Going Shopping
Investors who are looking for market insulated returns are often attracted to special situations. There are many different types of special situations including spin-off investing, liquidation investing and one of my personal favorites: arbitrage. For individual investors, arbitrage is one of the most important concepts to internalize and understand for two major reasons: It provides an effective way to store and utilize excess cash during a period of low rates and it allows investors to generate insulated returns during bear markets.
Each arbitrage operation must be approached as it's own unique entity. While there are similarities between each situation, there are also many variables involved that make it difficult and potentially dangerous to utilize a template. Given enough experience, investors will eventually develop a sense of which deals are both worth committing to and are likely to close. This is an instinct that must be honed over a long period of time.
One situation that is in the process of unfolding is the potential acquisition of R.G.Barry (DFZ) corporation by one of it's largest minority shareholders, the investment firm Mill Road Capital. I believe that this situation deserves more examination as investors are situated to benefit from understanding R.G Barry no matter the outcome of the buyout.
What R.G. Barry Does
(Quoted Text Courtesy of Google Finance)
The company has a focus towards building and marketing brands in the North American market, where it operates "in three areas of the retail accessories category. These products include footwear, such as slippers and sandals; foot and shoe care products, such as cushioned insoles; and handbags, tote bags and travel products. The Company operates in two segments: Footwear segment and Accessories segment. The Company's Footwear segment includes slippers and sandals. The Company's Accessories segment includes foot and shoe care products, handbags, tote bags and travel products. The Company's Footwear and Accessories segment consists of three individual business units (BU) footwear; foot and shoe care products; handbags, tote bags and travel products."
R.G Barry has been involved in developing and promoting brands including the popular Dearfoams slippers, Baggalini and Kiva bags as well as "Footpetals" comfort insoles.
The Numbers on RG Barry
With a market capitalization of slightly less than $222 million, the company is tiny. Currently priced at $19.49 against $7.99 of book value, the company trades at a premium to it's tangible assets, something that I believe is understandable given the intangible nature of it's brands. The company is both well capitalized, with an almost 1:1 ratio of cash to debt as well as a current ratio above 3, currently standing at 4.31.
The company also pays a dividend of 1.85% with a payout ratio of .30, a ratio that is relatively low and indicates to me the potential for further dividend increases if the company's earnings can not be retained and compounded internally for expansion in an effective manner. The company has also increased its annual dividend over the past three years, something that is encouraging given when viewed in conjunction with its low payout ratio.
Insider ownership in the company is also high, currently standing at slightly under 17.49%. Institutional ownership in the company is also high, currently standing at 69%. One investment entity in particular, Mill Road Capital, owns 9.6% of the company and it's offer for shares in the company is what I will now discuss in depth.
A Second Time Around With the Same Suitor
Mill Road Capital, an investment fund that works with micro and small cap publicly traded companies recently offered to purchase the company for $20 per share, currently representing a spread of 2.6% when compared to the current price of the company. Mill Road cited both the strength of the company's management and the company's brands as being key drivers of their decision to purchase shares in the company which they believe currently has limited prospects as a public entity due to its small size and the competitive nature of its core markets (apparel and accessories).
This is not the first time that Mill Road has offered to buy RG Barry, the first offer being extended during the depths of the financial crisis in 2009 for up to $7.75 per share, an offer which was rejected by R.G Barry's management as being insufficient. This time around, Mill Road Capital has made more progress, with the company agreeing to enter into a Standstill and Non-Disclosure Agreement earlier in December, increasing the possibility of a deal being reached.
Should One Attempt Operations?: Watch The Spread For An Opening
Some criteria I utilize when I evaluate a company for potential arbitrage are the following series of questions: Is it a good business that I would want to own outright if the deal falls through? Is there a definitive agreement signed? What is the past track record of the acquiring party? Is the difference between the acquiring price and the current price higher than a comparable risk free rate?
Several of these questions are necessary conditions that must be an unqualified yes including if the spread is worth making from an annualized perspective relative to risk free alternatives and if the business is good. In this case, I believe that this business is good from the perspective of both brand strength and potential to grow. In addition the company also produce both fee cash flow and has a low payout ratio, allowing it to either retain and compound earnings internally or to increase its dividend.
From an annualized perspective, the current spread between Mill Road's bid and R.G Barry's price is 2.6%. Should the deal close in one year, investors will receive 2.6% plus a 1.8% dividend, totaling 4.4% - a number that while not high is higher than risk free alternatives should the deal be concluded. The shorter the time frame however, the more attractive the proposition becomes. Should it take half a year for the deal to close the numbers begin to look better at a 6.1% total return annualized ( factoring in two quarters of dividends). Should the deal take one quarter to close the return is 10.8% annualized plus one quarter of dividend payments. Clearly, the less time it takes the better.
Another thing investors must be aware of is that because of the small size of the company, the spread fluctuates with the price of shares having dropped in price to $18.61 and thus affording investors a significant spread of almost 7.4% excluding any dividends, providing an incredibly attractive opportunity from an annualized perspective. Should the shares of the company decline from this current price on broader market volatility, this deal becomes increasingly compelling.
Is A Higher Bid In The Cards?
When one company enters into an agreement to buy another, there are typically "Go-Shop" clauses involved in the agreement, raising the possibility that there could be a higher bid in the cards from another investment fund or perhaps another company. While the new bid is typically only modestly higher from the previous offer, it is welcome from an annualized perspective. A higher bid could also originate from Mill Road during the due diligence phase in order to facilitate the transaction and ward off troublesome shareholders lawsuits that could threaten to slow the conclusion of the deal down significantly.
While I would never advise planning on this outcome it often provides a little "icing on the cake."
A Place to "Coat-Tail" On Good Ideas
One appealing facet of Mill Road's investment portfolio is that it allows investors insight into potential buyout targets. The company's holdings currently include the publicly traded Destination Maternity (DEST) and the now private Rubio's restaurants. I believe that investors will be well served to explore Mill Road's filings and to see what turns up in the future as I believe that there is a very high likelihood that should their bid for R.G Barry be rebuffed, they will seek to purchase another company in their portfolio or potentially initiate a new position. While I do not recommend purchasing any of these companies on speculation, it could help to illuminate the perspective of investors who are analyzing these companies and provides another source of good ideas for those who are attracted to special situation investing.
Risks
As with any arbitrage situation, there are significant risks attached to the process if the deal does not go through including the potential for the shares of the company to decline significantly in price as arbitrageurs exit the trade. Despite this risk, depending on the degree to which the price of the company has declined, investors with a longer term orientation might be provided an attractive entry point and can use the valuation of the would-be-acquirer as an important goalpost.
Another potential risk is the involvement of shareholder litigation or a longer than anticipated due diligence process that could delay the acquisition and thus erode the gains of an arbitrageur from an annualized perspective. In addition, due to the fact that no definitive agreement has been signed I would caution against the use of leverage in this situation.
Broader market volatility is also something that must be kept in mind, as many buyout agreements (should one be signed) carry clauses that terminate the deal if the broader market (typically the S&P) declines by a significant percentage before the deal is concluded.
Final Thoughts
I believe that investors are very well served to attempt to pay this spread when the price of shares reaches $19.00 or below, particularly as more information about the deal emerges as from an annualized perspective the deal is extremely attractive at this price or lower. While shares currently priced at $19.49 are attractive to some investors, transaction costs and tax issues could erode the spread for others and make this deal only marginally acceptable.
Should this deal fall through, I believe that R.G Barry represents an attractive retailer with strong brands and healthy growth potential, particularly if the company elects to increase its dividend - something that I believe is possible given it's free cash flow and low payout ratio.
I also believe that there is the possibility of MIll Road slightly increasing its bid for the company and the potential for investors to find a "road map" to future acquisitions in the company's ownership filings. I myself have noticed overlap on my watch list with one company that they own shares of and will be watching this firm in the future.
Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in DFZ over the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
This entry passed through the Full-Text RSS service — if this is your content and you're reading it on someone else's site, please read the FAQ at fivefilters.org/content-only/faq.php#publishers.
Aucun commentaire:
Enregistrer un commentaire