Tag Archives: business

takeover defense: getting bigger and uglier

February 18, 2014 By in mergers and acquisitions, Recent Market Action, stock market Tags: , , , , , , , , , Leave a comment

MW vs. JOSB

Men’s Wearhouse (MW)–yes, W-e-a-r–and Jos. A Bank (JOSB) , two publicly traded men’s clothing companies, are involved in a takeover struggle.

the companies

MW is larger, in terms of yearly profits, number of stores and market capitalization.

JOSB has just over half as many stores.  By most important measures–return on capital, return on equity, earnings growth, cash flow growth–it is the superior company.

action so far

JOSB got the ball rolling by making an unsolicited bid for MW last October.  MW reportedly thought about trying to buy shoe company Allen Edmonds (the stratefy of making itself bigger and less attractive) but opted to go on the offensive and bid for JOSB instead.  MW did so in November, and upped the offer last month.

This maneuver, although not exactly rocket science, apparently caught JOSB by surprise.  Its response…

Last week, JOSB announced that it intends to buy Eddie Bauer from Golden State Capital.  According to the New York Times, GGC purchased EB in a bankruptcy auction for $286 million in 2009 (EB’s second bankruptcy in a decade).

The price?  …$825 million in stock and cash.  In a separate move, JOSB also intends to repurchase in the open market the same number of shares issued to GGC .

When the dust clears,

JOSB will own EB and have the same number of shares outstanding.  But it will also have $340 million less in cash and $589 million in new debt.  If the JOSB presentation materials talk about any borrowings EB may be bringing with it, I can’t find where, so the actual amount of debt on its balance sheet may be higher.  JOSB is projecting interest expense of $40 million for 2014.

what’s going on?

JOSB says the Eddie Bauer purchase will boost the combined company’s earnings by 40% in 2014 and another 50% in 2015.  Wow!

But if that’s true, why did JOSB ever pass over EB and bid for MW first?  According to JOSB’s investment banker, Financo (in a Bloomberg Surveillance interview), it presented Eddie Bauer to JOSB as an acquisition candidate in early 2012!  Moreover, Financo touts EB as a superior acquisition choice to MW.

I have a more cynical view of the situation.  I should be clear, though, that while I’ve studied this industry extensively in other countries, I don’t know much about the ins and outs of either JOSB or MW.  Rightly or wrongly, I’ve regarded men’s clothing as too highly cyclical to be worth the trouble.

Anyway, in this case, I see two sources of added value to the acquirer:

–the positive effect of ending situations where an MW store and a JOSB store compete head-to-head, lowering income for both.  Store openings for all brands under the acquirer’s umbrella can be coordinated to avoid this in the future.

–the merged company doesn’t need two CEOs, or CFOs or virtually any other head office employee.  The same for regional supervisory people.   The budget for advertising and other marketing probably can be a smaller percentage of revenues, as well.  This is the main synergy I see in any acquisition of this type–the management of the acquiree all become redundant and lose their jobs.

The net result–intended or not–of buying Eddie Bauer would be to make JOSB $1.2 billion more expensive for MW.  It’s questionable to me whether “diversification” into the technical or casual apparel EB offers is something MW–or JOSB, for that matter–should want.  I find it hard to believe, despite JOSB’s projections of fabulous earnings gains, that making itself bigger and uglier isn’t the purpose of the Eddie Bauer bid.

Note, also, that there’s nothing in the EB acquisition that requires JOSB to tender for $300 million of its own shares at $65 each.  The only thing the tender does is to erase a huge chunk of cash from JOSB’s balance sheet–making it unavailable for a potential acquirer to use to pay for its bid.

After all, doing so is a standard tactic of takeover defense.

breaking companies apart: the cons

February 10, 2014 By in activist invstors, economics, hedge funds, Portfolio management Tags: , , , , , , 3 Comments

Many times, separating a conglomerate into its component parts creates value.  Sometimes, it can produce enormous gains.  Spinoffs of corporate stepchildren are often particularly lucrative.  Take Coach (COH) for instance.  Its stock rose by 40x in the first five   years after it was spun off, unloved and starved for expansion capital, from Sara Lee.

There are other instances, however, where breakup can be disastrous.  This may not be evident at first in the stock price action of the separate components, but the ultimate bad news can happen in a number of ways:

1.  Onerous corporate liabilities–debt, lawsuit liabilities, incompetent executives…may all be shunted into one of the new parts, which is more or less designed to fail.  No one will say this, of course.

The first place to look for this kind of imbalance is in the part where the CEO and other top executives aren’t going.  Often, executives in the disfavored part of the split will be so excited to finally be the top dog that they’re delusional about their ability to deal with the negatives they’re being loaded down with.  After all, Davy Crockett might have survived the Alamo if he’d been a step quicker;  the Donner party might have gotten through those mountains…

2.  Sometimes a proposed split will end up forcing apart two businesses which need each other to be successful.  In the current hedge fund era, when individuals with little operating experience can wield large amounts of financial capital, this is a particular danger.  Activists. for example, have wanted Target (TGT) to sell/divest its credit card operations a couple of years ago.  Yes, TGT would receive a large one-time payment, and its stock would probably go up.  But its credit-related operating costs would rise.  And the company would have lost the considerable “Big Data” advantage that it gets from being able to see all the credit transactions of its cardholders–not merely transactions done at Target stores.

I think the current talk of splitting up Microsoft (MSFT) is well worth monitoring in this regard.  Sure, spin off  the consumer device business.  To my mind, though, splitting Windows, Office and the cloud from one another is just asking for trouble.

3.  Another issue that has emerged in recent years–the activists may be bunglers.  Look at J C Penney (JCP).  Activists correctly saw that JCP was crediting profits it got from its control of valuable real estate to its retailing operations.  That covered up the true weakness of the company’s retail offering.  But their attempt to “fix” retailing before breaking up the company went horribly awry.  Worse, they persisted in their mistaken direction so long that they created a downward spiral the company has yet to pull out of.  The stock, which some speculated could be worth $50 a share, has dropped from around $30 to $5 or so as a result of their “stewardship.”

the shakeup at Pimco

January 28, 2014 By in bond market, securities markets Tags: , , , , Leave a comment

Pimco shakeup

Last week bond management giant Pimco announced a number of high-level promotions.  But the biggest headline was the resignation of its well-known market commentator Mohamed El-Erian.  Mr. El-Erian, who will remain a consultant to Pimco’s parent, the German insurance company Allianz, had been touted as the heir to Bill Gross (who is Pimco’s version of Warren Buffett) when he was hired back from Harvard in 2007.

Why?

foundering equity business

A small part of this is an effort to revitalize the equity business Pimco launched several years.  It hasn’t had notable success so far.  Maybe this area didn’t have the strongest leadership.  But Pimco’s main overall marketing message continues to be that bonds are a better choice than stocks.  Hard to sell a product when your own company is telling potential customers to stay away.

who succeeds Bill Gross?

The main issue, however, is Mr. Gross himself, who will be 70 years old on his next birthday.

When a star manager reaches, say 60, the first question any potential pension client (prompted by the pension consulting firm he hires) asks in a due diligence interview will invariably be “Who is your successor?”  The client, who is spending hundreds of thousands of dollars on the search for a new manager, has two worries:  what happens if the star retires?, and what happens if the star stays on but (think: any aging sports figure) begins operating at only a fraction of his former speed?

While the manager’s performance remains stellar, this may not be a serious obstacle.  But if it begins to become merely ordinary, as seems to be the case today with Pimco, the age/successor becomes key.

That’s how I read last week’s news.  The promotion to deputy CIO of two bond managers with long practical investment experience and visible track records attributable to them says to me that clients weren’t happy with the idea of Mr. El-Erian as Mr. Gross’s successor.

Three possible reasons:

1.  Mr. El-Erian is in his mid-50s.  If Mr. Gross were to work for another five years (he’s tweeted he’s up for another 40!), then the age question recurs, only with Mr. El-Erian as the subject.  So to have a credible succession story Pimco needs forty-somethings.

2.  Mr. El-Erian’s credentials are unusual.  He’s an expert on emerging markets debt, which makes up only a tiny fraction of the total bond universe.  He worked for two years as the CIO of Harvard’s endowment, where it isn’t clear whether he had a positive or negative effect on returns.  The scanty press reports I’ve read suggest the latter.  Since his return to Pimco, Mr. El-Erian’s main role seems to have been as the public marketing face of the firm, where his professorial demeanor and/or his Pimco connection make him vary popular with financial talk show hosts.

It could be that Mr. El-Erian doesn’t have a long enough, or strong enough, identifiable track record as a portfolio manager for clients to take a chance on him.

3.  It might also be that one or more of the the forty-somethings–who have strong track records identified with them–were about to leave, either to start their own firms or to join a rival.   Their motivation to depart would be that the door to advancement was closed at Pimco by Mr. El-Erian’s presence.   If so, Pimco would have been compelled to choose between them and Mr. El-Erian.

Of course, it’s possible that…

4.  … Mr. El-Erian is leaving Pimco voluntarily.  But the lack of detail he’s providing about his future plans suggests otherwise.

a US holiday shopping post-mortem

January 17, 2014 By in Industry Analysis, internet, Portfolio management, Recent Market Action, Retail, Stock ideas Tags: , , , , , , , Leave a comment

Information is trickling in about how the holiday shopping season in the US went.  What jumps out at me (not necessarily exactly what was said) so far is:

–overall retail sales were up by 3.8% year-on-year.  To my mind that’s great, not the disappointment (vs. expectations of +3.9%) it’s being pitched as.  The reason:  the comparison is between the shortest possible holiday season, in 2013, and the longest possible in 2012.

–extended store hours didn’t appear to do much for sales.  It increased costs, though.

–the weak got weaker (think:  Best Buy, Sears, JC Penney).  Sears and Penney are both closing stores.

–Macy’s is laying off 2,500 in-store workers and hiring an equal number to work on its on-line offering

–mall traffic (not sales necessarily, but the number of visits by potential customers) is down by 50% from three years ago

–on-line sales were up by 9.3% yoy

my take

I’ve begun to believe that generational change–a passing of the baton from the Baby Boom to Millennials–will be an important stock market theme in the US for years to come.  I think the just-passed holiday season is evidence in favor of this idea.  (By the way, I heard the other day–but haven’t checked the source–that the single most important attribute to current car buyers is the technology in the car, not styling or engine power.  If I heard correctly, another piece of evidence.)

I’ve always thought that the greatest risk to equity portfolio managers performance  is that as they become more successful and wealthier, they gradually lose touch with the way normal people live their lives.  As that happens, they become less able to see the economic currents that ultimately influence stock prices.  Celebrity hedge fund managers are particularly vulnerable, in my view–but that may just be my prejudice.

Why is this important?    …because you and I will see this change going on long before the professionals do.  So we’ll be able to find the names and position our portfolios to benefit in advance of the wave of buying that will come as the light bulb comes on for gated-community pros.

 

 

 

natural resource production companies: accounting quirks to watch for

January 15, 2014 By in Energy, Gold, Industry Analysis, Mining Tags: , , , , , , 1 Comment

mining

Mining is mostly about how a company develops resources that have already been discovered, sometimes very long ago.

1.  Metals orebodies can vary considerably from one part ot the next in the proportion of valuable minerals they hold.  Standard practice is to mine the highest-grade ore when prices are low, and the lowest-grade when prices are high.

Not a lot of operating leverage this way.  But the idea is to enable the mine to stay open even during the inevitable cyclical downturns.  Doing the opposite, which will likely boost the stock price in good times, can lead to disaster during the bad.  There’s no easy way for an outsider to tell, except by the reputation of company management.  In the case of gold, we may find out who’s been prudent and who’s been reckless when the 2013 financials are published.

2.  Same thing with site preparation.  Standard, and prudent, practice is to routinely spend money on things like removing overburden (layers of dirt covering the ore) in places where the company is not mining today, but plans to in the near future.  This activity can be quite expensive.  But it’s necessary.  On the other hand, a firm can make short-term profits look considerably better by not doing so.

oil and gas

Oil and gas is much more involved with finding new deposits, and how to account for those costs, than metals mining.

1.  Companies have two ways to account for the costs of buying mineral rights and doing exploratory drilling.  They are:

–successful efforts, where, as the name suggests, only successful fields are put on the balance sheet and gradually written of as oil and gas is produced.  The costs of unproductive areas are written off as expense as soon as they’re incurred.

–full cost, where all exploration costs, both for productive and non-productive projects, are capitalized and written off against production.

Successful efforts is more conservative, but normally results in lower earnings.

2.  Accumulated costs are written off pro rata as each unit of oil or gas is produced.  The amount expensed against the revenue from each unit is its proportionate share of the total cost of finding and developing all oil and gas (it’s a little more complicated than this, but this is basically what you need to know).  That proportion, in turn, is calculated based on periodic estimates by petroleum geologists’ of the total size of reserves.

Big oil companies use their own geologists; smaller ones hire outside consultants.  The important point is that this estimate–and therefore the amount of cost written off per unit produced–can vary a lot, depending on the particular consultant hired.  It may also depend on the tone, conservative or aggressive, company management sets.

Just as important, as I mentioned yesterday, oil and gas price changes can alter the size of total reserves.  The cost of recovery doesn’t change, but the amounts of hydrocarbons that can be brought to the surface at a profit can be.  Lower selling prices can raise the per unit amount expensed;  higher selling prices can lower the unit amount.  Potentially, lots of operating leverage–that’s completely out of management’s control.

3.  A minor clarification of #2:  subject to some limits, the company decides how to group reserves and associated costs into different “cost pools” for figuring out depreciation and depletion.  Artful grouping of these pools can help disguise an extended run of bad drilling luck.  Not usually a worry, except with small firms with limited history.

4.  As with any other capital construction project, when oil and gas companies explore and develop with borrowed money, they can capitalize (that is, put on the balance sheet rather than expense immediately) the interest expense on that borrowing.  The interest expanse becomes part of the general costs that are written off against oil and gas production.  For smaller companies with an ambitious drilling program, this can sometimes create the peculiar (and potentially disastrous) result that it shows positive earnings while it is suffering cash outflows.  This is because interest is being paid to creditors but these payments basically don’t show up on the income statement.  Check the cash flow statement!!