Fresh off our victory over management at Flamel
Yes, we're really recommending against the merger, but, no, it has absolutely nothing to do with power, blood, victory, defeat, or anything of the sort. We are somewhat reluctant corporate activists -- our focus on management excellence means that our natural proclivity is to back the men and women in the executive suites of the companies we recommend. Sometimes, as with Flamel, facts come to light to convince us that management isn't up to the task. And sometimes, as with Zeke Ashton's selection of Saucony, we take our stakes in companies because their valuations are compelling enough that we feel we can take a chance with a management team that hasn't necessarily proven its mettle. Saucony had nearly collapsed after a series of ill-conceived diversifications, but our hope was that management had learned its lesson.
Zeke was right. Saucony has been a stellar performer for us, up more than 150% (with a dividend, to boot). But on June 2, Saucony's management announced it had agreed to be acquired by Stride Rite for $23 per share in cash (or $170 million in total), a 19% premium to the market price. Backing out the cash on its balance sheet, Saucony is being purchased for around $140 million, or just seven times EBITDA. That seems extraordinarily cheap.
So, how do you know that a management team stinks? One surefire way is to regard what happens to the company's share price when management is replaced. The announcement that Saucony was selling out caused Stride Rite's stock to rise over 10%. That almost never happens.
The primary reasons are: (a) Investors think Saucony's stock is being seriously undervalued at acquisition, and (b) Investors lack confidence in Saucony's management team, which hasn't succeeded at expanding its brands of high-performance athletic shoes. There's simply no other way to interpret Stride Rite's double-digit rise on a day it announced plans to shell out $140 million for an acquisition.
We at Hidden Gems believe that Stride Rite's purchase price for Saucony is substantially too low. As such, we have recommended that our subscribers vote against the merger. Saucony's shareholders should expect -- demand even -- that Stride Rite's acquisition (which we support wholeheartedly in principle) come at a price sufficient to pay a true control premium. Stride Rite is acquiring Saucony lock, stock, and barrel, and as such can decide how and where to deploy cash flows generated by the company, flexibility that minority shareholders lack. This, in our opinion, Saucony's management has given Stride Rite for free.
Further, our eyes hurt to see $5.2 million paid to Saucony's outgoing CEO and executive vice president of business development. It is no small measure of their self-interest that Saucony's leadership rejected a $25 cash offer from another bidder just two months before because its terms were less attractive for management. We'd rather see that capital evenly distributed among all shareholders, boosting the purchase price by 3%. And frankly, our valuation calls for a fair value of an additional 10% to 20% above that. As we see it, Saucony should be sold for a minimum of $26 to $28 per share. At the very least, at this discounted price, Stride Rite should have been forced to make the acquisition with stock (enabling all shareholders to enjoy the immediate rise in its shares).
How did this happen? Well, one requirement is that companies ask a third party to produce a "fairness opinion," in which that third party says it believes management and board members have negotiated a fair price for shareholders. Even in the best of circumstances, these opinions are garbage, as it is fairly rare for an investment bank to go against the opinion of management.
Yet, no matter how passionately we shout "For shame!" and how strongly we believe this is a flawed transaction at an artificially low price, it will prove of little consequence. Saucony insiders own 49% of the Class A shares and 25% of the Class B shares. They like this deal, the executives are satisfied with their termination package, and the transaction will probably close at this price.
That doesn't mean that a vote "no" is an exercise in futility. We urge Saucony's shareholders to do just that.
Bill Mann doesn't have a financial interest in any of the companies mentioned in this article. He is also pretty unsure about the definition of "enormity." Bill is the guest analyst at Hidden Gems. A free 30-day trial to the Motley Fool's premier small-cap investing newsletter is completely free.Click here to give it a try.
