Bidding War Of Hudson's Bay: It's A Buy

Summary

  • HBC is a Canadian retail business group, which trades in the Toronto Stock Exchange since November 2012.
  • HBC hired a new CEO, Helena Foulkes, who worked at Goldman Sachs, and was appointed to create a financially stronger company.
  • With two offers at CAD 10.30 per share and CAD 11 per share, we don’t see a lot of risks.
  • If we use 2020 EBITDA of CAD 406 million, HBC is trading at 9.1x 2020 EBITDA, which we don’t believe is that expensive if we consider the company’s PP&E.
  • In our opinion, the group of shareholders will hold conversations with Catalyst and will agree on a fair price.

With two bidders, Hudson's Bay Company (OTCPK:HBAYF) is a must-follow stock at less than CAD 10.3 per share. Besides, we believe that the company did not contact many potential acquirers, which may lead to additional acquisition proposals. The company has debt, which is not ideal. However, it trades at only 9.1x 2020 EBITDA, which is cheap. Notice that the market expects the company to see an increase in its EBITDA margin in the following two years.

Business Model And Strategy

Founded in 1670, HBC is a Canadian retail business group, which trades in the Toronto Stock Exchange since November 2012. HBC operates a chain of department stores that operates in Canada and the United States.

Source: Company's Website

As shown in the image below, the company's key initiatives include connecting with customers and increasing its productivity. However, what we could learn from the annual report is that the acquisition of other businesses is very relevant for HBC. The amount of transactions executed in the most recent history is impressive.

Source: Q3 2019

See the image below and note that the company is acquiring businesses in the retail sector as well as closing or selling stores:

Source: Author's And Q3 2019

With regards to the real estate business, the company is selling its equity interest and assets. As noted above, the company is trying to diversify its assets in the different joint venture agreements signed. See the table below for more details on the matter:

Source: Author's And Q3 2019

In our view, the years 2019 and 2018 were very relevant for HBC. The change of the CEO in 2018 is very meaningful. HBC hired a new CEO, Helena Foulkes, who worked at Goldman Sachs (GS) and was appointed to create a financially stronger company. The new CEO was responsible for the sale and closure of non-performing stores and assets. In our view, with this CEO, many financial buyers will be interested in assessing the company's future projections.

In 2019, Sale Of Properties Pushed Operating Income Up

In the 39-week period ended November 2, 2019, HBC reported sales of CAD 5.547 billion, -0.76% of the amount noted in the same period in 2018. The gross profit margin was equal to 37%, 200 basis points less than that in 2018. We think that investors will not complain about this small decline in the gross profit margin.

The sale of property and sale of European investments really matter here. They are worth CAD 1037 million and resulted in the operating income increasing to CAD 556 million. If we subtract CAD 1037 from the operating income, the figure is much worse than that in the same period in 2018. Investors should understand that the sale of properties is an extraordinary event. HBC is making a lot of effort, but it is not a profitable company.

Source: Q3 2019

The loss from investment in the EDS Group was valued at CAD -282 million. As a result, the net loss for the nine weeks period ended November 2, 2019, was equal to 935 million. See the image below for more details on the company's bottom line:

Source: Q3 2019

Having said so about the numbers reported in 2019, the market is very positive about the company's EBITDA margin. Market participants expect EBITDA margin to increase from 3.6% in 2019 to 6.07% in 2021. Notice that investors are expecting the company to see a decline in its sales as it sells and closes stores. Sales are expected to stabilize at $8 billion:

Source: MarketScreener (Numbers in million of Canadian Dollars)

Sales Analysis, Seasonality And Store Count

Due to the holiday shopping season, HBC's Q4 sales represent a significant portion of the company's total sales. Approximately one-third of HBC's sales are due to Christmas and holiday shopping season. In the light of this fact, with $5.547 billion in Q1, Q2 and Q3, we would expect 2019 sales to be equal to $8.3 billion.

With regards to the sales percentage change, notice that the sales attributed to Hudson's Bay were lower than that in 2018. Besides, in 2019, the number of stores declined:

"During the third quarter of Fiscal 2019, the Company closed 13 Saks OFF 5TH stores and plans to liquidate and close one additional Saks OFF 5TH store prior to the end of Fiscal 2019 as part of its previously announced review of its Saks OFF 5TH store portfolio in the United States." Source: Q3 2019

Source: Q3 2019

Total Amount Of Leverage May Be Depressing The Share Price

Most investors claim that the company is receiving low bids. While we agree, market participants need to understand that the company's total amount of debt is considerable. The entity, which finally acquires HBC, will have to assume the company's financial obligations. It may have to provide equity financing. Notice that on November 2, 2019, cash on hand was equal to CAD 1.094 billion, inventories were worth CAD 2.5 billion, and PP&E was valued at CAD 3.37 billion. However, loans and borrowings were equal to CAD 2.78 billion. If we add finance lease obligations of CAD 0.3 billion, the company's financial obligations are larger than CAD 3 billion. See the images below for more details on the matter:

Source: Q3 2019

The market expects 2020 EBITDA of CAD 406 million, which means that the company's debt is 7.7x 2020 EBITDA. It does seem that significant. Note that Standard & Poor's Global Ratings gave the company a credit rating of B3. It is not a speculative rating, but is not far from being speculative:

"As of December 14, 2018, Standard & Poor's Global Ratings (S&P) revised the Company's credit rating outlook from negative to stable as a result of significant debt paydown by the Company. Overall S&P's issuer credit rating remains at B. Moody's has assigned the Company a credit rating of B3 and SGL-2." Source: Annual Report

Equity holders should understand that the company's net income is negative, and the market expects it to be negative in the next three years. Besides, the FCF is also not positive. With this in mind, those buying shares will need to understand clearly that HBC could take many years to deliver positive net income.

Valuation: Look At The Properties

Taking into consideration a weighted average shares outstanding of 184 million at CAD 9.88, the market capitalization equals CAD 1.817 billion. With debt of CAD 3 billion and cash of CAD 1.09 billion, the enterprise value is equal to $3.7 billion. If we use 2020 EBITDA of CAD 406 million, HBC is trading at 9.1x 2020 EBITDA, which we don't believe is that expensive if we consider the company's PP&E.

The company's properties really matter on this name. In November 2019, the company's property and equipment were worth CAD 3.37 billion. With a share count of 184 million shares, the PP&E per share is equal to CAD 18 (excluding debt and leases). As we saw above, in 2019, the company sold certain properties and obtained an impressive amount of cash. It means that the fair value of the assets in the balance sheet may be larger than that in the balance sheet.

Go-Private: Two Bidders

The company signed an agreement with a list of shareholders who collectively own approximately 57% of the common shares on an as-converted basis. They offered to buy the company for CAD 10.30 per share in cash:

"On October 20, 2019, HBC entered into a definitive agreement for the privatization of the Company with an entity controlled by a group of HBC shareholders, including individuals and entities related to, or affiliated with, Richard A. Baker, Governor and Executive Chairman of HBC; Rhône Capital L.L.C.; WeWork Property Advisors; Hanover Investments (Luxembourg) S.A.; and Abrams Capital Management, L.P. Under the terms of the Arrangement Agreement, the Common Shares not held by the Shareholder Group (who collectively own approximately 57% of the Common Shares on an as-converted basis), will be purchased for cancellation at a price of $10.30 per share in cash." Source: Q3 2019

In our experience, when a controlling group of shareholders decides to buy the company, many times the Board of Directors do not contact many interested potential acquirers. In fact, Glass Lewis, which recommended shareholders to accept the offer, agreed that HBC has not executed a market check:

"We recognize that the Company did not run a competitive pre-signing sale process here, which may raise questions among investors as to whether the Company was truly able to extract the highest possible value available to shareholders. In general, we believe that shareholders of a target firm are best served by a competitive process that is designed to invite or solicit expressions of interest from any likely suitor. Here, it appears to us that the Continuing Shareholders were never asked to compete for this deal." Source: Glass Lewis

Catalyst offered CAD 11 per share for the company and is also acquiring new shares below CAD 10 per share. Besides, an event-driven fund filed a lawsuit against the company. In the light of this new bid, many in the market are most likely thinking that the company may be worth much more than CAD 10.3 per share:

Source: Glass Lewis

The acquirer needs to have a simple majority of the votes cast by unaffiliated common shareholders to get its deal accepted by shareholders. So far, the group of shareholders doesn't have enough votes to get its offer accepted:

"This proposal, which seeks shareholder approval of the Arrangement Agreement, requires the affirmative vote of at least: 1) 75% of the votes cast by the Company's shareholders, voting together as a single class, present in person or represented by proxy at the meeting; and 2) a simple majority of the votes cast by unaffiliated common shareholders entitled to vote thereon." Source: Glass Lewis

Besides, the Board of Directors rejected the CAD 11 per share offer because Catalyst does not have enough support. Keep in mind that the group of shareholders offering CAD 10.3 per share would not vote for the other offer:

"On December 2, 2019, the Company announced that the special committee had completed its review of the Catalyst Proposal and had rejected such proposal. In arriving at this decision, the special committee noted that the Continuing Shareholders, in their capacity as HBC shareholders, were not interested in any transaction that would result in a sale of their interests in the Company. Since the Continuing Shareholders collectively hold a majority of the Company's common shares on an as-converted basis and do not support the Catalyst Proposal, and the Catalyst Proposal would require the approval of at least 75% of the votes cast by the Company's shareholders at a special meeting, the special committee concluded that the Catalyst Proposal was not reasonably capable of being consummated and thus could not be considered a 'superior proposal'." Source: Glass Lewis

We Think That HBC Will Be Bought At A Minimum of CAD 11 Per Share

There are two reasons to believe that the company will be bought at a minimum of CAD 11 per share. Firstly, Catalyst is a real estate firm and is not a retail business. In our view, other competitors of HBC could obtain synergies if they acquire the company. As a result, they may be able to offer a larger acquisition consideration than Catalyst. We believe that HBC has not contacted other potential buyers. If it commences to contact them, or a financial advisor does so, HBC may get an offer of more than CAD 11 per share. This scenario is, in our opinion, not that likely.

Besides, the group of shareholders will need to offer at least CAD 11 per share. We don't see that the CAD 10.3 per share offer will succeed when another investor offered CAD 11 per share. In our opinion, the group of shareholders will hold conversations with Catalyst and will agree on a fair price. We believe that the final price will have to be at least CAD 11 per share.

Risks

With two offers at CAD 10.30 per share and CAD 11 per share, we don't see a lot of risks. Note that if one shareholder withdraws its offer, we will have the offer from the other acquirer. Besides, the share price is trading below the lowest offer of CAD 10.3 per share.

There does not seem to exist a financial condition for the merger to go through, but, of course, there are several acquisition conditions. The shareholders will need to vote, and the antitrust authorities in the USA and Canada will need to approve the transaction. However, we don't think waiting for the close of the deal makes sense. In our view, if one of the bidders withdraws its offer, we would sell our position.

Conclusion

With valuable assets, HBC is an interesting target for real estate firms and retail operators. Besides, with two bidders, the shares could easily jump up to more than CAD 11 per share if they find a mutual agreement. In any case, we believe that HBC represents a magnificent buying opportunity at the current share price.

This article was written by

Investment Professional. I provide short selling ideas. I have worked in the indsutry for the las 10 years
Follow

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

To ensure this doesn’t happen in the future, please enable Javascript and cookies in your browser.
Is this happening to you frequently? Please report it on our feedback forum.
If you have an ad-blocker enabled you may be blocked from proceeding. Please disable your ad-blocker and refresh.