Shares of Men's Wearhouse (MW) spiked up on Wednesday's trading session after the company received an unsolicited take-over proposal from much smaller competitor Jos. A. Bank Clothiers, in a potential deal which could get really nasty.
The Proposed Deal
The board said that after evaluating the proposal with the assistance of financial and legal advisors, it decided to reject the proposal as it does not reflect the intrinsic value of the company, making it thereby not in the best interest for shareholders.
Under terms of the deal, Jos. A. Bank was willing to acquire Men's Wearhouse for $48.00 per share in cash, which represents a 36.2% premium compared to Tuesday's closing price. Lead director of the board Bill Sechrest commented on the decision to reject the offer:
After careful review and deliberation, our Board of Directors has determined that Jos. A. Bank's proposal significantly undervalues Men's Wearhouse and fails to reflect the Company's growth strategy and upside potential.
CEO Doug Ewert and his board are confident that the company can create more value for shareholders on a stand-alone basis, rather than to just sell the firm to Jos. A. Bank.
Continue On The Strategic Track
Management and the board claims that the offer fails to reflect the leading market position of Men's Wearhouse and its great prospects, as it is confident it can create more value for shareholders in a stand-alone basis.
Men's Warehouse sales are more than two times the size of its next competitor, which is Jos. A. Bank. The company has reported 13 quarters of positive same-store sales growth, while boosting operating margins by 250 basis points over the time period. The company also notes that Jos. A. Bank has been struggling recently.
Besides pointing towards a strong track record, the company sees growth ahead with 100 new store openings, designer products from Joseph Abboud, growing the outlet store base, attracting new younger customers with modern products, and forming partnerships with industry leaders such as Vera Wang.
Positive operating leverage should result in margins expansion through leveraging of the fixed costs, improved logistics and cost cuts.
An Opportunistic Proposal
Men's Wearhouse believes the takeover attempt is an opportunistic move to exploit the dislocation in its stock price, depriving shareholders of the intrinsic value of their investments, after a difficult second quarter.
The offer is furthermore non-binding, and contingent upon debt and equity financing. Men's Wearhouse is not happy to share confidential information needed to perform due diligence on its own business. And last, significant ant-trust concerns could arise, as regulatory review could de-rail a possible deal.
Men's Wearhouse ended the second quarter with roughly $32 million in cash and equivalents, and operates without the assumption of debt.
Revenues for the first six months of the year came in at $1.26 billion, up a percent on the year before. At the same time, net earnings fell by some 12% to $76 million. Full year sales are seen around $2.5 billion, on which the company could report adjusted earnings of $2.50 per share.
The $48 proposal would value Men's Wearhouse around $2.3 billion. This values assets of the firm at 0.9 times annual revenues and 19 times adjusted earnings for the year.
The quarterly dividend of $0.18 per share, provides investors with a 1.5% dividend yield at $48 per share.
Back Of The Envelope Calculations
One thing strikes me immediately after the deal has been announced, which is the positive reaction from the market.
Shares of Jos. A. Bank jumped up about 8%, boosting the value of the company by nearly $100 million to $1.25 billion. At the same time, the company is willing to pay a roughly $600 million premium for Men's Wearhouse, boosting the combined value by some $700 million. This means that the combined market value has increased by some 25% to $3.5 billion.
Jos. A. Bank is at current levels valued around $1.25 billion, or its operating assets just above $900 million after backing out the net cash position of $333 million. This values the company at 0.9 times annual revenues of $1.05 billion over the past year, and roughly 11 times last year's earnings.
In comparison, the offer values Men's Wearhouse at 0.9 times annual revenues and 19 times adjusted earnings, which is explained by structural lower earnings at Men's Wearhouse.
To justify the premium earnings multiple of Men's Wearhouse, Jos. A. Bank would have to identify quite some synergies. It states that it sees significant operating synergies, but does not quantify them in the investor presentation. Despite this, it sees significant earnings per share accretion, resulting in ongoing earnings per share north of $3.50 per annum.
The newly combined company under the proposal would operate 1,700 stores, which would generate $3.5 billion in annual sales, while reporting $418 million in EBITDA. Financing will be done with cash at hand, a $250 million investment from Golden Gate Capital and nearly $2 billion in new debt.
Some Historical Perspective
Last month I last took a look at Men's Wearhouse's prospects after the company reported a disappointing set of second-quarter results.
There has been a lot of turmoil surrounding the company after it fired co-founder George Zimmer back in June, after a disagreement about the strategic direction of the company. Ironically enough, Zimmer was in favor of exploring strategic alternatives, including a possible sale of the company.
Instead the company bought JA Holding, getting a hold of Joseph Abboud, a key brand name that is to play a pivotal role in the new growth strategy, in an attempt to create a full vertical model. Other cash was used to repurchase the company's own shares.
I wrote that some investors were angry, as they supported Zimmer in an attempt to get a deal done somewhere in the mid-40s. In fact, Jos. A. Bank is now offering $48 per share, so undoubtedly a large group of investors is probably eager to tender at these levels, after shares were trading as low as $30 at the start of the year.
I concluded to stay on the sidelines as only the transformed business model or a take-out create instant value for shareholders. In that respect I am surprised by the proposal from Jos. A. Bank.
Besides citing undervaluation, management and the board of Men's Wearhouse reacted negatively to the deal, most likely because the company is under threat to be taken over by its much smaller competitor. Note that Jos. A. Bank only generates 40% of the annual revenues of Men's Wearhouse.
Both companies have seen some weakness in recent times, on the back of weakness driven by cautious retail spending and intense competition. A possible deal, if passed by regulators could diminish competition and result in huge synergies, being a major boost to Jos. A. Bank's shares. This has already been partially reflected in the reaction of the market on Wednesday, bidding up the combined value of both firms by some $700 million.
So what does an investor have to do with all of this? Men's board is pissed off because it might be taken over by its much smaller competitor, which might seem humiliating. That being said, a $48 offer represents more than fair value. Remember that shares have never seen these levels, even not before recent weakness, and I would suspect that some investors would pressure the board to tender.
For Jos. A. Bank a deal at $48 seems nice, although quite some synergies need to be achieved to make the deal really worthwhile, and compensate for the risks being taken given the increase in leverage.
However, I don't expect that a possible deal would go smoothly, given the aggressive stance by the board and management of Men's Wearhouse.
This is far from a done deal. Keep an eye out for any news flow in the coming months in what could be a real battle of the boardroom.