WWII 113: An Arbitrage, an Activist Idea, and a Warren Buffett Stock Walk Into A Bar
Have you subscribed to my podcast yet? If not, you can click the buttons below to subscribe:
Main Topic: An Arbitrage, an Activist Idea, and a Warren Buffett Stock Walk Into A Bar
In this week's episode I bring you the bacon. That's right, I will lay out three ideas for you to take a look at. One is on an especially short fuse so lets get right to it!
Arbitrage in the stock of $JUNO
On January 22, Celgene ($CELG) announced that they would be buying Juno Therapeutics in an all cash deal for $87 per share.
This deal will be accomplished via a tender offer for all of the outstanding shares of Juno that Celgene doesn't already own. Celgene currently owns about 10% of the shares outstanding.
The key to completing the deal will be to pass regulatory scrutiny, and reach the minimum buy-in hurdle of 50% of all outstanding shares. Because Celgene currently owns 10%, only 40% remains to reach the hurdle.
Given the price paid and the large institutional and insider ownership, I would guess this hurdle gets met in the initial tender.
The deal closing can be extended to allow for any unexpected regulatory requests, but given the other details of this transaction and the two parties, I think that unlikely.
Here is a list of criteria and how this arbitrage shakes out:
- All cash consideration – PASSED - $87 per share in cash
- Big fish swallowing a little fish – PASS - Celgene has an enterprise value of $74 billion versus the deal price of about $10 billion
- Fair price – PASS – Paid high price to earnings, book value multiples.
- Little fish profitable and/or valuable – FAIL - mostly negative earnings
- Boards approved - PASS
- Major shareholders are supportive - PASS
- No financing or abnormal contingencies – PASS. Celgene will fund the deal with a combination of cash and a draw on its credit facility. There is no financing contingency that could blow up the deal.
- Low risk of regulatory intervention – PASS – Does not create a monopoly of any kind (in my estimation - this is just my opinion).
- Low competition for stock – FAIL – With 111mm shares outstanding and a market cap of $10billion, larger arbitrage funds can get involved
- At least a 1% actual return and 20% annualized return - PASS. Current spread is greater than 2% and with the tender closing date of 3/2/2018, the return should be far more than 20%. It only remains to be seen how long it actually takes to close.
Rent A Center Inc. ($RCII) Falls to Activist Investors
The situation at Rent A Center is getting interesting. I may have mentioned this activism in a previous episode.
Management had prepared a turnaround plan for the financial performance of the company and presented it to investors in summer of 2017. In that plan, they claimed the company could produce $2.00 in earnings per share by 2018-2019.
What happened in reality is that the companies performance deteriorated even further due to the hurricanes that impacted some of their major markets in Florida, Texas, and even worse, Puerto Rico.
The activist investor that is raking control of the company is Engaged Capital and a number of its funds, with support from other major shareholders. Incidentally, for those of you who follow the company Leucadia National, they are also buying stock in $RCII.
Engaged owns about 16% of the common stock of RCII with an average price of around $9.50. The stock is selling for below that today.
Engaged is going full throttle at the company, submitting a plan to declassify the Board so that Board members will have to be elected each year to remain on the Board.
On February 5th, the RCII board capitulated and entered into a cooperation agreement with Engaged
The way I view this situation, is that the company financial performance was impacted temporarily by weather related damage to its stores. Once the company works through those issues, it should see the performance come back.
To put it into perspective, even if they only earn $1 per share after the turnaround, that would mean it is selling at only nine times earnings, way to cheap for a company with the kind of cash flow that RCII produces.
If they manage to get close to $2 then todays cost is only 4.5x earnings.
With an activist investor effectively influencing the company, good things can happen, such as a sale transaction that would probably never have happened otherwise.
Now, of course, there can be more hurricanes or earthquakes and other problems that could impact the company negatively, but there is always risk in every investment we make.
For now, RCII seems like a cheap turnaround stock, a turnaround being led by profit-seeking major shareholders at Engaged Capital. And, the best part, you can buy in below what Engaged paid for its stock.
Warren Buffett Buys Some Synchrony Financial
One way to take advantage of large investors and their research is to peruse the 13-F forms they have to file on a quarterly basis to disclose any stock positions that represent more than 5% of the outstanding stock of the target company.
I love to look through Buffett's 13-F because sometimes I find something new buried within it.
In the case of Warren Buffett, you get to see what positions he owns in his personal account that he discloses on the 13-F HR for Berkshire Hathaway. You can check out the latest 13-F HR for Berkshire Hathaway by following this link.
Open up the information table which is one of the exhibits and you too can see what Buffett owns. In column 7 of that table, you can see the number 4, and that's a holding that Buffett has in his personal account.
As I said, Buffett now owns more than 17 million shares of Synchrony which is ticker symbol $SYF.
Synchrony was spun off from GE Capital in 2014.
Synchrony Financial offers private label and co-branded Dual Card™ credit cards, promotional financing and installment lending, loyalty programs and FDIC-insured savings products through Synchrony Bank. Amazon, Walmart, TJ Max.
I first read about Synchrony a few years ago and have been keeping an eye on it since then. Buffett started buying it in August 2017 around the same time I started to become interest in it.
Private label credit cards and loyalty programs are very profitable and sticky businesses to be in. It's rare for a company that offers a loyalty program to suddenly switch programs. That would eliminate the benefit to the customer and piss off a bunch of customers.
Synchrony has decent capital management in place, including growing dividends and a stock buyback. All that, and it's selling for a low multiple of expected forward earnings, around 11-12x. This is pretty inexpensive for a safe, stable, diverse company with some reasonable growth ahead.
You can analyze Synchrony like any other bank and look at capital ratios, 16% Tier 1 full Basel, and it's earnings power over time.
As I have mentioned before, banks are great to own during periods of steadily rising Fed rates. Their portfolio of securities throw off more and more cash as yields rise.
Conclusion and Disclosures
Here are three different types of ideas for you to check out. One arbitrage, one activism, and a potential long compounder that Buffett is buying. Let me know what you think about these ideas in the comments below.
Ask JB: How does the 10% correction cash rule work?
This question was posed by listener Stanley about my cash management rule related to 10% corrections.
"So you just mechanically put 10% of your cash IN? You didn't wait to see if the market kept falling or stabilized? If so, why? Because it's your RULE? Thanks.:
Hi Stanley, and thanks for your question. The 10% cash management rule triggers adding the cash to the buying program to be spent over the next few months as part of regular buying. You defintely do NOT dump it all in to the market at once. Buy adding it to your overall pool that is still spend over time, you will probably not have used much at all of it if the market snaps back quickly, like it has so far.
I'm definitely against any cash management rule that requires you to lurch into and out of the market. By spreading it over time, you give yourself the chance to either add more to positions, or not.
Ask JB: Days Sales of Inventory versus Average Age of Inventory
Hi Jeremy, been missing your podcasts for a few weeks!
I've got another question that I would like your help on.
I hold a sizable position in LGIH and I notice their Days Sales of Inventory going down and Average Age of Inventory going up as displayed in a data aggregator.
I thought they were the same thing, essentially Inventory/COGS*365. Could you enlighten me?
Hi Yaokai and sure!
Days Sales of Inventory is how many days of sales would lead to you selling completely through your inventory. Companies do this on a SKU level, individual product level to help them know when they should order, or manufacture, more inventory. A SKU with Days Sales of 60 days and a supply chain lead time of say 70 days will probably run out before it can be replenished. In my work as a turnaround consultant, I would attempt to drive this metric down as far as I could get it. Every dollar sitting around in inventory costs the company money.
On the other hand, the average age of inventory is how long the inventory has been sitting around in the warehouse. Certain types of inventory can spoil, or become obsolete, or rust, disintegrate, whatever and if you see that kind of inventory aging, there is a problem with sell through for that product, and a risk the inventory will be written down on the balance sheet and destroyed, or diverted, or sold for scrap.
The interaction here is that the lower your Days Sales of Inventory, the less the chance of the inventory aging, and vice versa.
Thanks for yet another great question!