Wednesday, October 12, 2011

Pensions Paying Premium For PIPE Deals?

Barbara Shecter of the National Post reports, CPPIB pays premium for major stake in 99 Cents Only stores:
Following a previous successful venture in the dollar-store retail space, the Canada Pension Plan Investment Board is teaming up with private equity firm Ares Management LLC to purchase regional U.S. chain 99¢ Only Stores in a transaction valued at US$1.6-billion.

CPPIB will be a “significant minority owner” of the 289-store extreme value chain, according to a source familiar with the deal’s structure. Relatives of the founding family will also retain a significant minority stake.

The buyers are paying a 32% premium to the chain’s share value before it became subject to a rival takeover offer, but Canada Pension Plan (CPP) officials believe there is value in the business which has performed well even in tough economic times.

“This investment is consistent with our strategy of investing alongside strong partners in an asset that we believe is well positioned for the long term and has shown good performance in various economic environments,” said André Bourbonnais, senior vice-president of private investments at CPPIB.

A similar investment in 2007 has paid off for the pension plan.

CPPIB teamed up with Kohlberg Kravis Roberts & Co. to purchase Dollar General, a chain that was privatized and then taken public two years later in 2009. The CPP, however, held onto 17.5 million shares. Dollar General shares closed Tuesday at US$39.07, up from the IPO price of US$21.

Elsewhere in the under-a-buck retail world, things are looking equally rosy. Shares of Dollarama traded at $37.73 on Tuesday, up sharply from the 2007 public offering price of $17.50.

The 99¢ Only Stores transaction is subject to shareholder approval and regulatory clearance and is expected to close in the first quarter of 2012.

The bulk of the stores in the “extreme value” chain are located in California, with others in Texas, Arizona and Nevada.

Industry watchers said the new owners could look to expand the chain, which was founded in 1982, into other geographies, perhaps even nationally. Privatizing a firm can ease the demand for quarter-to-quarter growth and make it easier to implement measures aimed at improving efficiency, they said.

This is not the first time the CPP has participated in a transaction in which a public firm is taken private. In the past 18 months or so, other such deals have included the purchase of Ontario’s 407 toll road from Australia’s Intoll Group, and the acquisition, with Onex Corp., of Tomkins PLC, a U.K.-listed auto and industrial parts maker.

The CPP funds totalled $153.2-billion as of June 30.

In his article, Tim Kiladze of the Globe and Mail reports, CPPIB bags second dollar store chain:

For the second time in four years, the Canada Pension Plan Investment Board is putting its multibillion-dollar balance sheet behind a retail chain that sells goods for about a buck.

Investing alongside U.S. private-equity firm Ares Management LLC, CPPIB has signed a friendly agreement to buy a majority stake in 99 Cents Only Stores (NDN) for $1.6-billion (U.S.), or $22 a share.

The purchase comes at a time when even the U.S. Federal Reserve Board expects the U.S. economy to struggle for at least two more years, as debt-laden consumers contend with persistent unemployment and stagnant wages.

As stretched budgets force consumers to move down market, large retailers such as Best Buy and Home Depot have been hurt – but not dollar stores, whose profits and stock prices have soared over the past two years.

So far this year the stock of Dollar General Corp., (DG) a $13-billion American dollar-store chain, is up 27 per cent. Rival Dollar Tree Inc., (DLTR) a $10-billion chain, has seen its shares skyrocket 43 per cent. The S&P 500 is down 5 per cent over the same period.

Although Canadian consumers are not as hard-pressed as Americans, Dollarama Inc., (DOL.TO) which trades on the Toronto Stock Exchange, has seen its stock rise 31 per cent this year. Since going public in October, 2009, the shares are up 93 per cent, a huge success story for private-equity firm Bain Capital, which has unloaded its stake in Dollarama over the past two years.

CPPIB has already profited from growth in the sector. The 99 Cents deal echoes its involvement in the Kohlberg Kravis Roberts & Co.-led private equity buyout of Dollar General Corp. in 2007. That deal resulted in an initial public offering two years later. The 17.5 million shares that the CPPIB still holds have risen in price about 75 per cent since the IPO.

The $147-billion pension fund hopes to repeat that success with 99 Cents which, from 2006 to 2009, churned out total profit of $33-million. In the past 12 months alone, it made $75-million.

The size of each party’s investment has not been disclosed, but CPPIB and Ares will share 99 Cents with the Gold and Schiffer families, long-time holders who held a 23-per-cent stake as of June 30, according to Capital IQ.

CPPIB referred to the discount sector’s strong growth in its statement announcing the deal on Tuesday. “This investment is consistent with our strategy of investing alongside strong partners in an asset that we believe is well-positioned for the long term and has shown good performance in various economic environments,” said André Bourbonnais, senior vice-president of private investments.

The details are still being hashed out, but CPPIB appears to be borrowing to pay for its portion of the investment. RBC Dominion Securities and BMO Nesbitt Burns have both committed financing.

Like its peers, 99 Cents’ stock has jumped higher this year, but it’s hard to tell how much of that stems from a hostile takeover offer it received in March. That offer piqued the interest of other private-equity firms and gave investors reason to believe 99 Cents would be bought at a premium.

To acquire 99 Cents, CPPIB and Ares had to beat out a bid from Leonard Green & Partners worth about $20 per share, or $1.41-billion, according to Reuters. It was Leonard Green’s second offer, following a bid worth $19.09 a share in March. Apollo Management LP had also been reported to be in the running, but pulled out in late September because it could not secure financing.

99 Cents is traded on the New York Stock Exchange and operates about 300 retail stores in California, Texas, Arizona and Nevada. While the company will have new owners if shareholders approve the deal, management is expected to remain, including chief executive officer Eric Schiffer and chief operating officer Jeff Gold.

It’s not the only dollar-store chain that has been pursued by private-equity firms this year. In March, Family Dollar Stores Inc. rejected a $7-billion takeover bid from Trian, an investment firm led by investor Nelson Peltz.

So is this a good deal for CPPIB and Canadians? Is it worth the premium? They obviously think so and it's hard to argue against the macro theme underlying the success of these dollar stores. The Atlantic published an excellent analysis, The Recovery's Silent Assassin: How Debt Deleveraging Killed the Economy. If you read it, you'll understand where the US (and other economies) are heading. In fact, I think these dollar stores will soon pop up pretty much everywhere around the world and it plays on two major macro themes: deleveraging/deflation and income inequality.

[Side note: I used to live next to the founder of Dollarama, a successful Lebanese-Canadian businessman. His family made a fortune when they sold a stake of their company to a private equity firm and held on to enough shares to continue profiting from the rise in share prices. I like when I see Quebec's "ethnics" succeed. And a little known fact, Quebec's most successful money manager was also a Lebanese-Canadian, but he was smart enough to move out of here and close shop at the right time to focus on his family. His brother still runs his own successful hedge fund.]

In another deal that plays on another macro secular macro theme, demographics, Kinetic Concepts' (KCI) shareholders vote for KCI's proposed merger with the consortium comprised of investment funds advised by Apax Partners, together with controlled affiliates of Canada Pension Plan Investment Board (CPPIB) and the Public Sector Pension Investment Board (PSPIB):

In its October 6, 2011 report, ISS stated:

"The proposed acquisition of the company by a private equity consortium for $68.50 per share in cash represents a one-day and sixty-day premium of 16.5 percent and 24.7 percent, respectively, and will provide certainty of value for shareholders." The report further noted that KCI "conducted a 40-day post-signing go-shop process from which one additional bidder emerged; however, that bidder ultimately withdrew its offer."*

With the backing of the consortium, a very seasoned group of investors, KCI can continue to develop, introduce and support the medical community with leading-edge innovation and differentiated products. The company firmly believes that given the premium and certainty of value, this transaction is in the best interest of the shareholders.

Pursuant to the merger agreement, KCI expects that the Apax consortium will acquire KCI for $68.50 per share in cash pending results of the shareholder vote to approve the proposed merger, regulatory approvals and the satisfaction of other customary closing conditions.

I think this is a reasonable premium given that the medical appliance/equipment sector is a very hot sector. For example, anyone who invested in companies like Intuitive Surgical (ISRG) early on made a killing. I'm looking at stocks of KCI's competitors like Hill-Rom Holdings (HRC) and Stryker Corp. (SYK) for long-term investments. There are many others in this sector worth tracking closely (check out this small cap: SURG) and believe all pension plans should be playing several secular macro themes in their portfolios and not just paying hedge funds 2 & 20 to pick these stocks.

Finally, someone from the Public Service Alliance of Canada asked me to attend the Public Sector Pension Investment Board's (PSPIB) forthcoming Annual Meeting scheduled for 3:00 to 4:00 p.m. on October 20th, 2011 at Government Conference Centre in Ottawa, Ontario. Haven't made up my mind but if I attend, know exactly which politician I'd like to bring with me. -:)

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