Hunter Becomes Hunted (and Still Hunts)
Louis Meyer (Oscar Gruss) Friday, December 06, 2013 1:39:22 PM On 12/5/13, Jos. A. Banks Clothiers, Inc. (Nasdaq-JOSB) announced 3Q FY14 results of $0.51 adjusted EPS (top end of $0.49-$0.51 guidance). Men’s Wearhouse, Inc. (NYSE-MW) announces 3Q results on 12/11/13; consensus is $0.86 EPS ($0.84-$0.92 range). JOSB made a non-binding $48/share cash offer for MW on 9/18/13; their rejection was publicly disclosed on 10/9/13, at which time MW announced it had adopted a shareholder rights plan. After some further prodding (such as a request to perform due diligence), JOSB withdrew its proposal on 11/15/13; MW had stated that it was reviewing the proposal but JOSB responded that the MW Board had "failed to engage in good faith discussions". In an unexpected turn-of-events on 11/26/13, MW made a $55/share cash proposal for JOSB. Last, on its 3Q earnings call, JOSB stated it could not provide a timeline for responding to MW (as they were focused on the holiday selling season) and that their proposal was not the only acquisition opportunity for the company.
Since the initial proposal was publicly disclosed on 10/8/13, the MW and JOSB stock prices have increased 45% and 36%, respectively. In comparison, the S&P Retail Select Industry Index (SPSIRE) is up 9% and the more narrowly-focused Bloomberg North America Specialty Apparel Stores Index (BINASAPV), which includes both MW and JOSB (3.9% and 3.3% weightings, respectively), is down 1.5%. The relative outperformance is quite spectacular, especially given the specialty retailing sector has performed poorly in 2H13 due to weak-to-negative same store sales comps as well as lower earnings guidance from many companies. The deal proposal premiums, combined with cost savings for the potential acquirer, have kept the MW and JOSB stock valuations fully inflated. However, the net effect of the strategic maneuvering by both companies over the past couple months, other than ratcheting up both share prices, appears to be a zero-sum game as we feel this will all end in a stalemate.
We believe this takeover battle has become a crowded trade; JOSB offers a safer haven than MW at this juncture. Although the Pac-Man tactical move resulted in a 7.5% higher share price the day in was announced, we are hard-pressed to identify a value-creating alternative for MW assuming JOSB is not receptive. MW shareholder activist Eminence Capital has hired a financial advisor and filed a preliminary solicitation statement (for a special meeting to amend the by-laws to remove directors without cause); this governance cattle prod may move the beast but does not stop it from kicking back. As we previously stated, we feel the MW Board and senior management has near-term cover of executing the strategic plan presented to investors in October 2013; the alternative to buying JOSB may be fill-in transactions (like Allen Edmonds) rather than a signature takeover deal. At $51/share, the MW implied FY15E valuation multiples are 7.9x EV/EBITDA ($286M, down 8% YoY, 11.4% margin) and 20.7x P/E ($2.46 EPS, down 4% YoY). Valuation multiples using 6.5x-7.0x EBITDA and 15x-16x EPS imply MW standalone values in the $39.30-$42.30 and $36.90-$39.35 price ranges, respectively.
JOSB continues to be cash-rich and have no debt; the company had $377M in cash and short term investments (~$13.45/share) as of 11/2/13. This available liquidity gives the company flexibility to make acquisitions, repurchase shares or pay a significant one-time dividend; it is an issue for shareholders given its de minimis earnings contribution. Based on the MW $55/share proposal price, the implied JOSB valuation multiples are 7.4x EV/EBITDA (157M, up 10% YoY, 14.1% margin), 18.6x P/E ($2.96 EPS, up 10% YoY) and 14.2x cash-adjusted P/E ($2.93 adjusted EPS). The JOSB Chairman said he would consider a similar premium right after the MW proposal was announced (low-$60s price). We expect that JOSB, in responding to the MW proposal, will make the case that their stock price should be trade in the $50s on a standalone basis. JOSB Valuation multiples of 6.5x-7.0x EBITDA, 15x-16x EPS and 12.5x-13.5x cash-adjusted EPS imply JOSB standalone values in the $49.91-$52.70, $44.40-$47.35 and $48.60-$51.55 price ranges, respectively.
While merging the two companies may make conceptual sense, the cultural rivalry between the two organizations seems to make a combination unlikely. JOSB appears to be mimicking the stalling game played by MW prior to the merger proposal being terminated; this tit-for-tat implies there is no love lost between these companies. JOSB claims it has better customer demographics than MW, but its current marketing campaign ("buy one, get three free") has a low-brow, bait-and-switch appearance (at least from the Ohio Attorney General’s viewpoint). MW is focusing on the fashion forward customer segment (with the addition of Joseph Abboud), but the messy mid-year exit of its founder (following disagreements with the Board) rankled its customer base. JOSB is expanding into tuxedo wear (to compete directly with the MW unit), but it has not gotten enough traction yet to report it as a separate segment. JOSB is also expanding into big and tall men clothing, mostly through direct sales. We still feel that JOSB should consider an acquisition of Destination XL Group Inc (Nasdaq-DLGX) as a defensive alternative to the MW proposal.
JOSB has better growth prospects (given its smaller sales base) from expansion into areas which MW is more mature (tuxedo rentals/sales and big/tall men). We note that MW is still marketing its K&G operations for disposal (announced mid-March 2013); Sycamore Partners was reported to be the leading contender but we have very low expectations on the potential price (which could be well under $100M) and do not view this potential divestiture as a valuation catalyst. Rather, the big kahuna being proffered to MW holders is an acquisition of its specialty apparel retailing rival. This is as much a defensive action (i.e. the Eminence Capital activism) as it is offensive (EPS accretion from $100M-$150M run-rate cost savings). Using $42M pre-tax savings (one-third of $125M midpoint) and a 7% blended interest rate on $1.22B deal debt (net of existing cash and assuming $50M deal expenses), we estimate MW P/F FY15E $3.60 EPS (46% accretion). P/F Debt/EBITDA would be ~2.5x leverage; the JOSB cash cushion would be no more. A MW P/F 13x-15x P/E multiple implies a $46.80-$54.00 MW share price. Based on a half stock/half cash deal consideration (price bump to $58/share and $52/share MW price) and a 5.5% blended interest rate, we estimate P/F FY15E $3.25 EPS (32% accretion); a 14x-16x P/E multiple implies a $45.50-$52.00 MW share price. Overall, while the Pac-Man defense may conjure fond memories of prior era takeover battles, we do not feel that is the case here. Rather, the MW proposal for JOSB appears to be a market elixir that has had an immediate price effect but may not support longer term sustenance.