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DEST - Destination Maternity


writser
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Destination Maternity (ticker: DEST, ~$50m mcap) is a "maternity retailer". I'm not a native English speaker and there is probably a more common name for such companies (may I suggest preggo shop?). Anyway, DEST is in the process of being taken over by a French maternity/children apparel retailer, Orchestra Premaman (ticker: KAZI, listed in France, ~$165m mcap). Each share of DEST will convert in 0.515 shares of KAZI, in the form of an ADR to be listed in the US. At this point in time you are effectively buying a 6-month forward on a French retailer at a 25% discount and I think that's a profitable proposition. Also, the deal ticks a lot of boxes that I like:

 

- Obscure microcap deal (not a single author on SeekingAlpha wrote an article about it, not a single question on yesterdays conference call)

- No hedging possible. You have to take some risks so it makes sense the arb spread is larger.

- Retailing is probably one of the most hated sector right now (but if I had to guess maternity retailing would be a relatively safe bet - just a thought).

- Cross-border deal - who the **** in the US wants to own an ADR of a French microcap retailer?

- There was a restatement of past annual reports at Kazi to make the deal even more hairier. Even though as far as I could see this was purely due to some accounting issues due to the pending US listing, so actually a net positive I'd say.

- Kazi is managed by an 'owner-operator with an entrepreneurial spirit', as Gio would put it. The CEO eats his own cake.

- Deal makes sense: combining two micro-cap maternity retailers to save overhead costs.

 

From the latest conference call: "The merger is also expected to result in estimated annual run rate synergies of 15 million to 20 million within three years of closing.". That might be too optimistic but even a quarter of that is huge for a company with a combined $200m mcap. To conclude, this is a crappy, risky deal and you should probably ignore it and go back to discussing the new Tesla truck. But DEST is trading at a 25% discount to KAZI and the deal is expected to close in 6 months so I bought a decent amount of shares. Some things can (and probably will) go wrong but there's a huge cushion.

 

Main risks:

 

- KAZI stock tanking (business seems to be doing reasonable but haven't done much due diligence).

- KAZI ADR trading at a discount to French listing.

- DEST stock (or the underlying business) performing so bad that KAZI will terminate or adjust the deal.

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hasn't KAZI stock already tanked?  its a lot lower than when the deal was announced...  can DEST walk away from this deal?  because at first they thought they were selling for X, and now since KAZI has tanked, they're selling for a lot less than X. 

 

would you be happy to own DEST if the deal falls apart?

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My two concerns with this (and I just noticed this deal yesterday) is that you are basically buying a crappy retailer at a perceived discount right now.  I am not sure where the ADRs will trade, despite where they should trade, so you are getting a retailer at a stock discount.  If it were a fixed cash price, this might be a different story, but then the spread probably wouldn't be so wide. 

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I think it looks cheap as well - I own both. (I actually owned KAZI before it tanked.)

 

DEST doesn't seem that great, but the company seems to have streamlined some in response to their issues, so that their net loss isn't too high, and is comparable to last year's in spite of a fairly big sales drop.

Of course there's still the possibility of a death spiral... but like writser I would tend to think maternity retail is somewhat less cyclical/less tough than general retail.

 

Management at KAZI is actually fairly savvy (KAZI has known a long period of profitable growth, including some cheap and well-handled acquisitions) but - point of attention - they might not always be fair to shareholders:

- they have done some asset swaps between KAZI and their holding that we have little information about

- in 2014, they tried to buy out KAZI with a tender offer at 40 €, which underpriced the real value of the stock quite a bit (it shot to 110 € in the following year).

 

We suspect DEST has fallen quite a bit in part because US shareholders don't want to (or can't) own shares in a foreign microcap retailer they know nothing about. KAZI has fallen in unison (some arbitrage was possible at times - though I didn't take part).

 

It could be really great if the management at KAZI manage to make their playbook work in the US. I'm not necessarily holding my breath for it however, since the US markets is known to be very different.

 

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The one thing I am skeptical about is current mothers hate to shop at retail locations now.  You usually have to drag your kids there, etc, etc.  Sure, first time moms may be ok, but shopping for kids stuff is such a losing fight with a current mom. 

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hasn't KAZI stock already tanked?  its a lot lower than when the deal was announced...  can DEST walk away from this deal?  because at first they thought they were selling for X, and now since KAZI has tanked, they're selling for a lot less than X. 

 

would you be happy to own DEST if the deal falls apart?

 

Interesting way of looking at things (no sarcasm). My reasoning is just the other way around. DEST has been in freefall the past few years and now trades at a big discount to deal value (unless you are arguing KAZI is trading at an articificially inflated price because it can't be shorted). I'd say that shareholders should be extremely happy if the deal goes through and I think the risk that KAZI cancels the deal with DEST is way larger than the other way around. I could very well be wrong though. If the deal falls apart I would re-evaluate but I don't think DEST is going to be the next Berkshire ..

 

My two concerns with this (and I just noticed this deal yesterday) is that you are basically buying a crappy retailer at a perceived discount right now.  I am not sure where the ADRs will trade, despite where they should trade, so you are getting a retailer at a stock discount.  If it were a fixed cash price, this might be a different story, but then the spread probably wouldn't be so wide.

 

I agree with you: lots of uncertainties and things to dislike here. The question is, can you quantify these issues? Given the current discount I am willing to make a bet. KAZI can drop another 20%, the ADR can trade at a 10% discount and I still end up approximately break-even if I bought yesterday. If you aren't buying at the current discount, when would you? At 50%? 90%?

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Interesting situation. It sounds from the call yesterday like DEST is pretty committed to the deal: https://seekingalpha.com/article/4062329-destination-maternity-corporations-dest-ceo-anthony-romano-q4-2016-results-earnings-call?part=single

 

Problem I'm struggling with is the KAZI shares received. I can't read the actual financials, but KAZI seems to be highly levered with declining profitability. They report semiannually so they haven't reported for the christmas season yet that I can tell. H1 2016 looked like a pretty sharp decline in EBITDA. Would they have to include full pro-formas in the proxy similar to what would be filed in a form 10? The December presentation here has the best financials I've found but they only included stale FY2015 figures.

http://investor.destinationmaternity.com/phoenix.zhtml?c=72323&p=irol-presentations

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I'm not sure the DEST to KAZI discount matters here. Since the transaction isn't in cash and we can't arbitrage, the important thing seems to be whether the combined company is cheap or not. I've been running the numbers and get to this:

DEST shareholders will own 28% of the combined company

At 3.73 DEST market cap is 48.65M$, which implies 173.75M$ combined company market cap.

Combined 2015 EBITDA 76M$

Combined 2015 net debt 170M$

Combined 2015 EV/EBITDA: 4.53

 

However it should be noted that:

- at least the DEST EBITDA is "adjusted", so this numbers might be a bit blown up.

- DEST net debt has gone up to 40.1M$ from 38M$

- KAZI 1S operating income fell from 13.2€ to 2.4M€

- KAZI 1S net debt increased from 184.2€ to 191.8€

 

This means combined 2016 EV/EBITDA is probably much higher

 

Identified synergies 15-20M$ in 3 years. Hard to value these.

 

So the question is: is this cheap? can you find cheaper with lower risk?

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  • 2 weeks later...
  • 2 weeks later...

I'm puzzled by the lack of correlation between the movements of KAZI and DEST. Today KAZI is up 10+% (and why, btw?) yet DEST has not moved any. Could anyone figure out why?

 

EDIT: Well, it has started to move now somewhat...Glad that I bought additional shares this morning when the spread was ~40%.

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I'm puzzled by the lack of correlation between the movements of KAZI and DEST. Today KAZI is up 10+% (and why, btw?) yet DEST has not moved any. Could anyone figure out why?

 

EDIT: Well, it has started to move now somewhat...Glad that I bought additional shares this morning when the spread was ~40%.

 

It looks like KAZI signed a new partnership agreement with a Saudi Arabian company to build 10 new stores there. It also seems like the Saudi owner recently bought/increased his stake in KAZI to almost 9%.

http://www.zonebourse.com/ORCHESTRA-PREMAMAN-30444391/actualite/ORCHESTRA-PREMAMAN-contrat-de-partenariat-en-Arabie-Saoudite-24360299/

http://www.zonebourse.com/ORCHESTRA-PREMAMAN-30444391/actualite/Orchestra-Premaman-point-sur-la-participation-d-Alchamey-24352585/

 

I've decided to take a bite at DEST today, wish I'd looked at it over the past couple weeks.

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I have no clue why DEST is trading the way it is either.. Almost looks like the market thinks the merger doesn't go through but I haven't seen any indications for that. So far this has been a disaster but fortunately a Saudi prince is coming to the rescue!

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The discount is at an all-time high today .. I bought a couple more shares. Quite a large position now .. We'll see how things turn out!

 

I bought some more too... with the intention of trimming down my position if the discount gets smaller.

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Funny, was just at a KAZI store today (twice).

Quite unsatisfied with the service... twice they gave us damaged stuff, one time they knew about it and assumed we would take it because it was the only one they had left?

It will also take 2-3 weeks to get some of the stuff we need, not really pleasant if we have to wait 3 weeks for stuff we need now (baby came early).

 

Not that any of this matters for the investment case, I added as well at 4,21$ today.

 

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The discount is at an all-time high today .. I bought a couple more shares. Quite a large position now .. We'll see how things turn out!

 

Thanks for this interesting special situation type idea.  What thoughts do you have about DEST not being a going concern if the deal breaks?  In the recent past, the company has gotten pretty unfavorable terms for refinancing loans/debt (i.e. libor +750bps).  Selling the company suggests there may be more pain if they continue to operate as a stand-alone.

 

I just did some quick math to write down assets for a fire-sale scenario (PPE at 50%, inventory at 50%, AR at 75% collection rate) and they're just shy of covering the liabilities if you do not include deferred rent expenses.  50% for PP&E may be conservative, but that's probably best.  Nevertheless, the value of the brand must be worth something, I'd think....  Pre-tax break up fee of $5million.  Also, if you're management, why do you now accept an inferior deal after turning down a deal 12 months prior.

 

This looks pretty promising.

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The discount is at an all-time high today .. I bought a couple more shares. Quite a large position now .. We'll see how things turn out!

 

Thanks for this interesting special situation type idea.  What thoughts do you have about DEST not being a going concern if the deal breaks?  In the recent past, the company has gotten pretty unfavorable terms for refinancing loans/debt (i.e. libor +750bps).  Selling the company suggests there may be more pain if they continue to operate as a stand-alone.

 

I just did some quick math to write down assets for a fire-sale scenario (PPE at 50%, inventory at 50%, AR at 75% collection rate) and they're just shy of covering the liabilities if you do not include deferred rent expenses.  50% for PP&E may be conservative, but that's probably best.  Nevertheless, the value of the brand must be worth something, I'd think....  Pre-tax break up fee of $5million.  Also, if you're management, why do you now accept an inferior deal after turning down a deal 12 months prior.

 

This looks pretty promising.

With this kind of return I don't think it's an important consideration. Must deals have between 30/50% downside when they break and offer a few percentage points of upside (usually). So even having 100% downside here if the deal breaks isn't that big of a deal if you think the chance of deal completion is somewhat comparable to your average deal. If the downside would really be that big the spread should probably still be sub 10%, assuming that deal completion risk is about average.

 

And actually, given the big spread the market is apparently already pricing in a huge probability that the deal will fail (I don't see any reason for this, but the spread is there) so perhaps the impact of deal failure will have a limited impact on the price. Perhaps the market agrees that this is a zero if the deal fails and the market price implied probability of deal failure is roughly 50%, but perhaps the expected price of deal failure is around the current price and the implied probability of deal failure is 90%+. Whatever it is, just doesn't make sense to me.

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I am struggling to find reasons why DEST shareholders would turn this down....

- When is the expected DEST proxy shareholder vote on the merger you reckon?

- When/Can Yeled buy more DEST shares in the open market?  (still reading the merger docs, not so transparent)

 

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I am struggling to find reasons why DEST shareholders would turn this down....

- When is the expected DEST proxy shareholder vote on the merger you reckon?

- When/Can Yeled buy more DEST shares in the open market?  (still reading the merger docs, not so transparent)

 

After reading the transcripts, many investors are pissed.  Same suitor, just a year later and a lower offer.  Still doesn't suggest the number that vote it down would be enough..

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The discount is at an all-time high today .. I bought a couple more shares. Quite a large position now .. We'll see how things turn out!

 

Thanks for this interesting special situation type idea.  What thoughts do you have about DEST not being a going concern if the deal breaks?  In the recent past, the company has gotten pretty unfavorable terms for refinancing loans/debt (i.e. libor +750bps).  Selling the company suggests there may be more pain if they continue to operate as a stand-alone.

 

I just did some quick math to write down assets for a fire-sale scenario (PPE at 50%, inventory at 50%, AR at 75% collection rate) and they're just shy of covering the liabilities if you do not include deferred rent expenses.  50% for PP&E may be conservative, but that's probably best.  Nevertheless, the value of the brand must be worth something, I'd think....  Pre-tax break up fee of $5million.  Also, if you're management, why do you now accept an inferior deal after turning down a deal 12 months prior.

 

This looks pretty promising.

With this kind of return I don't think it's an important consideration. Must deals have between 30/50% downside when they break and offer a few percentage points of upside (usually). So even having 100% downside here if the deal breaks isn't that big of a deal if you think the chance of deal completion is somewhat comparable to your average deal. If the downside would really be that big the spread should probably still be sub 10%, assuming that deal completion risk is about average.

 

And actually, given the big spread the market is apparently already pricing in a huge probability that the deal will fail (I don't see any reason for this, but the spread is there) so perhaps the impact of deal failure will have a limited impact on the price. Perhaps the market agrees that this is a zero if the deal fails and the market price implied probability of deal failure is roughly 50%, but perhaps the expected price of deal failure is around the current price and the implied probability of deal failure is 90%+. Whatever it is, just doesn't make sense to me.

 

OK, that is a fair way to think about it.  Thanks.

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Seems like the market will probably just "value" this company the same the day before the acquisition closes as the day after.  In other words, there might be a significant discount to KAZI after the ADR listing.  If you are buying for the merger-arb spread, I am not sure when you think this discount will close or why? 

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