Anyone who has been around this business for a while knows the name Saul Rubin (a former auto analyst for UBS). I wouldn't put him in the ranks of a Steve Girsky, Mary Ann Keller, or Nick Lobocarro. But I've always felt Saul did some pretty forward looking stuff. Especially some of the work he and a colleague did in the area of telematics back in 2000/2001.
So I was encouraged on Friday when the folks from Rockhampton Management sent me a press release with their response to the Keystone merger announcement. Saul Rubin is the Portfolio Manager of Rockhamption and the press release was a letter Saul sent to Ronald Foster, Chairman of Keystone (KEYS-OLD).
You will notice it is incredibly in sync with my view. Although I don't share their $75 price requirement (I also care about LKQ's (LKQX) shareholders and believe they should not pay too much for the deal). I suspect Rockhampton's strategy is to start high and hope the board meets them somewhere in the middle.
But just so you know, Rockhampton arrived at the value by calculating a $67 value (on a discounted cash flow basis using a 9% operating margin assumption in FY09) and then adding another $8 per share based on the synergies LKQ will receive.
Now, I am not going to go into the whole press release/letter, but here are a few key paragraphs:
Dear Mr. Foster,
I am writing to express my shock and dismay at the entirely inadequate price you and the Keystone Automotive board have unanimously decided to accept for the acquisition of Keystone by LKQ Corporation; and, to make it clear why I fully intend to vote the shares over which we have control against the proposed transaction, and why I hope that other shareholders will do the same. In short, I believe a transaction at any price below $75 a share to be unacceptable. Furthermore, I intend to vote against the re-election of several (if not all) of the directors proposed for re-election at the upcoming AGM scheduled for August 1, 2007. Rockhampton Management U.K. LLP currently controls on behalf of its clients 664,825 shares, or 4%, of Keystone Automotive Industries Inc.
Given the lowly sum being offered it is no wonder that on the day of the announced transaction (July 17th, 2007) the market's immediate verdict was a blow to Keystone shareholders. The amount by which the markets marked up the values of the two companies was an aggregate $252m; but the market delivered a staggering 79% of the increase to LKQ Corp. Often is the case where the markets reward the acquiree's stock and punishes the acquirer's stock. When synergies are obvious, the market will sometimes reward both. Rarely indeed does the market deliver the greater portion of the rewards to the acquirer. But the board of Keystone has managed to achieve just that.
Let me be clear at the start: a union of Keystone and LKQ makes perfect strategic sense in my opinion. There is no objection to the logic of combining the groups - merely a strenuous objection to the terms of the agreement. Furthermore, while a combination of Keystone and LKQ makes sense, there is no reason to believe other entities would not also be keenly interested in acquiring this terrific asset; in addition to strategic buyers such as large aftermarket auto parts retailers and wholesalers, given its characteristics (strong cash flow and strong growth prospects, combined with a strong, sub-optimal capital structure) the asset might be of considerable interest to a private equity buyer. . .
Keystone is a great asset that has yet to perform to its full potential. While I can fully recognize there may be appeal to some of selling ahead of further hard work and looking forward to a peaceful retirement, that logic cannot and should not determine the actions of the non-executive board members. I actually have a high degree of confidence in Mr. Keister. That said, if current management is not willing or able to work this asset to drive true value creation for its shareholders then I am sure that there are other highly capable people who would be willing to do it. The board ought to be ensuring that the highest caliber individuals are working to improve returns and drive shareholder value, rather than wasting time ruminating over derisory offers such as the one it has currently put its name to.
My team and I are looking into what options are available to us to ensure that proper value is garnered for Keystone shareholders. It is our opinion that this deal is so contrary to shareholders' interest that we can have little confidence in the current board of directors. As a result, and in light of this highly material proposed transaction, I would strongly urge you to delay the upcoming AGM scheduled for August 1st so that shareholders have time to consider putting forth directors of their own choosing.
A few closing thoughts
I also talked with Keystone's CEO Rick Keister this morning. Management felt they went through a comprehensive due diligence process and did work in the best interest of Keystone's shareholders. He indicated they hired JP Morgan to do an independent review of the deal. The stock is at a 22% premium to where the quarter began. The offer was about 11/12x on a total firm value multiple of EBITDA (highly attractive multiple).
Beyond that, it sounds like I need to wait for more details when the proxy is released.
I told Mr. Keister that so far (until I see more details from the proxy) this is just an area where we will have to agree to disagree. And the reason is because I am not concerned with what Keystone's historical earnings were (and multiples thereof), or what the market was valuing the stock at.
As I often write, at the end of the day, what really matters are the returns (earnings, cash flows, etc.), the company will deliver. And I still believe Keystone could achieve close to $70 million in operating income on its own in a few fiscal years, about 50% more than what they earned in fiscal 2007. And the merger with LKQ presents just a ton of revenue and cost synergies beyond that. So I still think the shares are worth more than what is currently being offered.
Now there is one criticism being put out there that I have a mixed opinion about. In Saul's letter and even comments posted by people on seeking alpha to my earlier articles, people have criticized Keystone's management for using JP Morgan to write the fairness opinion.
The reason people seem concerned with using JP Morgan is because they do not have active sell side (investment research) coverage on LKQ or Keystone and therefore are not likely to understand the industry.
A good point. But I should also point out that if they had gone with a brokerage firm that understands the industry, the brokerage firm providing the fairness opinion could have a serious conflict of interest.
Because LKQ is likely to do a secondary stock offering to bring down the debt after this transaction is completed. And the brokerage firms providing sell side coverage would therefore likely be involved in such a transaction (receiving hefty banking fees).
So having one of those sell side brokerage firms do the fairness opinion could be just as dangerous as using someone who doesn't understand the industry.
But once again, I sincerely hope the Board of Directors will hear shareholder and my pleas to reconsider the offer.