November 17, 2020- Vaccine News Causes Quant Shock and Record-Setting Short Squeeze. Is the Short-Covering in Low-Quality Junk Stocks Overdone?
LBOs Come to Canada as Apollo Seeks Great Canadian Gaming Buyout. Will This Deal Close Amidst Shareholder Opposition?
VF Shares Rally With $2.1 Billion Acquisition of Streetwear Brand Supreme. Why Did the Shares React so Positively?
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: All right. Welcome ladies and gents to The Absolute Return Podcast, episode 98, I’m Julian Klymochko.
Michael Kesslering: And I’m Mike Kesslering.
Julian Klymochko: Today is Sunday evening, November 15th, recording the podcast a little bit late this week, had a lot going on Friday and Saturday. So finally get into it, having a good day. And the reason I’m having a good day is because news just broke that Taubman and Simon announced that they rehashed their deal. Cut the price of 43 bucks a share, which I called. If you check out my Twitter last week and it’s a good feeling. So had some steak and cheesecake for dinner to celebrate, but nonetheless, let’s get onto the podcast this week.
VACCINE NEWS CAUSE QUANT SHOCK AND RECORD-SETTING SHORT SQUEEZE
Julian Klymochko: And I wanted to start off things with this crazy move we had in the markets specifically on Monday, we had a vaccine news that caused what I’m referring to a quant shock and a record setting, short squeeze, the likes of which I’ve never seen before. It was just massive. So, we’re wondering is this short covering and low-quality junk stocks overdone? And so, what happened specifically on Monday. Pfizer announced positive results for its COVID vaccine, which is obviously tremendously good for humankind/mankind. But that being said, it was awful if you’re short seller or a long-short quantitative investor from an investment standpoint, specifically stocks that had been performing well. So, we’re talking about the momentum factor here, stocks that have been performing well plummeted on the news, and then to make things even worse, beaten down low-quality junk stocks, absolutely skyrocketed. In fact, the long-short momentum factor suffered a 15 standard deviation event, which is, I don’t know how rare is 15 standard deviation events are, but they’re probably like a number of iterations of the universe or something along those lines. But the momentum factor lost 23% on Monday. It’s worst on record, so an absolutely shocking move for a long, short and systematic investor. Focused on the momentum factor. Now, this crash in the momentum factor was so rare that writing out the chances of the occurrence on any given day required a 16-digit number followed by 63 zeros. Now, of course, this assumes a normal distribution. Now this momentum factor draws down is further challenged. Evidence-based long- short investing this year. And the interesting quote I saw on the news, a guy claimed, “these aren’t your father’s equity markets”. And boy is he right about this short only fund. Ended the day down, double digits. Mike, just an absolute bloodletting for anyone in shorting of junk stocks. What are your thoughts on this enormous move to the negative and the momentum factor?
Michael Kesslering: Yeah, bloodletting is an accurate way of describing this and just incredibly rare event. And I mean, we were talking about this at our office and our CTO and head of research Derek, really described it as a reckoning for Nassim Taleb. As you had mentioned, Julian, any of the probabilities that are assigned to an event such as this are really using a normal distribution. And for those of you that haven’t read any of Taubman work is he really focuses on the fact that stock market’s really shown tab fat tails as opposed to a normal distribution. So, all that means is that crashes such as this or any sort of crash, not this in particular, but any sort of crash will happen more commonly than would be expected if you just look at a normal distribution curve. And really what was interesting, and you alluded to this as well yeah, short funds also got crushed, but it was really the long end as well. It was just a complete reversal in for long-short funds which is quite frustrating, but those things do happen. Those types of events do happen. It’s just frustrating when they do. This has been a very interesting year compared to the last 10 years in factor investing where 2020, it’s been quite volatile for all factors. You look at value and quality factors have been fairly volatile year to date. Like if you compare it relative to years prior, so it’s kind of a turn where we’re seeing a lot more volatility and momentum is being a factor that’s done very well over the last number of years. And so, a little bit of a reversal, but, you know, as any investor doesn’t like to see those types of moves sign on in a single day, right?
Julian Klymochko: Yeah, certainly a black swan event. And I should add on my comment. Taubman and Simon renegotiating restricting their deal at $43 per share, which is a massive win because it was trading in the mid-thirties last week. So, congratulations to all arbitragers and we are long in the Accelerate Arbitrage Funds. I imagined compliance, tapping me on the shoulder here, got to mentioned that. And the reason that it feels so good because when you make an investment call, that is non-consensus and say that the market is wrong and then you’re proven, right. There’s no other feeling in the world. And that’s why we truly love this investment business, but let’s get onto the next piece of news..
LBOs COME TO CANADA AS APOLLO SEEKS CANADIAN GAMING BUYOUT
Julian Klymochko: Which is leveraged buyouts coming to Canada as US private equity firm, Apollo struck a friendly leveraged of Great Canadian Gaming for $3.3 billion or 39 Canadian dollars per share. Now, this LBO is priced at a 34.9% percent premium, so higher than average, but it in fact faces an uphill battle as numerous shareholders have come out immediately against the deal complaining that the casino operator is being sold too cheaply to a foreign player. Now, this buyout is controversial because, just prior to the pandemic, Great Canadian Gaming announced a share purchase program at a price of up to $46 dollars per share, which is 18% above the buyout before cancelling the buyback in March as locked downs began. Now Great Canadian gaming, it’s a casino company with casinos throughout Canada. It has been hit very hard by the pandemic. Its entertainment and hospitality facilities are located in BC, Ontario, New Brunswick and Nova Scotia, they’re all forced to close throughout the COVID pandemic. And in addition, Great Canadian did not seek other bids prior to Apollo and this deal coming to a definitive agreement, Apollo’s approach was disclosed as unsolicited. So, they did not shop this deal at all, which somewhat frustrates shareholders, nonetheless, Great Canadian Gaming stock finished the week up 44.5%, close at 37 and change. Roughly 3.3% discount to the buyout price. And this is a really interesting dynamic because we have had a number of large shareholders come out against the deal. And it looks to be heading to somewhat of a standoff on deal terms unless the bid is improved or an interloper submits a superior proposal. Talking about some of the shareholders that have come out publicly against the deal. Bloombergsen Investment Partners, unrelated to Bloomberg LP, they own about 14% of Great Canadians shares. They told on an investor call that the Apollo deal doesn’t come close to the true long-term value of the stock. And then in addition, other shareholders, such as Madison Avenue Partners and Breach and Inlet Capital said they would also vote against the deal. I believe they don’t have the votes to get this transaction over the line. And if you’re a shareholder here buying at 37 and change, and the downside is pretty significant, call it 9 or $10 dollars, upside here to 39 is pretty slim. And with the $39 dollar per share deal, likely not to go through. Say they can get a bump, i.e. Apollo to improve the terms or an interloper to come in, say they come in 10% higher. What the share price is implying where it’s at, 37 and change. Given the downside that the market is pricing roughly a ⅔ chance of that happening, which are odds that I don’t necessarily like.
I got a comment here from the Canaccord Genuity Analyst. He stated, “this is a positive outcome, given the near-term challenges for both investors and the company alike, a Great Canadian is likely to remain challenged over the near to medium term due to the impact of COVID-19, which has resulted in facility closures and guest restrictions across the company’s portfolio”. And certainly Mike, this makes sense in the context of increasingly strict lockdowns during the second wave of COVID that’s really come into the country. What are your thoughts on this seemingly Mexican standoff? That’s coming to one of the largest LBOs in Canada in a while.
Michael Kesslering: Yeah, it’s certainly very interesting. And there’s a few areas to unpack here. Julian, you mentioned Bloomberg, Breach Inlet Capital and Madison Partners. That was on the earnings call Tuesday that they, all of them quoted on the call that they would not be voting for the deal.
Julian Klymochko: They were angry.
Michael Kesslering: Very angry, and I’ll get into that in a moment, but as well Bloomberg News also reported there’s a number of funds at CI Financial that also own shares through CI. Are actually the largest shareholders, but there’s a few different PMs. It has been reported that a few of them at least will be voting against the deal. So, if you take the whole CI state, you currently have 35% voting against the deal just that those quoted numbers. And so that would be enough to put an end to the deal just because you do need a 66 and two-thirds majority vote, but yeah, as you had mentioned, Julian, this was one of the most uncomfortable earnings transcripts I’ve ever read through. Unfortunately, I was not on the call, but you start out with some very, very hostile call. CEO was apologizing to some of the shareholders for, you know, basically hurt feelings, how they were feeling as well as made kind of a comment around, you know, if they’re not confident in the deal that he’s not doing his job. And there was an all-time quote from, I believe it was from the Bloombergsen PM where his comment was, if you want to do another job, I’m sure we can find someone else to ruin the company, which is very hostile.
Julian Klymochko: That’s very aggressive.
Michael Kesslering: To read on a transcript. As well, even the sell-side analyst from RBC was pushing management, fairly hard asking some pointed questions.
Julian Klymochko: At the end of the day, this is a 35% premium, which is significantly higher than the average control premium that we do see in the market, right? So, you’ve got to take that into account.
Michael Kesslering: Close to a three-year low. I don’t have a very strong opinion on this, but I do want to outline some of the complaints that shareholders have here. So, as you had mentioned, Julian, no formal sales process after the unsolicited bid from Apollo, that’s the main sticking point as well as selling a monopoly at, what these investors believe monopoly asset that’s close to a three-year low, and the investors were pointing out that the company produced $4 dollars per share free cashflow in 2009. Now, I don’t know if that’s really fair to be bringing up the 2019 numbers, not 2009, 2019. Because that’s before the COVID impact, and would imply a 7.5 times free cash flow number where the other thing that I saw quoted was that Great Canadian is trading at a substantial discount to its US peers. And specifically, there, I saw Wynn Resort being mentioned and, you know, I don’t know if that’s a fair comp. Wynn Resort is four times the size. They do have a little bit more leverage as well, but I mean, it’s just not an easy comp and yeah. Trades that kind of double the valuation multiple, but yeah, not a very good comp
Julian Klymochko: And it has the brand as well.
Michael Kesslering: Exactly, and the third kind of complaint was that the offer was below previous share buybacks of the company in 2018 and 2019 the company spent $350 million dollars buying back the stock about $45 dollars per share. And then was even this year planning on buying back another $500 million dollars at a range of $39 to $45 dollar this year too. And the fourth and final one was, there was negative guidance issued from management on the last earnings call which some of these investors believe contributed to the stock tanking prior to negotiations. And, you know, as you had mentioned Julian, opposed defending their $39 dollar offer, large premium as well as they did quote that it was above analysts price targets, which I mean for you and I, we take that with a grain of salt but really, yeah, it seems like interesting timing by management. I don’t think the company was cashflow negative at this point. I think they still were slightly cash flow positive, but it seems like an inopportune time, but I mean, if it truly is, I guess that’s what I would mention. If it is really that much of a low-ball offer, somebody else will come in and overbid. So, I think that’ll be a good indication of if there actually is a lot more value to be had here, or perhaps the investors were just looking at things a little too optimistically because obviously management doesn’t see it in the same light. And on their earnings call, there was discussion of future investment opportunities within the business and management, it wasn’t very positive on those.
Julian Klymochko: Right, and shareholders need to be careful. I remember looking at a deal last year, specifically, Ken Corporation, which got a go-private offer, which was at a substantial premium, almost a hundred percent at around I believe, $16 per share. Shareholders in fact voted it down and the stock went from nearly $16 to about $6 in March. Now it’s around $17 dollars, but that certainly wasn’t worth without volatility. So, shareholders should definitely be careful with respect to these types of situations. No superior proposal or alternative bidder on the table and where the stock is trading right now at $37 and change. It is pricing in a quite high probability, roughly two-thirds of either Apollo bumping or an interloper coming in over the top. So, you know, it’s not the most attractive odds to be betting in that type of scenario.
And the other thing to consider is that Great Canadian Gaming. They’re obviously in a recessionary environment. Some of their facilities are challenged due to COVID, which is rapidly spiking, surging throughout Canada, and could force even harsher shutdown measures. So certainly not a great time for the business. And the other thing is that they’re all caught up in this money laundering scandal happening in B.C. And as many listeners would know is that British Columbia in Canada is one of the foremost money laundering jurisdictions in the world and where people are money laundering is either through Vancouver real estate or B.C. casinos of which Great Canadian Gaming is right in the thick of it. And that’s, you know, not necessarily proven, however, there is some court litigation I believe going on.
Michael Kesslering: Definitely a tail risk.
Julian Klymochko: I’m just saying that, such that investors keep that in mind, because when you’re in these sort of a merger arbitrage situations, risk arbitrage, you got to keep in mind any specific risks that could emerge over the deal cycle. And in this one, I see a lot, not saying that we can’t see a bump or an overbid, but what you need to keep in mind are these attractive odds that the market is offering us and it’s not necessarily like this Taubman-Simon situation, which last week the sock was in the mid-thirties. And I believe there’s an extremely high probability that they’d settled before the court date was set to start on a Monday, the trial was set to start. And what we’ve been seeing recently is that no one wanted to fight over a material adverse change clause, and all these firms were settling. So, I thought settlement was high probability, and if it were to happen, it would happen in the low forties. So, I think that was a great risk-reward situation and Great Canadian.
Michael Kesslering: I’m a higher four as well with Tubman, right? Like, as you had mentioned, Juliet, like Great Canadian, you’re 100%, you need somebody to come overbid, right?
Julian Klymochko: Right.
Michael Kesslering: It’s not just going to magically rerate to an 18 times EBITDA multiple. And so, yeah, you’re really focused on. There’s one lever that can be pulled to realize value and that’s a little bit frustrating. As well for folks that want to follow along, I believe the vote’s planned for December 23rd, right before the holiday season. So, the information circulars should be filed shortly for those wanting to understand what actual process was in terms of when Apollo contacted them. That would be interesting to follow too.
Julian Klymochko: Yeah, it’ll be interesting to see. Will Great Canadian Gaming shareholders receive a present in their stocking? or will it turn out to be coal? roll some crops, but I digress.
VF SHARES REALLY WITH $2.1 BILLION ACQUISTION OF STREETWEAR BRAND SUPREME
Julian Klymochko: Let’s move on to a really interesting M&A situation in which VF Corp, the parent company of Vans and Timberland, they announced the acquisition of street wear brand Supreme for a shocking $2.1 billion dollars. Now, many people will know Supreme. There a New York based skate shop, streetwear brand with a cult following. They have 12 stores founded by James Jebbia. And they’re actually partially owned by Carlyle Group and Good Partners. Supreme was founded in 1994 as just a single skateboard shop. They branched out, and they do a lot of exclusives and they are able to get that pricing power for the clothing that they do offer. It’s managed to appeal to both mid-market and luxury shoppers by creating this sense of scarcity of which most brands cannot do. So that’s perhaps why Supreme, which is like a 12 store skate shop is being sold for $2.1 billion, which is absolutely just pretty crazy when you think about it, but there is some strategic rationale that makes the deal make sense. VF sought out an acquisition of Supreme because of the brand strong exposure to the segments where they see the market shifting to according to their CEO, VF CEO Steve Randle, specifically, consumers are gravitating towards the brands associated with active outdoors, and most importantly street wear. And perhaps VF is seeing somewhat a gap in their product coverage when it comes to street wear. And they indicated that Supreme is just a great, fine point on that move. And it’s very complimentary to other brands within their portfolio. At its core, Supreme is an East coast skate brand and its core products sell on average. I mean, they’re not super expensive, 40 bucks on average, but what’s surprising is that they do receive 60% of their revenue from online. So certainly, nailing the omni-channel in addition to their 12 stores.
And brief history on how private equity firms got involved. In 2017 Supreme sold at 50% stake in the business to Carlyle for 500 million. So, a $1 billion valuation. Now just three years later, their exiting at a 2.1 billion valuation. So, a great IRR for a call Carlyle there. Some nice foresight who knows that those PE guys could be so down with a skate shop brand and know what’s hot, but nonetheless Supreme does have revenue and more than 500 million. So, they are firing on all cylinders, just crushing it in the market. And Mike, what I thought was most interesting on this deal, is on news of the deal announcement. VF shares rally 13.6% this week, and they added 3.7 billion to their market cap. Now these 3.7 billion increases specifically off this deal, perhaps the market moves in there as well, but you got to admit that this Supreme deal did affect the share price to the upside. And if that 3.7 billion increase in market cap was attributable to this Supreme deal, then the deal more than pays for itself, right?
Michael Kesslering: Yeah, and it’ll be interesting to follow how the brand, it kind of evolves because as you had mentioned, Julian. They started out with kind of that mid-market. And it’s one of the rare brands that is enable to capture both the mid-market and especially in recent years, kind of the upper end of the market as well. As you had mentioned with the limited sneaker, like drops of apparel and sneakers and whatnot, that’s been pretty important for them. That real exclusivity at the upper end of their brand, where you can see everything from, as you mentioned, the $40 average costs for their apparel, but they also have some pieces that are, you know, in the hundreds of dollars, you know, nearing a thousand. So, they kind of have both ends.
Historically brands that try to do that sort of strategy. It doesn’t really work out that well. Because typically the upper end of the brand will just get diluted by the lower end. So, it’ll be interesting, this sort of distribution strategy they expect to roll out. Already Supreme and Timberland, one of the VF Corp portfolio companies, portfolio brands. They’re all announced a collaboration. And if you look at kind of VF where their specialty lies. It really lies in the mid-market. It will be interesting if they’re able to execute as well on the upper end. Cause I know Supreme they’ve done certain collaborations with companies such as Louis Vuitton and other kind of very high-end luxury brands. So, it’ll be interesting to see if VF can pull that off. And I mean, as well, the type of numbers that you’re talking about, Julian, in the hundreds of million dollars in sales. And the core of their base has traditionally been that skateboarder brand, you know, does it just become less cool now? Right. I don’t own any Supreme wear; I don’t know if you do Julian.
Julian Klymochko: Well, I am a big Vans guy and I don’t believe VF has ruined Vans and Timberland. So, they are good stewards of their brands and their attitude towards Supreme is, they’re going to be very hands-off and they want current management to run it just like it is and continue to grow and execute the exact same strategy. But it certainly is a good indication of the sort of real niche brands that have this aura, this kind of high brand value in the market. It also reminds me of Yeezy, Kanye West brand that expanded from footwear to similar type of a streetwear approach. And I remember when Kanye West, I believe is on Joe Rogan podcast recently. And he must’ve mentioned that he’s worth $5 billion dollars at least two dozen times. So, it’s interesting and certainly indicative of the value of these brands and, you know, perhaps should have gone into the skate shop business, shouldn’t we?
Michael Kesslering: Yeah, we certainly should have. It’ll be interesting where they’re able to find their niche and still say cool, right? It’s kind of a very fine line, but they need to thread there.
Julian Klymochko: One to watch, but as soon as Carlyle got involved, you knew that they were looking to flip it. So, this is not much surprising, but what is surprising is the $2.1 billion dollar price tag, and the fact that VF Corp shareholders reacted so favourably to it, but congrats to them. Interesting deal, cool brand. And it’s nice to see, so we’ll follow how this one develops, but nonetheless, that is about it for us folks for episode 98 of The Absolute Return Podcast. If you enjoyed it, definitely check out more on absolutereturnpodcast.com and check us out on Twitter, Mike, where can they find you?
Michael Kesslering: My handle is @M_Kesslering.
Julian Klymochko: And you can find me on the tweet machine @JulianKlymochko and until next week we wish you all the best in your investing. Cheers.
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