Special Situation Investing

Wednesday, September 27, 2006

Private Equity Buyouts

A good article can be found here which discusses the rates and trends of private equity buyouts of public companies. The article notes that several firms have failed to find buyers over the last month, including Bally Total Fitness:

Jones Apparel Group Inc., Bally Total Fitness Holding Corp., The Pep Boys -- Manny, Moe & Jack and Imclone Systems Inc. all halted their auctions last month after not getting the bids they wanted.

However, in spite of these cases, the aggregate quantity has been increasing:

To date, global M&A volumes have totaled $2.4 billion, up some 34 percent from this time last year, according to industry research firm Dealogic.

In regards to the multiples that buyers are paying:

Valuations for companies with $50 million or more in annual earnings before interest, taxes, depreciation and amortization, or Ebitda, hit 8.6 times Ebitda during the first half of the year, the highest level ever recorded by Standard & Poor's Leveraged Commentary and Data Group.

Monday, September 25, 2006

Western Union (WU) Spinoff & BFT Index Change

Standard & Poor's announced today that effective Sept 29, Western Union will join the S&P 500. Western Union was spun-off of First Data Corp (FDC) on Sept 21. As a side note, yahoo finance does not seem to list Western Union (WU) yet. Try google finance instead.

In the same release it was announced that Bally Total Fitness (BFT) will be removed from the S&P 600.

Thursday, September 21, 2006

Take Two Interactive (TTWO) Delisting Notice

Video-game developer Take Two Interactive (TTWO) received a delisting notice today from NASDAQ. The notice stems from the filing delay of their third quarter 10-Q. The company claims that it has had to delay filing as a result of an options backdating investigation.

Personally I don't consider this a significant event for long-term holders. The investigation into the options will play a moderate role in it's long-term stock performance but quite frankly I couldn't care less if it's part of an index. In the short-run, of course, you could and probably will see some pain if it's delisted. The fact is though, Dell was handed a similar warning today so I wouldn't be too concerned. If anything, I would consider delisting a long-term buying opportunity and would welcome it as the risk/reward at $14.50 is still a bit steep. Not that the company isn't going to go up, I believe it will, but you just have too much potential downside at $14.50 for it to be a "good" buy. For the record, I got in at $10.61 and am going to wait this out.

Ultimately, I believe the largest factor in this company's long-term performance will be it's profitability. It has not been profitable of late. However, as I pointed out previously, video game developers make essentially all of their profits in the christmas quarter. Last year's christmas quarter was heavily affected by the GTA sex-scandal, again see my past article. This year's christmas quarter is basically a clean slate with a new release of games. The company has delivered hits in the past and will probably do so in the future. Your hedge (well it's gotten a lot smaller at recent prices), is that the company is selling at a fraction of it's past revenues while competitors sell at multiples of 2-5x. Keep it on your radar screen.

Sunday, September 17, 2006

Hanes Brand (HBI) Spin Off

Hanes Brand (HBI) was spun off from Sara Lee Corp. on September 6. The new company produces a variety of undergarments and related items including socks and underwear. It's brands include Hanes, Champion, Playtex, Bali, Just My Size, barely there, and Wonderbra, all relatively well-known and mid-priced.

If we look at Hanes Brand in terms of the desired criteria for a spinoff play, the best I could say is that it partly qualifies as a good spinoff candidate. Ideally what you are looking for is a number of conditions which depress the price but are based on short-term factors. Of course, this is always easier to analyze (and less useful) after the fact.

1) Sara Lee, it's parent company is in the dog-house. The company is currently trading at a level not seen since the early 90's. Some of this reputation may rub off on Hanes Brand. In spite of this, Hanes Brand has strong brand names and an independant management team. For what it's worth, Coach, which was spun-off of Sara Lee in late 2000 has gone up approximately 10 fold.

2) Independant management. This one is a bit tougher and I can't provide too much insight. The current CEO was in charge of the division under Sara Lee as well, so he's not completely independant but you rarely see that in spinoff's. The main thing is that the really senior management (e.g. the CEO) from Sara Lee is staying with Sara Lee and those indvidiuals who have moved to Hanes Brand, are now working for a separate company.

3) Management Incentives - Again this information is not readily available. I do know that some of the senior management held shares in Sara Lee prior to the spinoff. However, given the nature of executive compensation today, it is very likely that senior management has or will receive options.

4) Company differences - One of the theories behind spinoff selling is that institutions are not interested in the business line of the child company. While the clothing segment is certainly different from food products you may actually be seeing the opposite effect here. As a result of it's name brand products the new Hanes Brand could be drawing in new buyers who would have steered clear of the packaged foods and weaker brands of Sara Lee.

5) Index delisting. While Hanes Brand is not a member of the S&P 500 it does belong to the S&P 400 midcap index. As such you are not likely to see the large scale disinterest with a non-indexed equity.

So what we have is a company which does not have sufficient differences or scale to warrant large scale institutional selling. For new buyers that doesn't present a good entry point. The stock has actually been a benefit to Sara Lee shareholders (who purchased prior to the spinoff) as the combined value of SLE & the HBI received in the spinoff is ~$17.75, while Sara Lee was trading for below $17 the day before the spinoff. Essentially, this financial engineering resulted in a short term gain of ~5% to SLE.

So while Hanes Brand did not receive the pummelling I would have liked does it qualify as a buy on it's own merits? Well at this point I would say no. The company DOES have a tremendous debt load of $2.6 billion against operating profits of $400 million. Their debt is junk-rated and hence they face relatively high interest payments. It is not that the company is a sell or even that it won't perform but there is not sufficient margin of safety at this point to bother buying. It is a low growth industry and without knowing more about managements strategy, there seems little reason for optimism.

I will leave you with Hanes Brands' management's opinion on the merits of the spinoff. Link available here.

"Hanesbrands is a large, strong and successful company that is going to get better by benefiting from greater focus as an independent public company," Noll said. "Hanesbrands has tremendous opportunity for growth and improvement through steady and strong cash flow, cost-saving initiatives and investment in powerful brands and product lines. We intend to build our largest and strongest brands, such as Hanes, Champion, Playtex, Bali and others, in core categories through continued innovation of key products."

PIPEs (Private Investments in Public Equity)

The New York Times published a good and fairly thorough review of modern day PIPE transactions, with special emphasis on their abuse by insiders. For those of you new to PIPE's a quick overview:

PIPE's involve the sale of equity to a firm (generally a hedge fund these days) at a price below the current market value. This is performed when companies are in need of capital (often desparately in need) and their financials or the size of the firm makes traditional equity offerings unappealing. The problem of course is that the sale is not handled through traditional markets and average investors do not have access to the deal. This in itself can lead to mispricing and abuse (in my opinion) of common shareholders rights. In addition, during the process of negotiating PIPE's numerous individuals (potential buyers) are made aware of the transaction and are in a position to make short trades as PIPE's generally cause decline in share prices.

From the article:

Over the last 18 months, the Securities and Exchange Commission has filed four lawsuits against individuals and hedge funds that the commission said had profited on nonpublic information about stock offerings.


The hot tips at issue in these cases involve an increasingly popular type of security called a “private investment in public equity.”

To be objective we should put these numbers into perspecitve:

According to Sagient Research Systems in San Diego, 2006 is on the way to becoming the biggest year for PIPE’s. As of this month, almost 800 deals worth $18 billion have come to market; in 2005, a total of 1,301 deals worth $20 billion were done.

I am not particularly concerned about the insider transactions as insider trading is in no way isolated to PIPE's. What bothers me, as I said previously, is that certain companies are gaining access to funds at prices negotiated not by the market but by management and the purchaser. Furthermore it seems that at least some of the purchasers have the shortest of time frames in mind:

After the deals close, a company issuing the securities typically files a registration statement with the S.E.C. that will, when approved, let buyers resell their shares in the open market — a process that usually takes about 60 days.

I would be extremely wary anytime a company you are following raises capital through this type of transaction. If the purchase price is at a steep discount, if the company does not desparately need the funds or if there has been any evidence that the deal was leaked (via trading spikes prior to the annoucement), you would be better off investing elsewhere.

As a side note and more rant that practical information, the article also made reference to a web site www.measuredmarkets.com that performs analysis of stock trading patterns. Their goal is to give individual investors information which can be used to predict these types of insider trading activities. So far so good. I looked at the web site and the analysis they have performed, they have indeed shown that they are able to spot the insider trading in some cases. They have not, however, shown that they are able to differentiate betweeen trading pattern changes caused by valid insider trading and those caused by any other type of regular transactions (large institutional buyers). This bothers me and is fairly typical of wall street. Tools are provided, success stories are listed but in the end there is no hard evidence that you can reliably predict what is going to happen. I would love to be proven wrong but I see no alpha here.


I received a reply from an individual involved with measuredmarkets.com after publishing this blog. While I am not going to post his reply, in the interest of accuracy I will just concede 1 point. His site may be able to predict block trades as separate entities from insider trading. Block trades can be a major component of institutional buying but certainly not all institutional buying is done through this type of trade.