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Summary

  • Destination Maternity called off the proposal after refusing to raise the bid after Mothercare’s two rejections of previous price and stock offers, showing sound financial discipline in refusing to overpay.
  • Higher uncertainty over the merger was anticipated by my thesis due to the changing sentiment of the U.S. administration toward tax inversion deals and Mothercare’s several objections to the merger.
  • The merger cancellation is overall positive for DEST shareholders. I reiterate my bullish thesis and a $26.30 price target. DEST’s hunger for growth or return of value will continue.

Destination Maternity (NASDAQ:DEST) announced on Friday that it "does not intend to make an offer for Mothercare Plc. and is withdrawing its proposal for a possible combination with Mothercare Plc." Higher uncertainty over the merger and its potential benefits was anticipated by my thesis. The primary reasons were the changing stance of the U.S. administration toward tax inversion deals and lack of enthusiasm from Mothercare Plc. regarding the potential synergies, financing and pricing of the merger. A relatively large share of DEST's stock compared to cash in the deal was one of the factors that probably demotivated Mothercare, too.

Because the merger included a DEST share dilution proposal and due to the fact that DEST would have had to pay a very high price in order to make the deal eventually happen, it is overall positive for DEST shareholders that the merger did not go through. I remain even more bullish on DEST after the announcement as the hunger for growth will likely intensify. Destination Maternity will now scramble to acquire growth fast to show a full-year 2014 top line growth. The growth thesis is likely to be satisfied with or without this merger through another merger, faster store expansion or higher share buybacks and dividends. As the company said in the announcement: "We will continue to focus on delivering our strategy to drive sales and profit growth, both in the United States and through the continued expansion of our brands internationally." In the medium term, investors should closely watch for any potential announcements of a new merger proposal.

In the near term, the next step for the company is to release its full 10-Q earnings results for the second quarter of 2014. Due to U.K. merger rules, DEST was only allowed to release sales results but not earnings data and other details including a forward guidance. However, DEST previously warned that the guidance would certainly be updated downward below the lower boundary of the previous range. The full Q2 10-K SEC filing is expected to be made by the August 11 deadline and may temporarily bring higher volatility to the DEST's stock price, together with potential merger arbitrage trades unwinding. However, any price weakness should be used as a buying opportunity unless the earnings announcement is shockingly negative. I reiterate my long thesis as well as the previous price target of ~$26.3 per share, which offers a roughly 20% upside within 12 months.

Source: Update: Destination Maternity Drops Merger Proposal For U.K.'s Mothercare Plc.