Spear Point LLC
220 Camp Street, 5th Floor
New Orleans, LA 70130
July 9, 2013
Board of Directors
14 Wall Street, 15th Floor
New York, New York 10005
Dear Members of the Board of Directors:
Spear Point LLC ("Spear Point") currently owns 718,197 shares of TheStreet's ("Company") Common Stock. As we have stated publicly and privately to the Company, we believe the Common Stock of the Company is undervalued and we have grave concerns about the Company's ability to increase value for a number of reasons. The most pressing of these relates to the Preferred Stock position held by Technology Crossover Ventures ("TCV" or "Preferred Shareholders"). We strongly believe the Company must act now to address the $55 million liquidation preference attached to those shares rather than waiting until the Company's cash position is depleted through a string of small acquisitions that have little chance of having a material impact on the Company's growth. In particular, we believe it is in the best interest of all stakeholders that the Company immediately engage an investment banking firm to seek strategic alternatives for the firm, including a merger, acquisition or sale of all or most of the assets of the Company. We would intend to participate in such a process and would welcome the opportunity to discuss an initial offer for the Company that we believe would be fair to all parties concerned.
As background, we note that the Preferred Shareholders invested $55 million in November 2007. For this investment, they received 5,500 shares of Series B preferred stock (the "Preferred Shares") with a face amount of $10,000 per share. Such Preferred Shares are convertible into shares of Common Stock at a conversion price of $14.26 per share, meaning that if the Preferred Shares were converted into shares of Common Stock, the Preferred Shareholders would receive 3,856,942 shares of Common Stock (the "Conversion Shares").
Our position is that the Preferred Shares held by TCV greatly diminishes the value of the Common Stock. In addition to the liquidation preference, we believe these shares also inject significant uncertainty into the long-term value of the Company as a whole. It is our understanding that the Preferred Shareholders believe their Preferred Shares should be valued at the full $55 million liquidation preference.
We recognize that the Preferred Shareholders made an investment in the Company, have the rights attached to that investment, and that things turned sour rather quickly after they made the investment through a series of Company-specific and macroeconomic factors. We all make bad investments from time to time and suffer from events we cannot control. However, the idea that somehow they will receive the equivalent of $14.26 per share is highly dubious to any outside observer over just about any time frame and under any reasonable assumptions. If the Preferred Shares were converted into shares of Common Stock, the resulting Conversion Shares would be valued at approximately $7.02 million at today's share price of $1.82. Our research shows that upon conversion, the Company's overall Common Stock could appreciate in value by as much as $2.00/share. If that were to happen, the Conversion Shares would be worth approximately $14.73 million. We contend that is the fair value of the Preferred Stock.
We understand in the course of preparing its financial statements the Company had a third party evaluate the present value of the Preferred Shares at $39.2 million. However, it appears to us that this analysis merely assumed a liquidation event at some future date at which the Preferred Shareholders would receive the full $55 million liquidation preference and simply discounted that amount by some rate to arrive at the present value. It does not appear from the Company's financial statements that this evaluation took into consideration the likelihood that the Company gets to such an event, especially considering it would require the approval of the Common Shareholders.
We realize one can make the argument that the cash from the investment made by the Preferred Shareholders currently constitutes "cheap money" that acts like debt without interest or negative covenants, but we think this overlooks the impact of uncertainty on the market value of the Company. In addition, since the liquidation preference of the Preferred Stock is paid upon a change in control, the Preferred Stock acts as a "poison pill" that makes a strategic buyer less likely to acquire the Company, further dampening the value of the Company. We believe the Company's current strategy of leaving the Preferred Stock in place and executing an M&A driven strategy to grow the Company, in effect earning its way out of the liquidation preference, is highly risky and unlikely to be effective. The logic here appears to be that because the Preferred Stock has no real leverage over the Company, save the liquidation preference, it would make sense for the Company simply to spend the remaining cash on growth-oriented acquisitions. There are three potential outcomes from such a strategy:
· Scenario 1 - Significant organic growth occurs once the cash position has been exchanged in one or more acquisitions;
· Scenario 2 - Organic growth does not occur and despite additional acquisitions the Company essentially remains flat with regard to revenue and profitability (i.e. trading cash for more revenue but no real growth); or,
· Scenario 3 - The Company continues the previous management team's history of simply using shareholder cash to offset subscriber and advertising attrition and we end up with a Company that has a greatly depleted cash position, neutral revenue and profitability, and no real potential for growth.
As optimists who hold the current management and Board in high esteem, we are inclined to give the Company the benefit of the doubt and say the most likely outcome would be Scenario 2. Therefore, we will explore the other two scenarios first and then focus our final analysis on Scenario 2.
Scenario 1 is the pitch to the overall stock market in which the Company continues to make one or more strategic acquisitions and reaches the holy grail of M&A, namely 1+1 = 5. It is the sizzle on this rather over-cooked steak and is the means by which the stock price leaps from current prices to levels not seen for years, for example, $10.00 per share. The risks in such a strategy are self-evident, but in the Company's particular case, it is even more pronounced based on a string of mediocre-to-disastrous past acquisitions, albeit under prior management teams. Due to its capital structure, we also do not believe that the Company can execute high-quality, large-scale acquisitions that would drive significant organic growth. Even assuming flawless execution by management, would TCV even be willing to convert their Preferred Stock at $10.00 per share? If so, they would still be nearly 30% out of the money.
This is an easily testable hypothesis. The Company merely needs to offer TCV $10.00 per share, or $38,569,420 and retire the Preferred Stock. Assuming that TCV accepted such an offer, the Company would then have approximately $20,000,000 in net cash and a clean capital structure that we believe would result in a higher price per share for the Company's Common Stock. This in turn could be used in future accretive transactions. However, we do not believe TCV would accept even this overly generous offer and as stated earlier, we think this is more than twice what we consider to be the actual fair value for their position. Therefore, even in this best case scenario they will continue to act as a virtual poison pill to further value creation.
On the other hand, Scenario 3 represents a far darker case whereby the Company squanders the cash position on acquisitions that not only fail to spur organic growth, but cannot even stem the erosion of subscriptions and advertising revenue. At best, the end result is a Company that limps along and continues to promise better days ahead as it dies a long, slow death. In this case, the Common Shareholders are left holding illiquid stock with declining value while the management team has wasted its time and the Company's resources. Of course, the Preferred Shareholders would merely delay their day of reckoning on marking their investment to its fair value, but they would have little or no hope of achieving more than a mere fraction of their initial investment. Exit values for all concerned would not be pretty.
So this brings us to Scenario 2 - We consider this the most likely outcome for the foreseeable future. The Company should be able to make one or more small "tuck-in" acquisitions, such as the recently concluded deals for The Deal and DealFlow Media. While these transactions appear to have been executed at reasonable values, there is a reason the sellers were willing to take such value. Furthermore, it is telling that to our knowledge these deals did not contain meaningful components of the consideration in Common Stock. We believe this is because the Company is not in a position to "sell" its future value to a target acquisition. With the Preferred Stock overhang, the Company must use cash for most of its acquisitions because target companies apparently do not believe the prospects for the Company's Common Stock are very good. This fact greatly restricts the scope of deals the Company can do, and almost certainly eliminates the prospects for large-scale acquisitions that could have a major strategic impact on value creation. One of the main reasons to tolerate the compliance costs, regulations and competitive scrutiny that comes with being a small public company is the ability to access the capital markets at strategic moments like acquisitions, but the Company apparently cannot do so even with the smallest of acquisitions.
Of course, we are aware of the arguments against diluting the Company's common stock with shares issued in an acquisition, but stock components in deals force the seller to participate in the risk going forward alongside shareholders and would give the Company the ability to go after significantly larger targets that have a higher probability of making a strategic impact on value. Unfortunately, this does not seem to be a tool the Company can use to scale its business and we attribute that directly to the Preferred Stock overhang. All things being equal, of course, we would prefer not to be diluted in acquisitions. But better to be diluted today in order to acquire an accretive set of assets that will produce significant future value than to push the cash position of the Company below the value of the Preferred Stock's liquidation preference. If that happens, as common shareholders we could find ourselves in the unenviable position of getting very little value in a future sale of the Company.
As best as we can discern, the plan for the next 24 months is to continue to make acquisitions using the Company's cash and hoping that one of these smaller acquisitions will contain the magic formula for finally achieving strong organic growth. We are concerned that this puts management in a position of significant moral hazard. In order to achieve enough growth from small scale acquisitions to pay off the Preferred Stock's liquidation preference, management may be tempted to pursue ever riskier deals with the Company's cash position. In the absence of a home run, the cash position will be reduced and the Preferred Shareholders will reap the vast majority of any sale of the Company at that time. Of course, a sale of the Company would require the vote of the common shareholders, who would be unlikely to agree to any value that substantially accrues to the Preferred Shareholders at their own expense. Therefore, one can argue that the liquidation preference is virtually worthless because the likelihood of common shareholders approving such a deal is minimal. The bottom line is that the Company should not reduce the cash position below the liquidation preference because it then shifts leverage and value to the Preferred Shareholders in a sale of the Company, but the Company cannot execute its M&A strategy because it cannot use its equity in deals.
Looking forward, our concern is that the Company finds itself a year from now with a depleted cash position, an unrealistic Preferred Shareholder and little to no growth. Then what? Bring in new management who can then blame Elisabeth DeMarse and her team and replay the entire fiasco on a smaller scale? Or perhaps seek a strategic exit? As stated above, with less cash and little to no growth, any potential strategic buyer and the Preferred Shareholders would be in a position to squeeze Common Shareholders even further. This is not a situation in which we would like to find ourselves.
Therefore, we believe it is in the best interest of all stakeholders that the Company immediately engage an investment banking firm to seek strategic alternatives for the firm, including a merger, acquisition or sale of all or most of the assets of the Company. As we have stated above, we believe that even under the best circumstances we may not be able to achieve enough growth to offset the liquidation preference of the Preferred Stock. Ms. DeMarse and her team have shown great skill in finding strategic buyers for the companies in which they have worked in the past and we believe they should pursue such action for our Company now while we still have a strong balance sheet that could be used to offset the onerous, value-killing Preferred Share overhang. Finally, Spear Point would intend to participate in such a process and would welcome the opportunity to discuss an initial offer for the Company that we believe would be fair to all parties concerned.
We understand the challenges a public company management team faces on a day-to-day basis. That said, we would appreciate an answer to whether the Company will engage an investment bank and whether the Company would enter into a serious dialogue about a take-private offer from Spear Point by end of business on July 16, 2013.
Finally, we would like to note that we see ourselves as owners rather than passive investors and believe strongly that now is the time to act on a strategic transaction. Although we are ready and willing to work with the Board and management to create shareholder value, we are also willing to pursue an independent strategy if we feel we cannot align our views with current management.
Rodney "Ron" Bienvenu
Co-Chief Executive Officer
Spear Point LLC
Disclosure: I am long TST. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.