Dorel: Ride This COVID Beneficiary With FCF Yield Of Over 30% And 100% Upside
Summary
- Dorel was subject to a failed take-private by management. Shareholders thought the bid was inadequate and rejected it. As a result, risk arbs are forced to sell, pressuring the stock.
- Dorel is trading below the proposed take-private price, equating to a FCF yield of over 30%.
- At the same time, fundamentals for the business are extremely strong, benefitting from unprecedented demand for bikes and home furniture due to the Covid effect.
- Today, public investors can buy Dorel well below where management insiders and private equity were prepared to bid for the whole company, benefitting from tailwinds and FCF generation.
Ride This COVID Beneficiary With FCF Yield of Over 30% and 100% Upside
After a failed take-private attempt by Cerberus and management, which offered shareholders zero premium, shares of Dorel (OTCPK:DIIBF) trade below their pre- take-private price. Minority shareholders were dissatisfied with the bid, despite a bump versus original terms, and opted to keep the company public to benefit from a positive inflection in fundamentals. During the take-private period attempt, equity indices were +20% and Dorel reported Q3 2020 blowout earnings due to unprecedented demand for its products. Dorel is a rare stock that has benefited from Covid-19, that is not trading at nosebleed valuations.
The first three quarters of 2020 (not even full year) generated Free Cash Flow of $4.14 per share, equating to a FCF yield of over 30%. My conservative valuation estimates indicate 100%-200% upside from current levels. The reason for the extremely discounted trading price today is due to technical selling with the exit of risk arbitrageurs who were betting on a deal close.
Business Summary
Dorel Industries (“Dorel”) is a consumer product company operating in three verticals:
- Premium bicycles (Dorel Sports brands include Cannondale, Schwinn and GT);
- Juvenile products (Dorel Juvenile brands include Maxi-Cosi, Quinny and Tiny Love); and
- Home furniture (Dorel Home brands include Cosco, Signature Sleep and Ollie & Hutch).
Source: Dorel Q3 2020 Earnings Presentation
Revenues are roughly split evenly between the three segments and operating profitability split depends on the year in question. As one would expect, Dorel’s business has significant operating leverage (on top of financial leverage). The cyclicality of the business has created numerous cycles with Covid-19 acting as the catalyst for the next boom cycle for the business (more on this below).
Brief History
Dorel went public in 1987 with a dual-class share structure after a merger between Dorel (manufacturer of children’s gear) and Ridgewood Industries. Ridgewood was founded by Martin Schwartz, Alan Schwartz and Jeff Segal. The Schwartz family and Jeff Segal have been actively running and controlling Dorel since the IPO. The family owns a 19.2% economic interest (~6.6mm Class A shares), while controlling 60% of the votes. The stock did a whole lot of nothing from 1998-2017 – trading between $20 and $43 per share (while paying out significant dividends). The company suffered operational hiccups and margin compression in the bike business in 2018 and 2019, which combined with a heavy debt load, sent the shares to $6 at the end of 2019. When Covid-19 hit, the stock bottomed out at $1.34 on March 23, 2020 and proceeded to recover meaningfully over the coming quarters, hitting double digits in fall 2020.
Shareholders Say “No” to Take-Private
After three plus decades of floundering in the public markets, Dorel announced on November 2, 2020 that Cerberus Capital Management would acquire the company for $14.50 per share – representing a premium of $0.11 (i.e., less than 1%) versus the previous days’ closing price. Quite the generous takeover premium! As part of this transaction, the Schwartz family would roll their 19.2% economic interest in Dorel and their interest would increase to 26.7%-31.5% in “certain circumstances.” Furthermore, the announcement stated: “The Family Shareholders have advised the Special Committee that they are not interested in any alternative transaction, including the sale of their interests in Dorel or the sale of any of Dorel’s business segments or material assets.” So, the Schwartz family is willing to increase their interest in the company by 64% at levels above the current share price.
In the table below, I have provided a detailed account of the twists and turns in this take-private battle between Cerberus/Schwartz family and public shareholders. In summary, large shareholders publicly announced their displeasure for the $14.50 price (with a shareholder suggesting that various adjustments in the Fairness Opinion could take the value to $56.38 per share or ~290% higher than the original $14.50 bid). As a result, Cerberus/Schwartz family raised their bid from $14.50 to $16.00 (11% total premium versus undisturbed price).
Shareholders continued to publicly voice their displeasure at the new bid and Cerberus/Schwartz family ultimately terminated the transaction the day prior to the shareholder vote. I would also note that both Glass Lewis and ISS advised shareholders to vote against the transaction, as even the improved bid materially undervalued the company. In my experience, proxy advisors nearly always recommend votes in favor of management. When was the last time both proxy advisors recommended voting against a transaction on a judgment call on valuation? That is a striking piece of information as to just how much the bid undervalued the company.
- Nov 2, 2020: Dorel announced that Cerberus would acquire non-family controlled shares for $14.50 per share, which was a premium of <1% versus previous days' close. There was an exclusivity period for a few weeks with the definitive transaction formally announced on November 13, 2020. The transaction required approval from 66.67% of all shareholders and a majority of the minority.
- Nov 2, 2020: Letko Brosseau & Associates, which owned 13.1% of Class B subordinate shares, announced that it would vote against the transaction as it valued Dorel at 11.3x 2020 EPS and 2x cash flow per share. As well, Dorel Sport and Dorel Home generated record revenues in the previous quarter.
- Dec 9, 2020: Letko Brosseau reiterated its intention to vote against the transaction citing a host of reasons including no M&A premium and the bid price being a 61% discount on an EV/EBITDA basis versus its peer group.
- Dec 23, 2020: Letko Brosseau reiterated its intention to vote against the transaction citing a host of reasons including the M&A price being a large discount to the $20-$43 range over the last 20-years, record sales over the last 12-months and a punitive Fairness Opinion from TD Securities.
- Dec 24, 2020: Dorel postpones the shareholder meeting from January 12, 2021 to February 16, 2021.
- Jan 29, 2020: Letko Brosseau reiterated its intention to vote against the transaction - focusing on the flawed methodology in TD Securities' Fairness Opinion. "These adjustments total C$37.50 per share. Adding these back to TD's mid-point C$18.88 value per share results in an estimated value of C$56.38 per share."
- Feb 1, 2020: Cerberus and management improve the bid price from $14.50 to $16.00. Notably, no shareholder support was announced as part of this press release.
- Feb 2, 2020: Letko Brosseau announced it would vote against the revised acquisition price of $16.00.
- Feb 2, 2020: Brandes announced it would vote against the revised acquisition price of $16.00.
- Feb 15, 2020: Dorel announced it was terminating the go-private transaction.
- Feb 16, 2020: Letko Brosseau announced it was pleased that Dorel terminated the go-private transaction. "We have every confidence in the management and strongly believe in the long-term potential of the Company."
Why did Cerberus terminate the transaction and not try another bump? I think the bid/ask was simply too wide. Cerberus likely had numerous discussions with Letko Brosseau and Brandes and realized their ask was more than just a few extra dollars on the $16.00 improved offer (Letko Brosseau’s press release on January 29, 2021 indicated a $56.38 value could be achieved with some non-heroic adjustments to TD Securities’ Fairness Opinion). By February 15, 2021, the day before the shareholder vote, Cerberus knew it did not have the votes and that the bid/ask could not be bridged.
Since the termination announcement, shares of Dorel are down ~15% and are now trading below the undisturbed price on October 30, 2020. Meanwhile, the S&P TSX is up almost 20% during this period and Dorel announced blowout Q3 2020 earnings. Assuming a beta of 1.00 to the S&P TSX (actual is much higher), Dorel stock would be trading with an $18-handle rather than <$14.00 if it were not for the negative trading technicals of arbitrageurs exiting the position.
Side note: I think the reason Dorel announced the take-private on November 2 was because the Cerberus/management knew the bid would act as a ceiling on the share price ahead of announcing blowout Q3 2020 earnings on November 13. The stock probably would have risen to the high teens on the earnings announcement if this bid did not hold it down.
I think that once arbitrageurs exit their position, Dorel is set to play some serious catch-up as its underlying fundamentals are stronger than ever.
I also think there is a possibility that a new private equity bidder (along with management) could step up and take another shot at a go-private transaction. The family has shown its desire to take this Company private and there are lots of private equity dollars chasing assets. Dorel is the quintessential MBO/LBO candidate with significant operating and financial leverage and the ability to throw off gobs of free cash flow.
Covid Has Been A Massive Windfall for Dorel
Dorel Sport and Dorel Home have been massive beneficiaries of Covid as bike and home furniture sales have soared. Management commentary describes “demand for bikes took off to an extent never seen before”.
Source: Bloomberg Transcripts From Dorel Q2 2020 Earnings Conference Call
Demand for bikes is unprecedented, resulting in global shortages as production supply across all brands is unable to keep up with the shift in demand.
Bike Shortages Aren't Going Away Anytime Soon-Here's Why
Here’s a good first-person market check. Have you, or anyone you know, tried to buy a bike in the last year? If so, you should ask them about their buying experience. it was likely very difficult, with new bike shops completely sold out of inventory for months on end, forcing prospective customers into the second-hand market. For these poor souls, they quickly realized that the second-, third- or fourth-hand bike market is quite efficient and immediately priced in the supply/demand imbalance, resulting in astronomical prices for decades-old bikes.
Take this example – a 21-year-old Cannondale manufactured and sold when Pets.com was in the Macy’s (M) Thanksgiving parade and buying Super Bowl spots, listed with an asking price of USD$1,200.
Or how about this one, my guess is a near 30-year-old Cannondale bike, condition is “might need a tune up”, asking price is US$900, but keep in mind to not waste his time with cheap offers as he will not reply.
Massive Free Cash Flow Generation
Dorel’s financial windfall as a result of Covid-19 has been staggering. Through the first three quarters of 2020, free cash flow increased by 250% YoY – equating to a leveraged free cash flow yield of 38% (and that’s just on 3 quarters!). Leverage has also been reduced as Dorel’s long-term debt fell 20% YoY. Covid-19 has effectively allowed Dorel to equitize its balance sheet without issuing a single share.
When its balance sheet was in better shape, Dorel was a significant dividend payor. Prior to discontinuing dividend payments in Q3 2019, Dorel paid a quarterly dividend of US$0.15-US$0.30 per share. If they were to reinstate that same dividend, the stock would be yielding ~5.5%-11.0%.
There are only two analysts that cover Dorel – BMO Capital Markets and TD Securities. Upon termination of the take-private transaction, both analysts updated their target prices to $16.00 and $14.50, respectively. In other words, the analysts lazily used the original Cerberus/management bid price and the revised Cerberus/management bid price as their “new” target prices.
What Is Dorel Worth?
In 2017, Dorel generated north of US$2.00 per share in earnings. I think the Company can easily achieve north of US$2.00 in each of the coming years. Applying a conservative 12.0x multiple on those earnings gets a C$30.24 price target – which is ~120% upside from current levels.
Source: Dorel Q3 2020 Earnings Presentation
The circular for the take-private is interesting – particularly TD Securities’ Fairness Opinion. It is worth reading TD Securities’ Fairness Opinion (starts on PDF page 165) and then reading Letko Brosseau’s January 29, 2021 press release pointing out small non-heroic adjustments that could achieve a $56.38 value for Dorel.
I will utilize TD Securities’ 2021 unadjusted EBITDA estimate of US$161.3 million from the Fairness Opinion to derive my EV/EBITDA valuation (arguably conservative as analyst estimates on Bloomberg are higher). Note that the Fairness Opinion expected EBITDA to steadily increase every year from 2021-2024. Utilizing the Fairness Opinion 2021 EBITDA estimate and applying a 9.0x multiple gets me a target price of C$44.32 which is >220% upside from current levels. Regardless of how I slice this, Dorel stock is incredibly cheap at current levels.
Source: Dorel Management Information Circular Dated December 3, 2020
Conclusion
Dorel is an incredibly cheap stock. The current price provides an opportunity to acquire shares below Cerberus/Schwartz family’s takeout price (and even below the undisturbed price). The Company has tailwinds that will benefit its financials for 2021 and years beyond. Recall that the Schwartz family, who knows the business intimately well, was willing to increase their interest by up to 64% at $16.00.
I recommend BUYING shares of Dorel.
This article was written by
Analyst’s Disclosure: I am/we are long DIIBF. 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.
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Comments (18)
I do not think Dorel is an attractive stock here. The Schwartz family has mismanaged it horribly for decades -- just look at the sales and profit records going back years. It is a grab bag of mediocre assets with no upside facing it. Bargains are bargains for a reason and this one is likely to stay on the financial junk heap until the Schwartz family sells Dorel, and they show no interest in doing that. Their deal with Cerberus was an effort to take it private.
Congratulations on finding this real gem. The value is simply overwhelming, with FCF yield over 30%, as you note, and price to sales of 0.13 and price to book of 0.70 (according to Yahoo numbers). If I am way off on the latter, please correct me. It is most unusual to find such a bargain in today's overstretched market where grotesque valuations are being based on price/sales figures in the teens and accompanied by losses.Needless to say, I went ahead and made a substantial purchase and very much hope you will keep us appraised of developments with Dorel.
Yes, the overall market valuations are grotesquely high and I would not touch 98% of stocks right now. But, every once in a while, something comes along that makes a lot of sense. From my perspective Dorel makes sense and, incidentally, is involved in one segment of the economy and stock market (furniture) that happens to be very strong right now.
