allows consumers to pay for products directly out of their bank accounts while bypassing these so-called credit card rails altogether, which obviously would be very bad for Visa if payments are happening outside of their network. This deal can also help visa address banks concerns about security as more new players like Plaid gain access to their companies’ information obviously a highly sensitive subject. Ultimately, this price 5.3 billion represents a rounding error for Visa, which has a market cap of some four hundred and twenty billion dollars. So pretty much one percent of their current value. What are your thoughts on this massive Fintech exit from Plaid?
Michael Kesslering: Yes. So certainly a rounding error for Visa, but very much not a rounding error for Plaid’s investors with this massive premium, but as well, in terms of the strategic rationale, you kind of discussed some of the rationale where it’s a bit of a defensive move. You know, looking at the credit card rails, that payment side vs. the digital check wire transfers and those types of payments that visa was not a part of and really just looking to diversify their business model. As well, there is a little bit of inkling into how defensive this acquisition was with a one of their acquisitions last year of Earthport, which provides cross-border payment services to banks. Now, Visa had acquired them last year, but this was only after MasterCard had made an offer for the company. This Plaid acquisition, perhaps there was some interest on MasterCard side and Visa just really wanted to move in front of that or for another example, just looking to pre-empt any movement by MasterCard prior to an offer. Perhaps by doing so you know, although this does look like a very large premium that they’re paying could end up being less than what they would’ve paid in a bidding war had MasterCard made a bid first and then egos came into play as we saw in the Anixter, Wesco, CD&R situation as well.
Julian Klymochko: Yes, certainly this one looks like a so-called knockout bid at a valuation double their last financing round roughly one year ago. Nonetheless, really, interesting deal in the start-up world just shows you the interest in Fintech start-ups. 5.3 billion, huge price tag and certainly a lot of start-up investors with a big win with Plaid.
That is it, ladies and gentlemen, for Episode 48 of the Absolute Return Podcast. If you liked it, you can always check out more at absolutereturnpodcast.com. Obviously, you should definitely follow us on Twitter I am the people’s hedge fund manager and that is @Jklymochko. That is J-K-L-Y-M-O-C-H-K-O. And you are?
Michael Kesslering: And I am @M_kesslering.
Julian Klymochko: All right, guys. Well, wishing you all the best trading, investing, speculating over the week 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.
