November 2, 2020- Cenovus Walks into the Energy M&A Buzzsaw, Sees Shares Get Sliced with Husky Takeover. Why Did Cenovus Do it?

Tiffany and LVMH Make Peace, Strike New Deal at Slightly Reduced Price. Who is the Winner in this Hard-Fought Takeover Battle?

Qualtrics Founder Ryan Smith Buys Utah Jazz for $1.66 Billion. How did the Investment Perform for the Previous Owner?

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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 podcast guests to episode 95 of The Absolute Return Podcast. I’m Julian Klymochko. 

Michael Kesslering: And I’m Mike Kesslering. 

Julian Klymochko: Today is Friday, October 30th, heading into the Halloween weekend, had a bit of a scare in the markets this week, also heading into the US election next weekend. So, markets are expected to remain volatile as they say, the market hates uncertainty. And there’s a bit of uncertainty with respect to leadership in the US presidential election coming up. But once that’s resolved, we expect volatility to tick back down to more normalized levels. Nonetheless, a number of pretty interesting events in the markets this week. More so on the M&A side, we’re going to chat about more consolidation in the oil patch. 

    • Specifically, Cenovus walked into what we’re referring to as the energy M&A buzzsaw. Their shares get sliced with their Husky takeover. Why did Cenovus do this? 
    • Tiffany and LVMH to make peace. They struck a new deal at a slightly reduced price, who is the winner in this hard-fought takeover battle? 
    • And lastly, Qualtrics founder, Ryan Smith, he bought the Utah Jazz for 1.66 billion. We’re going to chat about how he made his fortune and how this investment performed specifically this NBA team investment for its previous owner. 


Julian Klymochko: But Mike, let’s start off on this Husky/Cenovus deal, which was announced last Sunday. So, made for some good weekend reading. Cenovus Energy announced a friendly acquisition of Husky Energy, both two local Calgary oil and gas companies. It wasn’t all stock $10.2 billion dollar merger, inclusive of debt. Now the main strategic rationale for a consolidation is basically just cost cutting. They indicated 1.2 billion of cost and capital synergies of which $600 million dollars is going to be cost synergies or annual cost cuts that they can affect, post-closing. Unfortunately, this one’s going to result in over 2000 job cuts, which is obviously a super negative for anyone working in the energy industry. It’s been struggling for a real long time and the dynamic that we’re seeing within the M&A space and the oil patch is consolidation, consolidation, consolidation. And we’ve seen a number of deals. For example, last week we talked about Conoco Phillips acquiring Concho Resources, and it was the same story then, you know, how did Conoco Phillips shares do? Well they tanked. Every company in the oil patch that is doing M&A, they’re just walking into an absolute buzzsaw shareholders hate it. Stocks are trading down and that’s not a good luck if you’re the CEO of an oil company and the shareholders are all upset because their stocks are down 10% in this Cenovus transaction. On the Monday after the deal got announced, their shares got absolutely hammered, dropped as much as 14% on news of the deal fell about 11% this week.

So, what we’re saying here is clearly shareholders are not supportive of this consolidation, no matter how much it makes sense. I mean, $1.2 billion dollars of cost and capital synergies that goes to the bottom line. And so economically sure it makes sense. However, practically energy investors are not liking this. The targets they’re getting very low premiums. Husky was supposed to be at a zero-premium deal, but their stock dropped so much. That is actually, you know, low 20%, I think 23%, including the warrants that are part of the consideration, but you know what, CEOs want all these shareholders angry at them. And, you know, ultimately if it gets bad, enough heads roll, and Cenovus, certainly has been a basket case over the years, going back all the way to spin off from the old in Canada. Another ill-advised corporate action, but in my opinion, oil patch, CEO’s will twice before walking into this buzzsaw that we’re seeing within energy M&A. 

Saw it with Conoco Phillips, we saw it with Devon Energy, WPX. All of these are low premium deals, but nonetheless shares are part of the consideration. And Mike, why do you think that the acquirer’s stock is trading down so much on these?

Michael Kesslering: Well, I mean, it really just comes down to, I guess, the expected synergies that are typically taking place in a M&A situation, really just haven’t actually been realized. And so, investors are very hesitant to be accepting of any M&A, especially from the acquiror’s standpoint, if it’s perhaps adding more debt, especially that will be viewed negatively by investors. And I guess for this beyond particular, some of the criticism I can be attributable to, I guess, one of our colleagues made a good point. Cenovus was split off from EnCana trying to make a more pure play, ENP Producer, where now by merging with Husky it’s back to kind of becoming more of that integrated player. So, what’s old is new again, right. And the really sad part, I guess, of the quoted synergy number is that how they’re going to get there is through a kind of 50% operational and 50% capital efficiencies. And on the operational side, what you’re seeing that synergy number being represented as you alluded to Julian is job losses. So, in the combined company, you’re looking at between 1,420 and 2100 jobs being lost in Alberta job market that is already struggling quite a bit. So that is pretty negative for the Canadian marketplace, but, you know, I guess when oil prices started coming down, many in the investment banking community and the energy industry as a whole. There was a lot of optimism that there would be a lot of this consolidation, but it really just hasn’t worked out where you just haven’t seen the broad-based industry consolidation follow through. And a lot of it has to do with the investor sentiment that whenever any of these deals get announced, the company’s stock price are going down, and it just makes it as you really kind of hammered home Julian. It just really makes it untenable for a management team to be able to recommend that.

Julian Klymochko: And Board of Directors. 

Michael Kesslering: Exactly.

Julian Klymochko: Yeah, Board of Directors, they’re looking out for shareholders. It’s kind of hard for them to recommend something that in which the stock’s going to tank 10% the next day.

Michael Kesslering: Absolutely, and the other aspect that you are seeing is quite a bit of the more international and US players getting out of the Canadian market, which doesn’t really help for, a lot of these smaller EMP companies, they’re looking for a large bidder to come acquire them as part of a larger consolidation play. But what you’ve seen is that the larger former consolidators are now just getting out of the Canadian market. So, you’re just having less bidders, in an auction is never good for the seller.

Julian Klymochko: Or you have the contrarians such as Canadian Natural that recently picked up painted pony in nice tuck-in acquisition. That was very much bite-sized and then all cash deal. And so certainly transactions such as that makes sense because they’re looking to buy it real cheap, and it’s not a huge deal with respect to the size compared to the size of the acquiror. But nonetheless, I mean, this one is a bit of a disaster, both Cenovus and Husky stock tanking this week. And with respect to an acquisition, typically the target stock goes up, but, not so much of that, just given the environment. Should disclose that we are short both of Cenovus and Husky in our ATSX fund, The Enhanced Canadian Benchmark Alternative Fund, short Cenovus and Husky, and from a merger arbitrage perspective looking at this deal. All shares plus warrants, not a great spread, roughly 6.8% annualized pricing in a 86% implied odds of success comparing the upside. If the merger goes through versus the downside shouldn’t break. But the main reason we don’t have a position, on this one on the merger arbitrage side is there is a buy-side vote specifically at Cenovus. Their shareholders need to approve the issuance of shares to issue to Husky shareholders. And the reason that we never get involved in M&A deals with the buy-side vote is because it opens up the acquired for a potential hostile bid. It basically puts the acquiror in play because the shareholders need to approve the stock issuance, however, a hostile acquirer that leaves them an opening to come in and lob in a bit for the acquire, which in that situation. So, you have the spread on, the stocks are short, the acquirer’s stock will skyrocket, so you’ll get your face ripped off on that. And on the other hand of it, the target stock will get slammed, the stock in which your long. So, you lose out on both sides of it. And it is the worst-case scenario in merger arbitrage. So, you never want to short the shares of an acquired company if their shareholders need to vote to approve the deal. So, there’s a bit of M&A 101 Oh for you. 


Julian Klymochko: I wanted to move on to another interesting M&A situation. And Mike we’ve chatted about this one a lot. One of our favourite players in the M&A space, what do they call them? The cashmere wolf? 

Michael Kesslering: The wolf in cashmere. 

Julian Klymochko: All right, yeah. So, we’re referring to Bernard Arnault, Europe’s richest man. And this relates to the Tiffany and LVMH drama. And this drama seems to have had a wild swing. Which was not too surprising from our perspective, as we discussed on this podcast, a number of times over the past few months is that LVMH struck a friendly deal to buy Tiffany for $135 dollars per share, 16.2 billion back in November, 2019 pre COVID. COVID hit, retail stores shut down. Tiffany and LVMH, they both suffered through COVID and are still feeling the effects, but certainly the pandemic has not been great for retailers. And LVMH had a bit of a change of heart. Our thesis was that they always maintained the desire to own Tiffany, however, clearly Bernard Arnault, he is quiet the strategist, a serial acquirer. And he really wanted to capitalize on the opportunity to, a moment of weakness and Tiffany perhaps try to get a lower price. 

Now, the merger agreement that they signed was fairly airtight, not really leaving him much of an opportunity. So LVMH did move on to what I consider somewhat unorthodox tactics. They did specifically go to their friends in the French Government and procure this odd letter stating that they couldn’t close the acquisition due to the trade war with the US which was a real head scratcher and a few hours after announcing that Reuters came out with a story claiming that the whole thing was basically just a sham invented by LVMH. And then the next thing they sued alleging a material adverse effect at Tiffany, which we’ve spoken about before the clause, a condition in the merger agreement that some acquirers have tried to utilize to get out of a deal, but more so tried to litigate to make it in their favour. What happened here in the end, instead of going through litigation in Tiffany, and our opinion had a really high chance of success. 

However, there was a bit of risk. So, the board of directors at the target did accept a 2.6% price reduction, which is, you know, pretty measly result for all the effort, all the drama that went into it. But you got to remember, this is a $16.2 billion dollar deal for Tiffany. So, it will save LVMH, a few hundred million dollars, I think around 400 million, but certainly their reputation is tarred a bit here. Perhaps future targets won’t view them as credible and their reputation has taken a hit, but nonetheless, I mean, Tiffany stock rallied 6.3% on the week. Traded back up, and obviously we’re happy because we do hold it in The Accelerate Arbitrage Fund. It’s a merger arbitrage position. We like this one, obviously. They got to put it up to another shareholder vote and we expect the deal to close in early 2021. Mike, what are your thoughts on these pretty interesting turn of events from the wolf in cashmere?

Michael Kesslering:  Yeah, it’s been a very interesting term in advance here. Where, you know, when you’re looking at the winners and losers of this is one of the key winners here has been some of the arbs that have had the fortitude to still stick with this deal.

Julian Klymochko: Oh man, that’s the toughest part. A lot of the times deals hit turbulence and, you know, you get the pit in your stomach and, you know, monkey brain looked at the massive drop and wants to get you to sell. But, you know, merger arbitrage is not a strategy for those with a thin skin and without the kahunas to go through that turbulence.

Michael Kesslering: Exactly. 

Julian Klymochko: Intestinal fortitude, right?

Michael Kesslering: Yeah, exactly. And this is where some of the managers really kind of earn their fees. But as well, prompts to the Tiffany’s management team and the legal counsel in standing their ground and having conviction with their strong legal defence of the deal. As you had mentioned, Julian, this was an airtight merger agreement, they stuck to that. They didn’t fall prey to some of the tactics used by Arnault, which in all reality, like, I mean, nobody really holds that against him. I mean, he tried all of the tools in his toolkit to try to get a less expensive deal. So, you know, can’t really blame him there. When you ask about the reputational damage for Arnault and LVMH. Now saving themselves $420 million dollars, I mean, yeah. A lot of that would be, you know, eating up by their significant legal costs, but as well. I mean, Arnault has been part of some very public battles before. So, this isn’t anything new to him. However, typically. 

Julian Klymochko: Sharp elbows. 

Michael Kesslering: Yeah, exactly. But typically, it’s not in backing out from a deal where it’s aggressively pursuing a company that likely does not want to be sold. He is very quick to go hostile on companies. If you look at it really, he has quite a track record of this, where you look at his original takeover of Louis Vuitton, Moet, Hennessy back in the late eighties. An unsuccessful battle for Gucci in the late nineties, Hermes in the 2010s. And now with Tiffany’s, which ended up working out for Tiffany’s shareholders, but it seems like every decade he’s in a very well-publicized battle for another company to add to the LVMH empire. So, it seems like clockwork. So, I guess we should be ready on cue around 2030 for another battle.

Julian Klymochko: Yeah, assuming he’s still around, he’s getting up there in age, but certainly still rebels in these tough fought M&A battles, but clearly Tiffany and LVMH kissing and making up, looking to consummate their merger here in early 2021, commenting on the merger arbitrage spread as expected, relatively low 4.6% annualized pricing, and roughly 96% implied odds of success. At this point, relatively safe deal. We are still long in the ARB fund. And it’s interesting, and there’s a good lesson to be learned aside from sticking with your convictions and really just you know, trusting the process in terms of the regulatory process and the fact that you know, a good merger agreement can really drive the outcome. But if you think of the book, the Art of War by Sun Tzu, been thinking about putting together a new one called The Art of M&A, and in The Art of M&A, I’d have one Sun Tzu like quote that stated a reprice deal, never breaks.

And that’s my attitude, if they go through the process of repressing the deal, it’s pretty damn safe at that point. And that’s why the market’s pricing this one at roughly 4.6% and annualize it is a dynamic that we’ve seen a lot through COVID. Back in March, the market was pricing a ton of deal breaks. And in fact, at one point, I believe at the bottom of the market in March, the market was pricing in more than half of all deals were going to break. And we’re mostly done going through, nearly all the pre COVID deals. And we actually did not see an elevated number of deal breaks. However, what we did see was an elevated number of deal-repricing. We saw that with Delphi-BorgWarner, we saw that with Advanced Waste Disposal and Waste Management, which closed just today. And we did see that with a number of other ones as well. But that’s a dynamic to consider is that the market really got it wrong in terms of, you know, deals falling part. I think those were somewhat normal in a normal environment, but there were elevated downwardly repricing, another of which was the ForeScout Advent transactions. So, something to keep in mind there. Just a really interesting case study. And if you had the intestinal fortitude to hold on, perhaps even been buying the lows, then congrats to you. You earned your stripes as a Bonafede Merger Arbitrage.


Julian Klymochko: Last topic we want to chat about today is interesting deal in the sports arena, specifically Ryan Smith, the 42-year-old co-founder and CEO of Qualtrics. He made a big play for the Utah Jazz, picking it up for 1.66 billion. Now this perhaps presents interesting personal wealth diversification for him because he recently sold the company that he co-founded in 2018 to SAP, for what 8 billion? He’s done fairly well for himself, didn’t he? 

Michael Kesslering: Yeah, it was for $8 billion with him and his brother making 3 billion in total.

Julian Klymochko: Wow, that’s a pretty interesting story there. And the Utah Jazz getting a pretty exceptional valuation of 1.66 billion. Now I wanted to discuss the previous teams’ owners, the Miller Family. They actually bought their control of the jazz in two transactions in the mid-eighties, ultimately paying $22 million, which was actually a really risky bet at the time, but looks like that bet worked out astonishingly well for them cashing out for 1.66 billion. Now here’s a point that I want to drive home to investors, is you talk about turning $22 million into $1.66 billion, that just makes your jaw drop because it’s such a massive number and such a huge win. However, if we break down the numbers like that, growth in value took place over 35 years. So, if we do the calculation and that works up to a 13.1% annualized return over those 35 years,

so, if you tell someone, “oh, I made 13.1%,” you know, is their jaw going to drop? No, but it just gives you a sense of the power of compounding. If you can do that 13.1% over 35 years, which is, you know, an exceptionally good long-term investment, just like incredibly, well if you do that, then you’re going to make an incredible amount of money. In this case, the Utah Jazz investment for the Miller Family went from $22 million to $1.66 billion, not just that, but I mean, two NBA finals. They did have Karl Malone, an absolute all-star, John Stockton too, can’t forget about him in the 1990s. So not only did the value of their investments sore, but I’m sure they had a lot of fun with it. Interesting dynamics happen within the league as they owned it. Television money really flooded the league and valuations of teams clearly skyrocketed. 

Wanted to mention comparable evaluations. There have been a few other NBA teams traded over the past few years, for example, in 2019, the Alli Baba co-founder he bought or traded a minority stake in the Brooklyn Nets for $2.35 billion evaluation. That was the highest price of any US professional team. Then in 2017, Tilman Fertitta paid $2.2 billion for the Houston Rockets. And then if we go back to the time when Steve Balmer acquired the LA Clippers for $2 billion, that was about six years ago. Valuations for NBA teams have really skyrocketed because if we rewind to pre Balmer deal, the teams that were there were sold around that time, say 8 to 10 years ago, we’re going for around 450 million. And so, you know, that Balmer transaction really seemed to change the nature of M&A in the NBA space, so super interesting deal. 

Wanted to note that issue of compounding and how powerful it can be over the very long-term. So definitely keep that in mind, Mike, what are your thoughts on this really cool diversification for Ryan Smith and perhaps you know represents a key aspect of alternative investing. I know not a lot of people can own a basketball team, but certainly interesting if you’re wealthy enough?

Michael Kesslering: Absolutely, and by nature, they are trophy assets. And that’s part of why you’ve seen such a compounding in pro sports teams. And a lot of this has to do with the fact of the very good timing of the Miller Family, where they acquired the team. And as you had mentioned, Julian in the early eighties, where the dynamics for all of the pro sports leagues really started changing was the early nineties. and that was with the major TV deals. They always did have TV deals, but this is where those TV deals really started to be a material portion of the value of the teams. And so that really played a big factor in their success as an investment, but looking at Ryan Smith in particular from, you know, made his wealth in Qualtrics, as I’d mentioned, they had made $3 billion him and his brother, but this company was pretty unique in the sense that Ryan, his brother and their father who was a professor. And I believe they started initially by selling into the academic community, their product, which is basically engagement surveys and things of that nature, which has expanded a lot since then. But was a really untapped market in kind of an inefficient niche that they were able to digitize and create a lot of efficiencies for their clients. The Qualtrics as a company was profitable from day one, where they effectively bootstrap the company achieving profitability, like I’d mentioned right from the very beginning, which is the complete opposite from how you think of a typical software company nowadays, where you would look to raise seed capital from venture capitalists. But in this situation, they never actually took VC money until a very late stage. So that was why when they did sell Qualtrics, the founders still did have a very material portion left of the company.

They were actually sold to SAP. This was about two years ago and it was right before they were about to go through their IPO process. And right at the last minute, SAP came in, gave them a very large premium to where they were looking to raise that, they basically couldn’t say no to. And so, this made Ryan Smith and his brother very rich. But now you have an interesting turn of events here over the last number of months after this acquisition, is that in July, SAP actually announced plans to spin out Qualtrics, this is just within a couple of years, which is really uncommon for a strategic acquiror to do so in a private equity situation, you’ll have a private equity firm will look to IPO in acquisition after a couple of years, that’s very common, but in this scenario, that’s quite uncommon, and Julian, when you mentioned Ryan Smith diversifying his investment portfolio, he now acquired the Utah Jazz and at the time of the announcement for the Qualtrics spinoff from SAP, they did expect Ryan to be the largest single shareholder of the pro forma Qualtrics. So, it looks like he’ll have all his eggs in two baskets, but two very strong companies. But I thought it was just an interesting background with Ryan’s story.

Julian Klymochko: Yeah, and speaking of SAP, things not going well that the side, their stock just getting hammered about 25% this week on a very bad quarter and weak guidance. So, going through a bit of a rough patch there at SAP, but I digress a lot of interesting things happening in the market this week. We had an oil patch, the M&A buzzsaw, Tiffany and LVMH making amends and Qualtrics founder picking up the Utah Jazz for $1.66 billion. So, we’ve got another sports team, transaction comp for you M&A junkies. These transactions don’t happen too often, but when they do, we always find it topical. And we always got interesting things to say about it. So, thank you for joining us on the podcast, listening to it. I hope you enjoyed it, if you did check out more and tell your friends, colleagues, family about it. And until next week, we wish you all the best in your investing and we’ll 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 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.