In our market update last week, which can be found here, we discussed our observation that the market is not rallying through the current earnings season like it did in February when Q4 earnings were released. After a strong rally, it seems that the market is settling into a trading range between 1,350 and 1,425 on the S&P 500 (SPY). Following the declines at the end of the week, it looks like the market may test the bottom of this range. If a breakdown from this range emerges, the market could see sharper declines in the near term.
Monday, July 23, 2012
Market Update: The New Trading Range And How To React
[First appeared on Seeking Alpha on May 7, 2012]
In our market update last week, which can be found here, we discussed our observation that the market is not rallying through the current earnings season like it did in February when Q4 earnings were released. After a strong rally, it seems that the market is settling into a trading range between 1,350 and 1,425 on the S&P 500 (SPY). Following the declines at the end of the week, it looks like the market may test the bottom of this range. If a breakdown from this range emerges, the market could see sharper declines in the near term.
In our market update last week, which can be found here, we discussed our observation that the market is not rallying through the current earnings season like it did in February when Q4 earnings were released. After a strong rally, it seems that the market is settling into a trading range between 1,350 and 1,425 on the S&P 500 (SPY). Following the declines at the end of the week, it looks like the market may test the bottom of this range. If a breakdown from this range emerges, the market could see sharper declines in the near term.
MGM Resorts: Maintaining Positive Outlook After Q1 Earnings (Long-Term Price Target: $24)
[First appeared on Seeking Alpha on May 4, 2012]
A few days ago, we presented our analysis of MGM Resorts International (MGM), which can be found here. We believe that MGM can reach $24.00 per share by 2014 based on a Las Vegas recovery, with additional upside from growth at MGM China, growth at CityCenter, potential legalization of online gambling and other opportunities.
A few days ago, we presented our analysis of MGM Resorts International (MGM), which can be found here. We believe that MGM can reach $24.00 per share by 2014 based on a Las Vegas recovery, with additional upside from growth at MGM China, growth at CityCenter, potential legalization of online gambling and other opportunities.
Own Your Own LBO: MGM Resorts International
[First appeared on Seeking Alpha on April 30, 2012]
With record low interest rates, we are looking for investment opportunities in companies that can take advantage of the situation. One of our low interest rate plays is to invest in the equity of highly levered companies that are positioned to grow and repay debt over the next few years. As small investors, we do not have the wherewithal to do take-private LBO transactions like large private equity funds, but we can invest in public companies that have the characteristics of LBO transactions. These companies are not expected to be targets of LBOs themselves, since they already have high levels of debt, but patient investors may be able to generate attractive returns. The high leverage in these situations will amplify the return to equity holders, if successful outcomes are achieved.
With record low interest rates, we are looking for investment opportunities in companies that can take advantage of the situation. One of our low interest rate plays is to invest in the equity of highly levered companies that are positioned to grow and repay debt over the next few years. As small investors, we do not have the wherewithal to do take-private LBO transactions like large private equity funds, but we can invest in public companies that have the characteristics of LBO transactions. These companies are not expected to be targets of LBOs themselves, since they already have high levels of debt, but patient investors may be able to generate attractive returns. The high leverage in these situations will amplify the return to equity holders, if successful outcomes are achieved.
Market Update: Q1 Earnings Are Not The Catalyst Investors Are Looking For
[First appeared on Seeking Alpha on April 30, 2012]
This time is different, at least so far. Back in January the stock market rallied through the Q4 2011 earnings season. On January 9, Alcoa (AA) released its Q4 results, marking the beginning of earnings season, and the S&P 500 continued its rally over the following weeks and months.
This time is different, at least so far. Back in January the stock market rallied through the Q4 2011 earnings season. On January 9, Alcoa (AA) released its Q4 results, marking the beginning of earnings season, and the S&P 500 continued its rally over the following weeks and months.
Wednesday, November 16, 2011
Own Your Own LBO: SUPERVALU (SVU)
You don't need to be a private equity fund to do an LBO. With many highly levered public companies, investors can replicate LBO strategies on their own. The Soha Group blog is launching the "Own Your Own LBO" series to look at such opportunities, starting with SUPERVALU (NYSE: SVU).
Background
SUPERVALU is retail grocery chain with over 2,500 stores. The company has made many acquisitions over the years, most notably the $16 billion acquisition of Albertsons in 2006. Today, SVU's banners include Acme, Albertsons, Cub Foods, Farm Fresh, Hornbacher’s, Jewel-Osco, Lucky, Save-A-Lot, Shaw’s / Star Market, Shop ’n Save, Shoppers Food and pharmacies. SVU also has a supply chain business for independent grocers.
The Albertsons deal had a big impact on SVU. SVU paid 6.6x TEV / LTM EBITDA and 20x P/E for Albertsons and took on over $6 billion of debt. Since then, the company has struggled with operational challenges and an unfavorable macro-economic environment due to the recession and high unemployment. One key operational challenge has been SVU's high prices compared to competition. As a result of these headwinds, SVU's top line has been declining (see "Historical Financials" in the model below). Nonetheless, from 2006 through February 2011, SVU reduced total debt by $2.75 billion and is continuing to reduce debt further. Some of the cash for debt repayment has come from selling non-core assets, but most is from free cash flow.
SVU appointed a new CEO, Craig Herkert, in 2009. Prior to joining SVU, he was a senior executive at Wall-Mart and served as CEO of the Americas since 2004. Before he joined Wal-Mart in 2000, he spent 23 years with Albertsons and its related companies.
SVU's motto is to be "America’s Neighborhood Grocer" and its strategy is focused on hyper-local retailing. It believes in decentralizing certain decisions to give its store managers more say in what brands to put on the shelves. Nonetheless, SVU maintains a centralized purchasing and management system across all of its banners. SVU's turnaround plan is called "8 Plays to Win" (see below).
SVU's 5 year stock price chart:
Following a significant fall in the share price over the last few years, SVU's low valuation is compelling. Despite certain challenges, SVU is still generating a substantial amount of free cash flow, $600 million annually (free cash flow is defined as EBITDA, less CapEx, less interest, less cash tax). Even after a $74 million annual dividend and a $110 million pension contribution, SVU has ~$400 million of free cash flow annually that can be used to pay down debt (and thereby increase equity value). In a classic LBO, a private equity fund buys a company that has high debt and then uses the company's cash flow to pay down debt and increase the equity value. SVU is a similar opportunity.
SVU closed at $7.03 on November 24, 2011 and it is approaching the 52-week low of $6.26. Currently, it is trading at 4.23 TEV / LTM EBITDA, 5.62 forward P/E (guidance midpoint) and has a 4.98% dividend yield.
Investment Thesis
Risks
Investment Checklist
Valuation & Model
The following analysis presents:
The returns analysis presents 3 scenarios. The return in the Base Case is projected to be a 18% IRR through 2015 and a 1.93x multiple. The range of returns is from a Low Case multiple of 0.82x to a 34% IRR and 3.20x multiple in the High Case. We think that the most likely outcome is in the range between the Base Case and the Upside Case, so the expected returns are 1.93x - 3.20x over this time period.
Base Case
In this scenario, SVU's financials continue to decline in 2012. EBITDA decreases -4% in 2012 compared to LTM September 10, 2011. EBITDA then stays flat for 2 years and increases 1% in 2015. Debt repayment, a key driver of returns, decreases to $329 million for the next three years because of the lower projected EBITDA (debt repayment in 2011 is expected to be over $525 million in 2011, so this is a conservative assumptions). SVU continues to be valued at 4.23x TEV / EBITDA, which is the current multiple.
Through 2015, SVU managed to repay $1.3 billion of debt, which is the main driver for the increase in equity value. In addition, SVU continues to pay a $0.35 per share annual dividend.
In the Base Case, SVU's stock is projected to increase to $12.16 in 2015. The cumulative return is $13.56, after adding dividends. In this scenario, SVU is expected to generate a 1.93x return and a 18% IRR.
Low Case
Although the Base Case is conservative (EBITDA decline in 2012, less debt repayment than current run-rate, no multiple expansion), the Low Case is even more conservative. It assumes that EBITDA continues to decline each year through 2015 (though at a slower rate each year). As a result, the debt repayment is even lower. Furthermore, the TEV / EBITDA multiple is expected to decrease to 4.00x, from the current 4.23x.
In the Low Case, SVU's stock is projected to decrease to $4.38 in 2015. However, the cumulative return is $5.78, after adding dividends. In this scenario, SVU is expected to generate a 0.82x return and a -5% IRR.
High Case
The High Case assumes that SVU is able to turn-around its operations. EBITDA is projected to decline -2% in 2012 (less than -4% in the Base Case) and return to the LTM level in 2015. As a result, in the High Case SVU can repay $1.5 billion of debt over the period, as opposed to $1.3 billion in the Base Case. Furthermore, the TEV / EBITDA multiple is projected to expand to 5.0x in 2015.
In the High Case, SVU's stock is projected to increase to $21.12 in 2015. The total return is $22.52, after adding dividends. In this scenario, SVU is expected to generate a 3.20x return and a 34% IRR.
NOTE: The model below is meant to present a summary of potential returns and is for illustrative purposes only. The model is not intended to forecast specific annual financial results. Additionally, SVU does not report its fiscal year on a calendar year cycle.
DISCLOSURE: LONG SVU & LONG SVU THROUGH OPTIONS.
Background
SUPERVALU is retail grocery chain with over 2,500 stores. The company has made many acquisitions over the years, most notably the $16 billion acquisition of Albertsons in 2006. Today, SVU's banners include Acme, Albertsons, Cub Foods, Farm Fresh, Hornbacher’s, Jewel-Osco, Lucky, Save-A-Lot, Shaw’s / Star Market, Shop ’n Save, Shoppers Food and pharmacies. SVU also has a supply chain business for independent grocers.
The Albertsons deal had a big impact on SVU. SVU paid 6.6x TEV / LTM EBITDA and 20x P/E for Albertsons and took on over $6 billion of debt. Since then, the company has struggled with operational challenges and an unfavorable macro-economic environment due to the recession and high unemployment. One key operational challenge has been SVU's high prices compared to competition. As a result of these headwinds, SVU's top line has been declining (see "Historical Financials" in the model below). Nonetheless, from 2006 through February 2011, SVU reduced total debt by $2.75 billion and is continuing to reduce debt further. Some of the cash for debt repayment has come from selling non-core assets, but most is from free cash flow.
SVU appointed a new CEO, Craig Herkert, in 2009. Prior to joining SVU, he was a senior executive at Wall-Mart and served as CEO of the Americas since 2004. Before he joined Wal-Mart in 2000, he spent 23 years with Albertsons and its related companies.
SVU's motto is to be "America’s Neighborhood Grocer" and its strategy is focused on hyper-local retailing. It believes in decentralizing certain decisions to give its store managers more say in what brands to put on the shelves. Nonetheless, SVU maintains a centralized purchasing and management system across all of its banners. SVU's turnaround plan is called "8 Plays to Win" (see below).
SVU's 5 year stock price chart:
SVU closed at $7.03 on November 24, 2011 and it is approaching the 52-week low of $6.26. Currently, it is trading at 4.23 TEV / LTM EBITDA, 5.62 forward P/E (guidance midpoint) and has a 4.98% dividend yield.
Investment Thesis
- Potential For ~2x and ~20% Return with Conservative Assumptions - Assuming SVU can continue to repay debt, without any growth or any multiple expansion, SVU has the potential to generate a ~2x return over the next 4 years.
- Base Case Assumes No Growth - In order to achieve a 2x return in SVU over the next few years, the company does not even need to grow. In fact, the Base Case even assumes that EBITDA decreases 4% next year. Due to the economic environment, the return analysis assumes no growth to be conservative. Should there be growth, then the returns could be higher.
- Low Valuation - SVU is trading at a low valuation of ~4.2 TEV / LTM EBITDA. Although the multiples for the retail grocery sector are low in general, ~5x TEV / LTM EBITDA, SVU is trading at a discount to this level. If SVU experiences multiple expansion, the stock price should increase to a higher level than assumed in the Base Case.
- Deleveraging Opportunity - SVU is currently generating ~$600 million of free cash flow (EBITDA, less CapEx, interest and cash tax). After $74 million in annual dividends and $110 million of annual pension contribution, SVU has ~$400 million for annual debt repayment. Currently, SVU has a market cap of $1.5 billion and $6.6 billion of net debt. Because the market cap is 19% of the TEV, the deleveraging will have a significant impact on shareholder value. An annual debt repayment of $400 is equal to 1/4 the current market cap and should increase the equity value by that amount, assuming the TEV / EBITDA multiple stays the same.
- Dividend Yield - SVU pays a quarterly dividend of $0.0875, or $0.35 annually. At the current share price of $7.03, the dividend yield is 4.98% annually. Considering that the dividend represents a $74 million annual use of cash while the company has ~$600 million of pre-dividend free cash flow, there is good cash flow coverage of the dividend payment. SVU has substantial debt, but with no large near term maturities, the dividend seems safe.
- "8 Plays to Win" - The Base Case assumes no operational turnaround. However, SVU's management has launched a turnaround and growth plan that it calls "8 Plays to Win." Should management succeed with this program, the company's financials could improve and provide additional upside for the stock price. Most importantly, SVU needs to focus on lowering prices to remain competitive. SVU is undergoing a shift from relying on promotions to draw customers into their store to a more balanced approach of lower everyday prices, plus promotions. Should the company succeed in lowering prices in a way that does not have a meaningful impact on margins, the company's revenue decline could end and it may experience growth.
Risks
- Continued Revenue Contraction - Revenue has declined for over two years. SVU has been losing customers, in part, because its pricing has not been competitive. SVU's management has been been talking about "investing in price," meaning using the reduction in costs to fund a reduction in pricing to become more competitive. However, SVU may not be successful in reducing price effectively and may continue to lose customers and revenue. For this reason, the Base Case assumes a 4% decline in EBITDA in 2012.
- Food Price Inflation - If prices continue to rise and SVU cannot pass on the increase to its customers, its margins will be impacted.
- Competition - The retail grocery segment is very competitive and, as discussed above, SVU's pricing is currently seen as not competitive.
- High Debt - Although SVU's debt load seems manageable, especially without upcoming large maturities, the high debt load is a potential risk.
- Pension - As of February 26, 2011, SVU had a pension obligation of $2.5 billion and pension assets of $1.9 billion. It appears that the pension was underfunded by $619 million. In FY 2012, SVU projected a pension and post-retirement benefits contribution of $100 million, rising to $133 million in FY 2016. SVU is assuming a 7.75% return on its pension assets, which is high. There is a risk that SVU's pension will not return the projected amount and will be more unfunded than expected. In this scenario, SVU may need to use additional cash for pension contributions instead of debt repayment. The models below assume $110 million of annual pension contributions. SVU's pension disclosure are not sufficient and it is expected that SVU will disclose more data about the pension in the future. However, this is an important risk factor.
Investment Checklist
- Why is this security mispriced?
- SVU's revenue has been declining for over 2 years, its pricing is not competitive compared to other grocers and it has limited growth opportunities. Furthermore, it has a high debt load compared to its peers. As a result the market is currently valuing SVU at a very low valuation.
- What is the market ignoring about this security?
- The market is ignoring the cash generating capabilities of SVU, even in a tough environment, which can continue to fund the company's deleveraging. Even if SVU's multiple does not expand, the deleveraging should be a catalyst for share price appreciation. In addition, there are growth opportunities that we are excluding from our analysis, which could create additional upside.
- What are the key drivers for the security?
- SVU's stock has been declining because of concerns about its above market pricing and concerns of market share loss, combined with concerns over the weak economic environment.
- What is the downside?
- The main concern is that SVU cannot become more competitive and turnaround its declining performance. Should that be the case it may not be able to continue to generate enough cash to continue deleveraging (currently ~$525 million annually). In such a scenario the dividend may also be cut, but it only represents a $76 million use of cash, so free cash flow would need to drop significantly for the dividend to be cut. The company has a manageable debt maturity schedule in the near term, but if it experiences cash flow problems over the long term then it may have difficulty meeting debt obligations. Additionally, SVU's pension is underfunded and has a seemingly unrealistic return expectation of 7.75%. Therefore, SVU may need to contribute more to its pension than currently expected. With an already low multiple, there is little risk of further multiple contraction.
- What is the upside?
- If SVU continues to delever at the current run-rate, or even slight lower, then the stock could rise 1.9x in the next 4 years just based on the delveraging (assuming a constant multiple), which is the Base Case in the model. If SVU experienced multiple expansion to the industry mean and/or growth then the stock could rise further (see High Case).
- What are the upcoming catalysts?
- The investment thesis is based on SVU continuing to delever, which will take time and will occur in small increments. We believe that this process will have a significant impact on the stock in the mid to long term, but may not be apparent in the short term. In the short term, quarterly financial results may provide a catalyst for the stock. SVU's top line has been declining and if it halts the decline, the sentiment regarding SVU may change which could act as a catalyst for the stock.
Valuation & Model
The following analysis presents:
- Valuation overview
- Returns analysis
- Historical financials
- Comparable companies analysis
The returns analysis presents 3 scenarios. The return in the Base Case is projected to be a 18% IRR through 2015 and a 1.93x multiple. The range of returns is from a Low Case multiple of 0.82x to a 34% IRR and 3.20x multiple in the High Case. We think that the most likely outcome is in the range between the Base Case and the Upside Case, so the expected returns are 1.93x - 3.20x over this time period.
Base Case
In this scenario, SVU's financials continue to decline in 2012. EBITDA decreases -4% in 2012 compared to LTM September 10, 2011. EBITDA then stays flat for 2 years and increases 1% in 2015. Debt repayment, a key driver of returns, decreases to $329 million for the next three years because of the lower projected EBITDA (debt repayment in 2011 is expected to be over $525 million in 2011, so this is a conservative assumptions). SVU continues to be valued at 4.23x TEV / EBITDA, which is the current multiple.
Through 2015, SVU managed to repay $1.3 billion of debt, which is the main driver for the increase in equity value. In addition, SVU continues to pay a $0.35 per share annual dividend.
In the Base Case, SVU's stock is projected to increase to $12.16 in 2015. The cumulative return is $13.56, after adding dividends. In this scenario, SVU is expected to generate a 1.93x return and a 18% IRR.
Low Case
Although the Base Case is conservative (EBITDA decline in 2012, less debt repayment than current run-rate, no multiple expansion), the Low Case is even more conservative. It assumes that EBITDA continues to decline each year through 2015 (though at a slower rate each year). As a result, the debt repayment is even lower. Furthermore, the TEV / EBITDA multiple is expected to decrease to 4.00x, from the current 4.23x.
In the Low Case, SVU's stock is projected to decrease to $4.38 in 2015. However, the cumulative return is $5.78, after adding dividends. In this scenario, SVU is expected to generate a 0.82x return and a -5% IRR.
High Case
The High Case assumes that SVU is able to turn-around its operations. EBITDA is projected to decline -2% in 2012 (less than -4% in the Base Case) and return to the LTM level in 2015. As a result, in the High Case SVU can repay $1.5 billion of debt over the period, as opposed to $1.3 billion in the Base Case. Furthermore, the TEV / EBITDA multiple is projected to expand to 5.0x in 2015.
In the High Case, SVU's stock is projected to increase to $21.12 in 2015. The total return is $22.52, after adding dividends. In this scenario, SVU is expected to generate a 3.20x return and a 34% IRR.
NOTE: The model below is meant to present a summary of potential returns and is for illustrative purposes only. The model is not intended to forecast specific annual financial results. Additionally, SVU does not report its fiscal year on a calendar year cycle.
Action Plan
The portfolio already has a long position in SVU. The portfolio is long SVU shares with an average cost basis of $7.25. Additionally, the portfolio sold January 19, 2013 $7.50 put options on SVU. We are considering adding to our SVU position.
The portfolio already has a long position in SVU. The portfolio is long SVU shares with an average cost basis of $7.25. Additionally, the portfolio sold January 19, 2013 $7.50 put options on SVU. We are considering adding to our SVU position.
DISCLOSURE: LONG SVU & LONG SVU THROUGH OPTIONS.
Sunday, October 30, 2011
SemGroup's Saga
After the board of directors of SemGroup Corp. (NYSE: SEMG) rejected an acquisition offer of $24.00 per share in cash from Plains All American Pipeline, L.P. (NYSE: PAA), PAA issued a press release with the news. SemGroup's stock price shot up 20% from $23.56 to close at $28.27 the day after the announcement.
By contrast, SemGroup says in a press release:
Consistent with its fiduciary duties, and in consultation with its independent financial and legal advisors, the SemGroup Board previously reviewed the unsolicited proposal and determined that it substantially undervalued the Company. It also noted that the proposal was opportunistic and not compelling as it fails to adequately reflect SemGroup's bright prospects for stockholder value creation.
PAA's offer of $24.00 per share values SemGroup at 11.02x TEV / LTM EBITDA, which is a discount to PAA's EBITDA multiple of 13.40x. Assuming PAA values SemGroup at the same multiple it is trading at, PAA could pay $30.35 per share for SemGroup based on trailing EBITDA or $36.34 based on the midpoint of SemGroup's EBITDA guidance for 2011. Considering the synergies that PAA believes that it could generate from the acquisition, PAA could reasonable increase its offer to $30-$35 ($32.50 for discussion purposes) and still not overpay.
While SemGroup still seems undervalued at the current price of $28.30, the risk/reward profile has changed. In the near term, the stock price will be influenced by the PAA offer, should PAA continue to pursue a deal. In such a scenario, PAA may raise its bid to the $32.50 range, which would result in approximately $4 per share of upside.
However, if PAA does not pursue a higher offer, more difficult now with the poison pill in place, SemGroup's stock could fall back to the $24 range where it was trading before the PAA announcement, resulting in approximately $4 per share of downside.
While other factors may emerge in the short term that could positively or negatively impact the stock price, such as a bid from another party, the Rose Rock IPO or completion of the NGL transaction, there seems to be balance of upside and downside potential for the stock.
I decided to sell my holding in SemGroup a bit under $28. While I originally thought SemGroup's stock would rise higher, I felt that the 20% increase in the stock price due to the PAA offer created a good opportunity to sell. I may have sold too early and a bidding war may emerge for SemGroup, but I am happy to take my profits and deploy the capital elsewhere with less near term event risk.
Furthermore, I was disappointed with SemGroup's strategic plan, even before the offer. Although SemGroup's assets were undervalued, especially in the low $20s, the plan to transform SemGroup into a holding company with significant positions in two MLPs seemed strange. There is a risk that SemGroup would trade at a discount to its holdings in the two MLPs and it may be more attractive to hold each MLP separately (or deploy the capital elsewhere). I decided not to sell my position in the low $20s because of the upside I believed existed in the assets, but with a sharp increase in the stock price and new dynamics, I am pleased to move on.
If SemGroup's stock falls, I may re-establish my position. Also, I am long Blueknight Energy Partners L.P. (NASDAQ: BKEP), the former subsidiary of SemGroup's predecessor company that has some similar assets as SemGroup. I am considering increasing my stake in Blueknight with the proceeds from the sale of the SemGroup position.
DISCLOSURE: I AM LONG SEMG AND BKEP.
With the stock up 20% on the news and trading well above the offer price, what should shareholders do now? Sell the stock at around $28 or wait for a higher offer from PAA or another party?
Let's start with some background. SemGroup emerged from bankruptcy, which was caused by the trading activities of the previous management team, in November 2010 with a post-bankruptcy equity value set at $25.00 per share. Although, SemGroup's assets are suited for an MLP structure, SemGroup is structured as a corporation.
Since emerging from bankruptcy, SemGroup has tried to reorganize its structure and its assets. In June 2011, SemGroup announced that it was planning to create and IPO a subsidiary MLP, Rose Rock, which would contain most of the assets of its SemCrude division, including crude oil storage terminals in Cushing, Oklahoma; a gathering and transportation system in Kansas and Oklahoma; Bakken Shale operations and a Platteville, Colorado crude oil unloading facility. Then, in August 2011, SemGroup announced that it was selling its SemStream business to NGL Energy Partners LP (NYSE: NGL) in exchange for approximately one third of the common units of NGL, a 7.5% interest in NGL's GP and cash.
Following these two transactions, SemGroup would essentially become a holding company with holdings in two MLPs as well as assorted other assets.
PAA came into the picture on October 6, when it offered to acquire all of SemGroup for $24.00 per share in cash, which was promptly rejected by the board of directors. Later, PAA disclosed that it had made an offer to acquire SemGroup once before. In March 2010, PAA offered $17.00 per share in cash for the company.
It is clear from all of this that there is strategic interest in SemGroup. PAA has had its sights set on SemGroup for a year-and-a-half and NGL is interested in a large part of the business. The question remains will a bidding war begin for SemGroup, which could push the stock price up further?
While PAA seems interested in the business, it seems hesitant to pay up for it. The $17.00 per share bid in March 2010, was well below the $25.00 per share value that emerged in the plan of reorganization. PAA's current $24.00 per share offer "represents a premium of approximately 16% to SemGroup's 10-day average closing price through October 5, 2011, the day immediately prior to PAA's proposal, and a premium of approximately 20% over the 10-day average closing price immediately prior to SemGroup's August 31, 2011 announcement of its pending asset sale to NGL" (PAA's press release). Still, it was only slightly above the $23.56 share price the day before PAA issued its press release about the bid. With the stock at that level, SemGroup could not reasonably accept that bid.
Although PAA went public with its intention to acquire SemGroup, it has not yet issued a higher bid. The press release left the door open for a higher bid in the future, as PAA says:
As a result, we believe you and the SemGroup Board should reconsider our proposal. As we indicated in our previous letter and our discussions with you, we based our proposed value upon public information, and we will consider increasing our proposal if we have full access to SemGroup's non-competitive information and are able to identify additional opportunities to create value. As we also indicated, if preferred by your stockholders, we would consider alternative forms of consideration, including PAA common units... We are committed to completing a transaction with SemGroup. Given the liquidity and substantial value represented by our proposal, we are confident that a substantial majority of SemGroup's stockholders will support our proposal. We have taken the step of making this letter public to explain directly to your stockholders our proposal, our actions and our commitment. Your refusal to engage with us will only further delay the ability of your stockholders to realize liquidity and receive the substantial value represented by our all-cash proposal. In order to move forward quickly, we have retained Evercore Partners as our financial advisor and Vinson & Elkins and Morris Nichols as our legal advisors, and they, alongside our senior management, have already completed extensive analysis and due diligence based on publicly available information. We could complete our confirmatory due diligence, finalize the terms of a transaction and make the appropriate regulatory filings very quickly.
By contrast, SemGroup says in a press release:
The quick rejection of the PAA offer, which SemGroup calls "opportunistic," seems to have brushed off PAA. While PAA still wants to acquire SemGroup, it wants SemGroup's shareholders to encourage the board to pursue a deal before it puts forward another offer. SemGroup's attack on PAA as being "opportunistic" seems warranted.
Furthermore, SemGroup adopted a poison pill on October 28, 2011 to prevent PAA from making a hostile bid for the company. This move limits PAA's ability to execute the deal without increasing its bid significantly.
Furthermore, SemGroup adopted a poison pill on October 28, 2011 to prevent PAA from making a hostile bid for the company. This move limits PAA's ability to execute the deal without increasing its bid significantly.
With SemGroup's stock in the $28 range, 17% above PAA's last offer, the market is already pricing in a higher offer from PAA, which PAA isn't yet ready to put on the table since it feels that the board would not pursue it without shareholder pressure. (NGL, with a $320 million market cap, is not in a position to make an offer for SemGroup.)
PAA's recent actions leave the door open for a higher bid, but also do not necessarily indicate that one is forthcoming. Let's look at what PAA can pay for SemGroup:
While SemGroup still seems undervalued at the current price of $28.30, the risk/reward profile has changed. In the near term, the stock price will be influenced by the PAA offer, should PAA continue to pursue a deal. In such a scenario, PAA may raise its bid to the $32.50 range, which would result in approximately $4 per share of upside.
However, if PAA does not pursue a higher offer, more difficult now with the poison pill in place, SemGroup's stock could fall back to the $24 range where it was trading before the PAA announcement, resulting in approximately $4 per share of downside.
While other factors may emerge in the short term that could positively or negatively impact the stock price, such as a bid from another party, the Rose Rock IPO or completion of the NGL transaction, there seems to be balance of upside and downside potential for the stock.
I decided to sell my holding in SemGroup a bit under $28. While I originally thought SemGroup's stock would rise higher, I felt that the 20% increase in the stock price due to the PAA offer created a good opportunity to sell. I may have sold too early and a bidding war may emerge for SemGroup, but I am happy to take my profits and deploy the capital elsewhere with less near term event risk.
Furthermore, I was disappointed with SemGroup's strategic plan, even before the offer. Although SemGroup's assets were undervalued, especially in the low $20s, the plan to transform SemGroup into a holding company with significant positions in two MLPs seemed strange. There is a risk that SemGroup would trade at a discount to its holdings in the two MLPs and it may be more attractive to hold each MLP separately (or deploy the capital elsewhere). I decided not to sell my position in the low $20s because of the upside I believed existed in the assets, but with a sharp increase in the stock price and new dynamics, I am pleased to move on.
If SemGroup's stock falls, I may re-establish my position. Also, I am long Blueknight Energy Partners L.P. (NASDAQ: BKEP), the former subsidiary of SemGroup's predecessor company that has some similar assets as SemGroup. I am considering increasing my stake in Blueknight with the proceeds from the sale of the SemGroup position.
DISCLOSURE: I AM LONG SEMG AND BKEP.
Sunday, October 23, 2011
Intel Then and Now
On Friday, Intel's stock price closed the week at $24.03 per share and reached $24.24 on Wednesday. Sitting above $24, Intel is at a multi-month high, despite the tablets-replacing-PCs story and the gloom and doom coming out of Europe.
Intel last closed above $24 three times in April 2010, reaching a monthly high of $24.22 on April 15, 2010. Previously, Intel traded above $24 for a short period right before the fall of Lehman Brothers, reaching a monthly high of $24.52 on August 12, 2008.
It is interesting to look at how Intel's fundamentals and valuation have changed since its last two trips above $24.
Date: October 21, 2011
Share price: $24.03
P/E: 10.4x
Dividend yield: 3.50%
Shares sold short: 150.3 million
Revenue: $51.6 billion
EBITDA: $22.6 billion
Net income: $12.8 billion
EPS: $2.31
Net Cash: $8.1 billion
Date: April 15, 2010
Share price: $24.22
P/E: 22.2x
Dividend yield: 2.60%
Shares sold short: 57.5 million
Revenue: $38.3 billion
EBITDA: $16.3 billion
Net income: $6.2 billion
EPS: $1.09
Net cash: $13.8 billion
Date: August 12, 2008
Share price: $24.52
P/E: 20.3x
Dividend yield: 2.28%
Shares sold short: 106.3 million
Revenue: $39.9 billion
EBITDA: $14.9 billion
Net income: $7.1 billion
EPS: $1.21
Net cash: $9.9 billion
(Intel's past results come with the caveat that it acquired McAfee for $7.7 billion in a deal that was announced on August 19, 2010 and closed on February 28, 2011. At that time, McAfee had $2.0 billion of revenue, $430 million of EBITDA and $168 million of net income.)
Compared with the previous two periods that Intel traded above $24, today Intel's valuation seems more compelling. Revenue and profits have increased, the P/E multiple is lower and the dividend yield is higher. Also, net cash has almost returned to the 2008 level, before the McAfee acquisition.
Intel surely faces challenges. It is relatively weak in tablets and mobile, which are growing fast at the expense of PCs. End-markets in the US and Europe face economic uncertainty. Furthermore, it is much harder to grow as the company keeps on getting larger and semis always face cyclicality. That said, Intel has a few bright spots, especially data centers and emerging markets that are driving its growth.
There is considerable negative sentiment concerning Intel right now. Short interest has increased from a low of 48 million shares in January to 150 million shares today. And, 150 million shares sold short is higher than the last two times the stock reached $24. Goldman Sachs' research analyst James Covello has a Sell rating on the stock since May 18, 2011, when the stock closed at $23.41.
With the stock back to $24, both the bulls and the bears can make a good case for their bets. There is a lot of uncertainty now with the ongoing European debt saga, so at any moment macro events may shake the market. However, like several other large caps, Intel's stock price is basically flat for the last decade, despite improving fundamentals. At some point, multiple contraction will give way to a new driver for the stock.
DISCLOSURE: I AM LONG INTC.
Intel last closed above $24 three times in April 2010, reaching a monthly high of $24.22 on April 15, 2010. Previously, Intel traded above $24 for a short period right before the fall of Lehman Brothers, reaching a monthly high of $24.52 on August 12, 2008.
It is interesting to look at how Intel's fundamentals and valuation have changed since its last two trips above $24.
Date: October 21, 2011
Share price: $24.03
P/E: 10.4x
Dividend yield: 3.50%
Shares sold short: 150.3 million
Revenue: $51.6 billion
EBITDA: $22.6 billion
Net income: $12.8 billion
EPS: $2.31
Net Cash: $8.1 billion
Date: April 15, 2010
Share price: $24.22
P/E: 22.2x
Dividend yield: 2.60%
Shares sold short: 57.5 million
Revenue: $38.3 billion
EBITDA: $16.3 billion
Net income: $6.2 billion
EPS: $1.09
Net cash: $13.8 billion
Date: August 12, 2008
Share price: $24.52
P/E: 20.3x
Dividend yield: 2.28%
Shares sold short: 106.3 million
Revenue: $39.9 billion
EBITDA: $14.9 billion
Net income: $7.1 billion
EPS: $1.21
Net cash: $9.9 billion
(Intel's past results come with the caveat that it acquired McAfee for $7.7 billion in a deal that was announced on August 19, 2010 and closed on February 28, 2011. At that time, McAfee had $2.0 billion of revenue, $430 million of EBITDA and $168 million of net income.)
Compared with the previous two periods that Intel traded above $24, today Intel's valuation seems more compelling. Revenue and profits have increased, the P/E multiple is lower and the dividend yield is higher. Also, net cash has almost returned to the 2008 level, before the McAfee acquisition.
Intel surely faces challenges. It is relatively weak in tablets and mobile, which are growing fast at the expense of PCs. End-markets in the US and Europe face economic uncertainty. Furthermore, it is much harder to grow as the company keeps on getting larger and semis always face cyclicality. That said, Intel has a few bright spots, especially data centers and emerging markets that are driving its growth.
There is considerable negative sentiment concerning Intel right now. Short interest has increased from a low of 48 million shares in January to 150 million shares today. And, 150 million shares sold short is higher than the last two times the stock reached $24. Goldman Sachs' research analyst James Covello has a Sell rating on the stock since May 18, 2011, when the stock closed at $23.41.
With the stock back to $24, both the bulls and the bears can make a good case for their bets. There is a lot of uncertainty now with the ongoing European debt saga, so at any moment macro events may shake the market. However, like several other large caps, Intel's stock price is basically flat for the last decade, despite improving fundamentals. At some point, multiple contraction will give way to a new driver for the stock.
DISCLOSURE: I AM LONG INTC.
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