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Absolute Return Podcast #47: M&A 101: When Hostile Takeovers Go Friendly

By January 10, 2020 No Comments


January 13, 2020—Hudson’s Bay Chairman Settles With Shareholder Activists, Raises Bid to $11.00. Does This Mark an End to the Saga?

HP Rejects Xerox Approach After Financing Secured. What’s Next?

Softbank’s Vision Fund Continues to Struggle After Zume Pizza Crumbles. Does This Call into Question its Investment Process?

Jobs: Canada Beats While U.S. Misses. What’s the Story Behind the Numbers?

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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 47 of The Absolute Return Podcast, I’m your host Julian Klymochko.

Michael Kesslering: And I’m Mike Kesslering.

Julian Klymochko: Today is a frigid January 10th 2020. Got a number of important things happening in the market this week that we want to chat about, off the top?

    • Hudson’s Bay- finally, a resolution to this saga that we have been chatting out for the past six months or so. Richard Baker, the chairman of Hudson’s Bay he settled with the shareholder activist by raising his bid to eleven bucks a share.
    • Next, on M&A news HP rejected Xerox’s approach after Xerox secured their financing. What happens next on this deal?
    • Going to chat a bit more about SoftBank’s vision fund. They ran into some struggles at portfolio company Zume Pizza. Does this call into question its investment process?
    • Lastly, going to touch on the jobs reports out of Canada and the U.S. We are going to chat about the story behind the numbers there.

Hudson’s Bay Company

Julian Klymochko: Hudson’s Bay Company Chairman Richard Baker, he increased its offered to take the retailer private from $10.30 cents per share to eleven bucks, which seems to have sealed the deal for the shareholder activists on this one. This deal values the company around two billion dollars. Now, some background he initially started out with an unsolicited proposal at $9.45 cents a share, got the board onside at 10.30, got shareholders onside at eleven bucks. My thoughts on the deal? Well, it certainly is better than letting a deal break and the stock fall 50 percent. A small win for shareholders, eleven bucks still pales in comparison to the underlying net asset value of the company. Not to mention talking about the activist campaign by shareholder Catalyst Capital. Now they are a private equity firm based out of Toronto, and they held a 17.5 percent stake in Hudson’s Bay. They became the loudest critic of the buyout, which was first announced in early June. They built up a stake and then did a tender offer for about 10 percent of the company at $10.11 cents. So giving eleven bucks to them after all the hard work they put in, all the legal fees and such, not a huge win, but a win nonetheless, making a bit of profit here. The major point of debate and major disagreement between shareholders and the chairman his group is really the value of Hudson’s Bay Real Estate.

Now they have a flagship store in Manhattan. The flagship Saks store in 2014, it was valued by the lenders at over four billion dollars. Now, they had a valuation on this go private. They picked it at roughly two billion so it is hard, shareholders had a difficult time swallowing that pill on a 50 percent decline on perhaps one of the prime pieces of real estate globally. That was a major issue. Another thing was very poor share price performance. I mean, since 2015, the stock is down from twenty-nine bucks prior to the deal being announced, it was six bucks and change now kind of a mercy kill here at eleven bucks. Still some smaller shareholders against it but this one is getting it done. What are your thoughts on it?

Michael Kesslering: Yeah, I would agree that it is going to be done especially with Catalyst now agreeing to vote for the deal. There are some conditions that need to be met in terms of when their proxy is filed, but it does look like they will be voting for it. As you had mentioned, they own about 17.5 percent of the company, which actually represents about 32 percent of the minority shareholder votes needed. So that is their biggest hurdle was getting Catalyst on board as the Baker Consortium they own about 57 percent but there was a majority of the minority shareholders needed for this vote to pass through. As well as you had mentioned, there still are a few smaller shareholders that are not in favour of the deal. Ortelius Advisors there a New York based activist hedge fund. They are still proceeding with their lawsuit against HBC and Baker despite the offer increase seeking an injunction against the deal, they are still not happy with the price. Just a little bit further to your point about the Saks Fifth Avenue flagship store it is well known that New York real estate having some struggles over the last couple of years. You do make a good point that it is such a prestigious location that it is not as clear at the high point at the premium listings on the real estate market. If it has been going down in a 50 percent air cut is quite massive.

Julian Klymochko: Right. And as for stock trading, still trades at a slight discount to the takeover value of 11 bucks, it’s at about a 1 percent spread, which, you know, 8 to 10 percent annualized should close in the next month or two. I should just caution investors could be some negative tax consequences on that so if you’re involved or want to be involved, it requires some tax due diligence on your side.

HP rejects Xerox takeover

Julian Klymochko: In other M&A news, HP rejected a Xeroxes approach after Xerox announced that they did secure financing for this 33 billion dollar takeover, which is really just the story of Minnow trying to take over a whale. Xerox, a printer company trying to take over another printer company but Xerox is quite a bit smaller, roughly one quarter of the size of HP. Now, this bid at 22 bucks a share for HP it is made up of seventeen dollars in cash and the remaining five-dollar in Xerox shares, of course, unsolicited, potentially hostile proposal. HP hit back today, stated that it, quote, significantly undervalues HP and is not a basis for discussion. Pretty harsh rejection on that one not leaving open any door for discussions from Xerox. However, figure activist investor involved, Carl Icahn, is shareholder on both sides. He is really pushing these companies to merge. He called it, a quote, “no brainer”. When Carl Icahn calls something a no brainer, I listen up because last time he did that was on Apple stock in 2013 when it was trading at roughly seven to eight times earnings and had a massive win on that one. The stocks up a couple hundred percent since that. So Icahn, the octogenarian, a billionaire, he owns roughly 4 to 5 percent stake in HP and an 11 percent stake in Xerox. This is a pretty big deal. Thirty three billion Xerox indicated that they have secured $24 billion in financing for this takeover, but what are your thoughts on this one? Likely to get done, likely not to get done? You look at the share price action HP up 10 percent. Xerox up 6 percent. Since this was made public shareholders like it.

Michael Kesslering: Yeah, in terms I guess, long story short, I do not believe that the deal will get done. First of all, hostile bids that contain share consideration are typically not successful. Also, this wasn’t really a massive premium or anything of that nature that would really entice investors to act but just as a general rule, hostile bids typically don’t have a share consideration, usually just cash. Obviously that is very difficult for Xerox to make a fully cash offer. When they came out after announcing they had scared financing for the offer, it was kind of a moot point, since HP’s main point of contention was both financing and undervaluation of the HP shares. So they really only addressed one of the issues and really just a secondary issue. Their main issue the undervaluation of the shares. When you mentioned Carl Icahn, he does sit on Xerox’s board but you know, Carl Icahn is never, never one to be shy from any sort of potential conflicts of interest or anything of that nature.

Julian Klymochko: Yeah. He does not give up easily either.

Michael Kesslering: Absolutely, not. Ultimately, both sides have acknowledged that there are a lot of pros to them being combined, to them consolidating into one entity just in terms of the synergies. So really, it sounds like it is just semantics over which company will acquire the other but in its current form, I do not think there is any way that this deal gets done.

Julian Klymochko: Right. That makes sense because there will be a lot of debt in the pro forma entity if it’s Xerox acquiring HP because HP has a $30 billion market cap versus Xerox is at 7.7 billion. So like I said, Minnow trying to swallow a whale here, what do we think is going to happen? Well, I think if a deal is to get done, the tables will probably be turned and HP will be like, okay, consolidation makes sense. We will just buy you Xerox instead of the other way around that way. That way the pro forma entity is far less leveraged and doesn’t have all those financing issues. That definitely makes sense and I am sure Carl Icahn, the activist investor, a major shareholder of both companies, he would be on side because massive synergies available here.

Michael Kesslering: Absolutely. I think he is completely indifferent as to who acquires who that is just semantics from his standpoint.

Softbank’s Vision Fund

Julian Klymochko: Some more struggles up at Softbank’s Vision Fund. Now, this is specifically at one of their portfolio companies, Zume Pizza, whose novel concept involved robots making pizza. They have just raised a ton of dough. They raised three hundred and seventy five million last year from Softbank’s Vision Fund at a 2.5 billion dollar valuation. It was not just the amount of money and valuation that was insane, what was also crazy is this 2.5 billion dollar valuation was up from only one hundred and seventy million dollar valuation one year prior. That is right. A pizza restaurant’s valuation going up north a tenfold in one year just boggles the mind. It goes to show you that perhaps this was not the best investment because now they are announcing major layoffs or cutting 80 percent of their staff and pivoting, believe it or not, from pizza to packaging. No more Zume pizza for them and this is not an isolated incident.

Other Softbank backed start-ups, one being Getaround, the other one being Oyo. Or is it O-Y-O? I do not know it is based out of India, so we do not really have an exposure. They also announced very large layoffs and it really represents this push by Softbank’s portfolio companies and really other VC backed start-ups in this big push to become profitable because we have seen a lot of unprofitable companies come public. Public market investors just were not having their share price performance has been poor and it really has not worked out well for Softbank, has it?

Michael Kesslering: No, it certainly has not. In terms of their actual cash burn. Now, I’d read some reports that they were losing about fifty million dollars per year, but it was also reported, I believe that was earlier in 2019 and that by the end of 2019 the later months of 2019 that their cash burn was up over 10 million dollars per month. They were burning cash at a high rate as well you did mention that they had raised money at that 2 billion dollar valuation, which was a massive bump up between financing rounds. As of November 2019, just a few months ago, they were also planning on raising an additional capital round at a four billion dollar valuation. So then doubling that obviously they were not able to do so. They were not successful with that.

Julian Klymochko: When you think about it, how do you spend hundreds of millions of dollars on a pizza restaurant? That is going to boggles the mind, does not it?

Michael Kesslering: Yeah, it certainly does and so with regards to their new pivot to sustainable packaging, along with food production and delivery systems, they do have their sustainable pizza boxes being tested by Pizza Hut. Currently, I believe just in Phoenix, Arizona so they do have a pilot project going. Typically, a company that is worth in the billions of dollars is not just working with a small pilot project and as well, the pizza box is not really the largest part of the value chain. If you look at the whole pizza buying experience, that is just a small component of the value chain and I really do not see how that would be supportive of such a high valuation. I guess Softbank must be coming to that realization as well. One other point on Softbank is that, you know with their vision fund now, we have talked about them a lot with WeWork, but this is just another of a list of high profile investment flops for the vision fund. As well, you have a few other ones you’d mentioned a couple, but Getaround and Wag, they’ve had to cut staff and pivot their business models, which you really don’t see with late stage VC investing. You do not see that as much with seed investors, absolutely, you are going to see some pivots, but that is rare. Typically, these companies, they raise some capital of Softbank and then just IPO.

Julian Klymochko: You figure when you are a so-called unicorn with a valuation above one billion dollars that you would have had a business model figured out. Is not that just table stakes at that point?

Michael Kesslering: Absolutely. As well, I mean, there was another report from Axios that came out this week talking about Softbank’s Vision Fund and how they have been walking away from a number of term sheets with start-ups, which really is not that surprising in the VC space. It is bad when that becomes public because that is bad for their brand. I guess the only thing is that Softbank itself and the Vision Fund do not really have a ton of competitors in the check sizes that they are writing at this point in time. Since they are just coming in there, the 10,000-pound gorilla in the room that is just throwing money at start-ups at such levels that not a lot of other VCs are able to compete with.

Julian Klymochko: Yeah and it looks like that strategy has ended, with all of them walking from all these term sheets. What Softbank was trying to do with respect to its portfolio companies was throw a tremendous amount of money at each one in each category and try to build up a category leader. What is happening now with Zume, Getaround, Wag, etc. it has not worked. In fact, it has turned into a complete disaster as you look at Softbank and scratch your head, what were they thinking? They were drawing a ton of money at these massive valuations at these later stage start-ups and clearly, it is not panning out. Softbank confirming that they do regret these situations. However, you know, that does not get their investors’ money back, nor does it really build their reputation here. It really calls into question their investment prowess.

Obviously, Softbank run by Masayoshi Son who was famous for one of the greatest VC investments of all time into Alibaba. I believe he sunk, what, 20 or 50 million now it is worth tens of billions and perhaps hundreds of billions of dollars after only knowing Jack Ma for about 20 minutes. It was never Masayoshi Son’s thing to do a lot of due diligence. Perhaps he just got lucky once and is trying to sort of, re-engage that magic, but who knows? They say if your first investment is a magnificent success, then that is actually bad because you do not learn about failure and perhaps you do not have the right risk management in place. Nonetheless, we will continue to watch what is going on at Softbank and their vision fund but right now, it is not looking great. Then on the VC side, I mean, things are really drying up for start-ups with this massive 100 billion dollar fund writing huge checks like nine figure checks into these start-ups that don’t really have much of a business model.

Michael Kesslering: Absolutely. It is just, you know, with the liquidity from Softbank drying up, really just engages back into the typical exit or companies at that stage of their growth cycle of going public. Softbank was really just delaying these companies, having to go public since they are able to raise money, dollar amounts that what you would typically get from the public markets on an IPO. They were able to forgo that and stay private. It is something that we are going to follow moving forward as it has a lot of big implications for the VC space as well as the start-up space in general.

Jobs Reports

Julian Klymochko: We wanted to touch on the jobs reports. We saw numbers from both Canada and the U.S. So Canada beat while the U.S. missed.

Touching on the Great White North. The Canadian economy really bounced back and the employment numbers two consecutive months of declines but in December, we are in a positive gain of thirty five thousand two hundred jobs in the month. This came in ahead of consensus economists’ estimates for a twenty five thousand gain. So nice to beat on that number. Now, this brings the total number of jobs created in 2019 to over three hundred and twenty thousand, which is the second largest annual gain since 2007 so the Canadian economy still chugging along. The unemployment rate did tick down on the month to 5.6 from 5.9 percent in November. However, we did touch on that November jobs report, which we believe was completely made up, totally false and perhaps some blowback from slightly fudged numbers coming into the October election.

Nonetheless, touching on the U.S. now, the American economy added one hundred and forty five thousand jobs in December. Now, this actually missed the consensus estimate for one hundred and sixty thousand additions. The unemployment rate in the U.S. is spectacularly low a fifty year low up 3.5 percent. This is down from November’s gain at hundred forty five thousand in December is down from two hundred and fifty six thousand in November but that was really swollen from GM workers getting back to work back in November. One thing, manufacturing was a weak spot in the U.S. numbers down twelve thousands jobs. Economists were expecting a gain there, but steady as she goes in both economies. Isn’t it?

Michael Kesslering: Yeah, it sure is. Really, it was focusing first early on Canada is that it really just backs the Bank of Canada assessment that Canada’s labour force really remains resilient despite the trade headwinds in both Canada and the U.S. They have impacted which we’ve discussed before, some of the surveys regarding sentiment, but they really aren’t showing through in jobs numbers. What you really want to focus on is the actual jobs numbers, as much as you would look at some of the sentiment. As well for Canada 2019, there are service jobs outpaced the goods producing industries, which is something interesting to note, simply just a data point in an array of data points. On the U.S. side, really just slow in growth but growth nonetheless.  As you mentioned, 10 straight years of payroll gains it literally just steady as she goes is the apt way to put it.

Julian Klymochko: Yeah, I wanted to touch on application for investors from a monetary policy perspective. We looked at both of these really in line with expectations, jobs numbers, are healthy, I should say. What does that mean to central bankers? Well, you look at the Bank of Canada and the Federal Reserve in the US and it means that they are going to hold off. They are not in any rush to hike rates anytime soon and they both seem content just holding, not cutting anymore. Obviously, the Fed had cut a number of times last year that the Bank of Canada has been holding steady, but we are not expecting any major changes from the major central banks in North America just off the steady jobs numbers that we have seen over the past number of months.

That is it for us on episode 47 of The Absolute Return Podcast. If you liked it, you can always check out more at absolutereturnpodcast.com. If you want to follow us on Twitter, I am the people’s hedge fund manager @JKlymochko – K-L-Y-M-O-C-H-K-O.

Michael Kesslering: And you can find me @M_kesselering – that is K-E-S-S-L-E-R-I-N-G.

Julian Klymochko: And until next week, we wish you happy trading, speculating, 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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