Yesterday, Staples announced that they commenced the cash tender for certain CE notes. There is nothing special about this announcement, besides the fact that Staples seems to continue the process as if nothing has changed. But then again, why shouldn't they continue like this, since we appear to have landed in some sort of high stakes poker game. By continuing the process this way, Staples can test the reaction of the market. There is no real need to change anything about the offer or the offer price of EUR 8.00 per share in the next three weeks, so why not try to influence the speculators to see what happens.
We should not forget that since the first announcement of the offer, many shares have changed hands, and I assume most ended up in the hands of speculators who have no interest in the long term prospects of CE, but are only interested in making a quick buck, or Euro in this case. We can be totally unscientific and try to estimate how many shares have landed in the hands of speculators since February 19th
If I assume that a on a normal day, an average volume of shares is traded of about 3-5 million, we can identify the high volume days, of let's say more than 10 million shares traded. These days were in the beginning of February when speculation about an offer started (24 mln), February 19th and 20th when the offer was announced (54 mln), March 17th when the market was worried Staples would not continue (12 mln), May 13th when Staples announced the offer would be increased to EUR 8.00 per share (14 mln), and finally May 21th when the merger announcement between CE and Lyreco came out (25 million). This is a total of 129 million shares traded in just 6 trading days. It is anyones guess how many of these trades were just short term round trips by day trading speculators, but assuming that a reasonable percentage of 30% of these shares traded, ended up in the hands of patient speculators, this would be about 39 million shares, or more than 20% of the ordinary share capital of CE. Given that in most other trading days, speculators would also have been buying, I am comfortable with this estimate and the true number could maybe be as high as twice this percentage in my opinion.
A percentage between 20% and 40% will matter, because it means that in addressing the shareholders, both Mr. Ventress and Mr. Sargent have to appeal to investors and speculators, and these two groups of shareholders have a completely different agenda. So in the next weeks, both these gentlemen have to play it cool, where certainly Staples will need to find out if it makes sense to raise the offer, and if this does make sense, how much is required to win the game.
vrijdag 23 mei 2008
Staples continues the acquisition process of CE
donderdag 22 mei 2008
The evening of the day after....
Today was a very quiet day with respect to CE, compared to the launch of the offer from Staples to buy the company just a couple of days ago, which was rapidly followed by a trick of CE themselves, namely the proposed merger with the French company Lyreco. After the announcement yesterday, shares of CE initially dropped about 8% to EUR 7.44, but recovered during the day to a level of EUR 7.99, just 1.5% below the previous day close with a volume of more than 25 million shares traded. Today was a remarkable day with the share price ending at a level of EUR 8.21, which is well above the offer from Staples. Volume with 9 million shares was also again strong. Like many others, I am very curious to see where this will eventually lead to, and it sure is interesting to speculate about it.
I believe very strongly that today's price moves were not caused by investors who think the Lyreco merger is a great deal. I rather think that it is caused by speculators betting on a last increase of the offer price by Staples to convince CE shareholders that an increased offer is superior to the merger with Lyreco, which may be only mildly superior to the execution of the stand alone strategy of CE.
Staples must surely be very surprised, like most of us, that CE was able to bring this deal to the table. Staples should however take part of the blame for allowing this to happen. The company smelled a bargain, when CE was really brought to extremely low share price levels, and took those low levels as the base line for their offer. It is no wonder this left many long term CE investors, who would have bought at levels of at least EUR 10 per share and more, insulted and reluctant to accept an offer that would lock in a substantial loss position for them.
CE must have surely been desperate to accept the deal with Lyreco at these conditions. I am willing to accept that CE and Lyreco were already talking for many months about a possible merger. But come on, you are paying 19 times 2007 net income and giving away the top job, and you call that a great deal? The deal was put together this way, because management of CE wants to block an acquisition by Staples. At a valuation well below the EUR 1,731 million price tag, I could have accepted this as a sensible deal for CE shareholders, but now I believe they would just go from one promise for the future to the next promise for the future.
In a nutshell, CE may get into a situation where they will incur initially additional finance costs of EUR 70 million a year, and get net synergies of negative EUR 12 million in the first year, EUR 48 million in the second year, and EUR 80 million in the third year. Only in year 4, which is 2012, the full annual benefits of EUR 100 million are expected. The additional profits still have to come from EBITDA margin increases and sales growth, just like in the strategic plan. The higher profitability of Lyreco may bring an instant higher margin and net income, but unfortunately this higher net result also has to be shared with 102.5 million new shares.
I am not able to see that a merger at these conditions is a master stroke by Mr. Ventress, although it could end up unintentionally creating more value for CE shareholders through an increased offer by Staples. If Mr. Ventress wants to take credit for that later, that's fine with me.
Lyreco is surely the smart party, until now, in this story. The situation with Staples allowed them to leverage their negotiation position, and get a lot more value and power out of this deal than would have otherwise been possible. Just imagine a possible alternative, where Lyreco would have had to speak with Mr. Buffett on his European tour. He would have been impressed with the company and may have offered them maybe 12 times 2007 net income in cash on the spot. No, this situation is much better for Lyreco, and the story may not even have ended yet for them, having shown that they are willing to be acquired.
While market participants will be pondering the merits of the merger with Lyreco, Staples must also be considering what their next move should be. It seems clear that the EUR 8.00 offer is dead. Even if it would be superior value for CE shareholders, they now have an alternative, that may be good enough reason for them to decline the offer from Staples. This can not be a pleasant outcome for Staples, unless they believe CE and Lyreco will screw up the merger and future years ambitions. In my opinion, Staples could and should consider raising the offer to a level where CE shareholders feel it is the safer bet, and gives them a better feeling about sharing the potential synergies of the acquisition by Staples. A raise to a level of EUR 8.50 may not do the trick anymore. Just consider if Staples would offer EUR 9.00 per share, which would be an increase of about $290 million, or about $ 0.40 per Staples share. Surely this will not be the biggest obstacle. Even a higher price would not be such a big deal, but I will not speculate further about the wisdom of Staples in setting an increased offer price.
If Staples can still acquire CE, and effectively block the merger with Lyreco, there may be another added advantage, being the fact that apparently Lyreco is willing to be purchased (in case Staples didn't know this already). This does not have to happen immediately, but at least the purchase price can be brought to more sensible levels, and given some time, Staples could probably pay in cash as well, or could consider issuing shares to finance a deal.
Staples could also be really bold, and block the merger with Lyreco by acquiring CE, and immediately renegotiate the terms of the merger with Lyreco, and make it a Staples/CE/Lyreco combination. That sounds like a perfect end game, but I am probably getting carried away now......
woensdag 21 mei 2008
Staples is considering all options
The initial reaction from Staples just came out. Not very surprising, and very short:
Staples, Inc. Acknowledges The Corporate Express N.V. Proposed Acquisition Of Lyreco SAS
FRAMINGHAM, Mass.--(BUSINESS WIRE)--May 21, 2008--In light of today's news about the proposed Corporate Express N.V. acquisition of Lyreco SAS, Staples, Inc.(Nasdaq: SPLS) and Staples Acquisition B.V. are considering all options.
Staples Acquisition reaffirms that its all cash offer of EUR 8.00 per ordinary share delivers certain, immediate and superior value to Corporate Express shareholders. Staples Acquisition's offer does so without the substantial execution and other risks inherent in Corporate Express' long-term plans, with or without the addition of Lyreco. (end of post)
A tip for Ron Sargent
The proposed merger of CE with Lyreco, could turn out to become an ever bigger and better price for Staples. Obviously Staples will have to pay more, but arguably they get a better company in return. If Staples would indicate that they are willing to pay EUR 9.00 per share for either CE stand alone or the merged company with Lyreco, it would create instant additional value for the Lyreco shareholders of EUR 100 million. If Staples would include the vendor note in the all cash offer, it would be even better for Lyreco shareholders, because they would generate about EUR 440 million additional immediate cash from the deal. Where the services of Mr. Ventress would probably not be required anymore after the acquisition, it may make sense for Mr. Sargent to offer Mr. Bigeard a position in the board of Staples. That would make a revised offer by Staples even more appealing to Lyreco...(end of post)
Read more...Some comments on the merger with Lyreco
This morning CE surprised most of us, if not all of us with the announcement of the proposed merger with Lyreco, a French private company. CE claims the merger has nothing to do with the offer from Staples, and would have also been announced without the offer from Staples. This may be true, but from the valuation of Lyreco, I do get the impression this was a defensive move to prevent the acquisition by Staples. Without the offer from Staples, CE most likely would have been able to negotiate a better deal. Having looked at the presentation from CE, I am not impressed with the advantages of this deal over the stand alone strategy. In the first 3 years, the net synergy, after integration costs only increases slowly, while CE will incur a substantial increase in financing costs, and a substantial increase of goodwill on the balance sheet.
Purchase price for Lyreco
The purchase price for Lyreco consists of 102.5 million shares, cash of EUR 560 million and a Vendor Loan Note of EUR 340 million. Thanks to the offer from Staples the shares are valued at EUR 8.11, making the value of the total consideration EUR 1,731 million, which is 9.6 times 2007 EBITDA. With EBITDA for CE in 2007 of EUR 298 million CE was valued at 5 times EBITDA. Before the offer from Staples, with a share price of EUR 5.50 this was only 3.4 times. This indicates that CE was willing to pay quite a lot for Lyreco. Maybe the fact that Mr. Eric Bigeard, the current CEO of Lyreco, becomes CEO of CE confirms their superior management capabilities. If this would not be the case, the conclusion must be that the threat of an acquisition by Staples has driven CE to pay a high price for Lyreco.
Post acquisition balance sheet
I think I am starting to understand the composition of the balance sheets of both companies, so it will be interesting to make an attempt to see what the post-acquisition balance sheet looks like. Following statements made by CE that the deal will close in Q4 this year, I simplified my assumptions and assume that the deal will close on December 31th. We have a balance sheet for CE for Q1-2008 and in the presentation by CE and Lyreco, a balance sheet for Lyreco for December 31th, 2007 was included. Based on the guidance given by CE and my own assumptions, the picture would look something like this:
I have made a calculation of the results for the full year 2008, and added the value to both equity and current assets. The exact way I have looked at results will follow later. This leads to balance sheets for both companies at the and 0f 2008. Following this calculation the transaction has to be executed. CE needs to pay the agreed consideration to Lyreco shareholders and will assume all assets and liabilities. The difference will go to goodwill.
And this part looks a bit scary to me. The equity value of Lyreco at the end of 2008 will be EUR 548 million. This means CE will pay a goodwill of close to EUR 1.2 billion for this acquisition. Taking into account the EUR 210 million already on the balance sheet of Lyreco as intangible assets, CE will have close to EUR 2.8 billion of intangible assets on its balance sheet, with an equity value of EUR 2.4 billion. No wonder the vendor note was issued at conditions that allows CE to qualify it as equity, and no wonder they intend to pay down debt and strengthen equity in the coming years!
Results until 2011
Guidance for 2011 is a revenue of at least EUR 9.5 billion for the combined company, with an EBITDA margin of 8% before synergy effects and 9% including synergy effects. Given that the CE guidance was 7% EBITDA in 2011, the amount of 8% for the combined company seems too high. The following table can illustrate this:
It seems very strange that Lyreco would be able to achieve an EBITDA percentage of 10.5% in 2011. This was also noticed by an analyst at the conference call today, who aksed the question to the CFO of CE. He did not have an answer and thought this margin to be unlikely, so I will assume this is just an error.
I will attempt to determine the results for CE and Lyreco on a stand alone basis for 2008 and 2011, based on the given guidance and historical information that can be found in the presentation. To be on the cautious side I took the more conservative guidance from CE as a starting point. To my surprise the conclusion is that the costs for financing this acquisition are so high, that it takes away a big chunk of the synergy effects. With a calculated net result for CE shareholders of EUR 1.10 per share in 2011, the combined company with Lyreco only leads to a net result per share of EUR 1.22. I could be completely wrong of course so let's go through the calculations:
I am not uncomfortable with an estimate of EUR 0.50 per share for CE in 2008, which is at the low end of the guidance given by CE. The net result for Lyreco is calculated with the EBITDA amount of EUR 201 million that can be found from the guidance by CE. From the presentation we can see that Lyreco has been investing in all 5 previous years, and I assumed an annual depreciation charge of EUR 22 million. With the assumption of some exceptional items this gives an operating result of EUR 175 million. Since debt is almost non-existent and the effective tax rate has been quite high for Lyreco, a net result of EUR 105 million follows. The available data showed some adjustments for minority interest in 2007, which I continued in 2008, leading to a net result of EUR 99 million as an estimate for 2008. The combined result of EUR 0.67 per share is obviously completely overstated, since it does not take into account the financing costs CE would have incurred to get the net result of Lyreco.
For 2011 the same logic has been applied, working towards the margin guidance from CE, corrected for what I believe is an overstatement of the Lyreco margin in 2011. For CE an effective tax rate of 25% has been assumed in 2011, and for the combined company the financing costs relating to the acquisition have been taken into account. To reduce these costs, I have assumed that CE will decrease debt by EUR 100 million a year until 2011.
With respect to the synergy effects and integration costs, I have assumed they are after tax effects and will take place in the years 2009-2011. This means that positive synergy effects are EUR 28 million, EUR 68 million and EUR 100 million in those years, while the integration costs are EUR 40 million in 2009, and EUR 20 million in 2010 and 2011 each.
So after all these assumptions a net result of EUR 1.15 follows for 2011, based on the low end of the guidance of CE. For 2009, a net result per share can be calculated of EUR 0.49 and for 2009 net result per share would be EUR 0.88. From 2012 onwards the full effect of the merger should be visible in the results.
Shareholders of CE are now confronted with three choices. The offer from Staples can be accepted, the merger can be approved, or both previous possibilities can be declined. These choices are not easy. I am very worried about the merger with Lyreco. I believe there is a lot of risk in the strategic plan, and the merger will not make things easier, although I have full confidence that Lyreco is a strong company. Again results are pushed further to the future, with 2012 probably being the first stable and fully integrated year.
Although I remarked half jokingly in another post that Staples should just bid for the combined company, I am not sure that this would be appealing for Staples after considering the above calculations.
With an offer of EUR 8.00 per share from Staples, there is a serious chance that shareholders will have a preference for the uncertainty of the merger with Lyreco, which means that Staples now has to ask themselves how badly they want CE. In the current situation, the best thing that could happen to CE shareholders is an increased offer from Staples, to a level that makes them realize the risk of the proposed merger by CE with Lyreco. It probably means that Staples has one more chance to convince CE shareholders, or should now just move on.
Corporate Express merges with Lyreco
Amazing and surprising news just published by CE:
"Corporate Express NV and Lyreco SAS announced today that they entered into a transaction, subject to shareholders’ approval, to combine both companies to create the undisputed leading global office products supplier focused purely on the business to business (B2B) market. The combination will benefit from a shared vision on industry and strategy, major economies of scale, a well-balanced international presence and customer mix." (end of post)
dinsdag 20 mei 2008
Comments on launch of public offer by Staples
Yesterday, Staples launched the offer for the acquisition of Corporate Express with an offer of EUR 8.00 per ordinary share. Shareholders can submit their shares until June 27th. Staples also made an offer for Corporate Express’ preference shares and subordinated convertible bonds due 2010. The most important condition for making the offer unconditional is acceptance of at least 75% of ordinary shares.
This acquisition process is at a peculiar stage, with both parties not negotiating with each other and accusing the other party of unwillingness to do so. For shareholders this is a very unfortunate situation, with a real possibility of a failed offer, and therefore a missed opportunity to create significant shareholder value for shareholders of both companies. However, based on the current offer we can try to evaluate the current situation from the perspective of both companies and their shareholders
Corporate Express shareholders have a choice to accept the offer or to allow management to continue with the execution of the strategic plan 2008-2010. With the presentation of the results for the first quarter of 2008, we were given some insight in the ambitions that Corporate Express has set for itself.
For the full year 2008, Corporate Express gave guidance for revenue between EUR 5.7-5.8 billion and an EBITDA margin of 5.6%-6.0%. This means an EBITDA amount of between EUR 319-348 million. Depreciation and amortization are expected to be EUR 100 million, and interest expenses EUR 85 million. If we add fair value changes to this, net result before taxes would be around EUR 122-151 million. With a 20% tax rate, net result would be between EUR 98-121 million or EUR 0.54-0.66 per share. It also means that Corporate Express will have to earn an average net result of EUR 30 million per quarter for the remainder of the year. If we compare this with the net result of EUR 8.5 million for this quarter, this seems quite a task.
The strategic plan calls for a 6% average annual organic growth rate for the period 2008-2010 and an EBITDA margin of at least 7% by 2010. Based on the current progress and the stated ambitions, Corporate Express believes revenue of EUR 6.8 billion is achievable for 2011 with an EBITDA of EUR 475 million. With depreciation and amortization increasing in line with sales, and finance costs assumed to stay constant, this would imply a result before taxes of around EUR 275 million. With an effective tax rate of 25%, this should lead to a net result of EUR 206 million, or EUR 1.13 per share for the year 2011. If market conditions are favorable for stocks by the time such results are announced in 2012, this could well mean a value of around EUR 16.00 per share. Declining the offer and allowing the company to achieve its plans, would potentially create value twice the value of the offer of EUR 8.00 made by Staples, after a period of 4 years. This would imply an annualized return of almost 19%, which is by all means attractive.
Success of the strategy is however not at all guaranteed, and there is plenty of risk in the execution of the strategy. Ron Sargent, the CEO of Staples, makes the risk of failure of the strategy one of the key reasons why Corporate Express shareholders should accept his offer, when he states in the offer memorandum: “I firmly believe that our offer of EUR 8.00 per share delivers superior value to Corporate Express shareholders, and does so without the risks found in Corporate Express’ long-term business plan. Rather than the uncertainty of potential value for your investment, our offer provides shareholders with the certainty of realizing immediate and premium value for your investment.”
There are indeed risks that may prevent Corporate Express from reaching its targets. If the company only reaches 80% of its ambitions by 2011, which would still be a reasonable accomplishment, net income per share would be somewhere around EUR 0.90, and with a likely lower P/E ratio, the stock price could be around EUR 11.00. Compared to the offer of EUR 8.00, this would only give an annualized return of 8%, and makes the offer from Staples much more attractive.
It is possible that investors will perceive the risks associated with the stand alone strategy of Corporate Express quite high. This may cause the share price to drop significantly following a potential breakdown of the acquisition.
From the perspective of Staples the picture looks completely different. The company sees a target that can add significant value. Besides the strategic fit, they undoubtedly see potential for cost savings and further synergies. If the added value from the acquisition is estimated to be a modest EUR 100 million a year, and the estimated low end net result for Corporate Express in 2008 is EUR 122 million, Staples would add 222 million to its annual results. In US-dollars this is about $350 million. Since the purchase of Corporate Express ordinary shares would be financed with debt, there could be an additional interest cost of around $140 million, or around $100 million after tax. This would mean an additional net annual result from the acquisition of $250 million, which is almost 25% of Staples’ net result for 2007.
With a P/E ratio currently at 17, it is very likely the market has already priced some of the advantages of the acquisition into the share price. Because of the acquisition of Corporate Express, there will be a significant level of debt on the balance sheet of Staples, and this may also have some effect on the P/E ratio. However, one could argue that the post acquisition share price of Staples could be about $5.00 per share higher than the share price would be without the acquisition, based on reasonable and achievable synergy targets that do not seem to be too stretched.
At this moment we find ourselves in a situation where the companies do not engage in serious talks and the offer is considered hostile by Corporate Express. They state that the offer does not do justice to the real value of the company, and undoubtedly they believe a higher share of the synergy effects should be priced into the offer. Staples believes they are paying a considerable premium over the share price of Corporate Express prior to the date the offer was made, and they will surely feel it is them who are creating the synergy effects and should receive full value for them. A recurring net synergy effect of EUR 100 million could have a market value for Staples of up to EUR 1.5 billion, which would be around EUR 8.00 per Corporate Express share. Assuming this is a reasonable estimate, Staples is offering EUR 2.50 of this value to Corporate Express considering an offer of EUR 8.00 per share and a share price of EUR 5.50 before the offer was made.
Both companies are now in a situation where they need to make this offer succeed. For the management of Corporate Express, the pressure would be tremendous for the coming years to make good on the promises of the strategic plan, while Staples shareholders are already starting to anticipate the benefits of the acquisition. If the deal collapses, because Corporate Express shareholders refuse the current offer, both parties lose. It is also understandable that Staples does not want to change its course of action, without a willing negotiation partner.
A negotiated and agreed final offer would probably identify many tangible synergy effects and would allow an integration plan to be implemented swiftly. I have no doubt that such a negotiated final offer could be higher than the current offer. Unfortunately this requires two parties who are willing to engage. The signals we are getting from both parties are not encouraging, and put a lot more uncertainty on the final outcome of this acquisition attempt. In today’s earnings conference call, Ron Sargent expressed his frustration with the unwillingness of Corporate Express to negotiate and allow due diligence. He also stated that if Corporate Express shareholders reject the current offer, Staples would move on. I am willing to believe that this is almost true, since there is still the opportunity to raise the offer one more time with the extension of the acceptance period.
